Define the terms financial sector and real sector. Describe the processes by which a number of banks becoming insolvent (or approaching insolvency) can have an adverse impact on the real sector

Answer 1

The financial sector consists of commercial banks, investment banks, brokerage firms, and other similar entities. The real sector consists of firms that produce goods and services, individuals who buy goods and services, and individuals who work for firms, among others. When a bank is insolvent it will cease to make new loans, reducing the amount of lending in the economy. A bank approaching insolvency will be inclined to cut back on its lending activities. With less lending in the economy, there is less economic activity such as buying and producing. As production levels fall throughout the economy, some firms will slow down production and other firms will go out of business. This results in lay-offs and an increase in the number of people who are unemployed.