Finance Banking

Global Banking Crises

Published at 07/14/2011 22:16:33

 The Global Banking Crisis, more commonly known as ‘The Great Recession’ commenced in 2007 and displayed a sharp downturn till 2008. It is characterized by irresponsible lending by financial institutions, credit risk-shifting more popularly referred to as securitization in the mortgage sector and reduction in the provision of loans commonly called credit-crunch. Increasing oil and food prices and rapid bankruptcies proved to be nails in the global economic coffin. This ultimately gave rise to drops in trade and amplified unemployment. The exact definition of the Global Banking Crisis has been a pendulum of fluctuation. But the ruthless instance of financial collapse and economic failure can best be understood by the predictable trends of the Business Cycle. It can be further emphasized upon by comprehending its causes, consequences and most importantly the defense mechanisms to be employed against it.

 The primary cause of this event would be the underestimation of the risks involved while borrowing capital. Borrowing is only favorable when asset prices are on the rise. However, the preceding smooth-flow of the economy led to major miscalculation on investors’ part. When asset prices unexpectedly fell, relatively greater interest rates charged by financial institutions created further indebtedness for the customer and so the profit pendulum swung towards the banking elite. In short, the rich got richer and the poor got poorer. When interests exceed taxation, the government is left with a minimal budget for public services like education and infrastructure. This results in a poor standard of living, unavailability of facilitation and hence rising prices. So in summation, as output falls, prices increase and employment decreases to cope up with inefficiency.

 So what really happened was the relaxation of the lending standards and increased fraud and default. When the drawbacks of such securitization were revealed, investment funds fled to liquidation that is hoarding money. Funding became hard for investors and monetary collapses and bankruptcies were initiated like dominoes. There was neither any spending nor any lending and risk aversion therefore increased rapidly. Trade contracted while prices expanded. Fiscal and monetary reforms were the only things that could come to the rescue of a world struck down. The Lehman failure seemed to be the last straw, following which, the insertion of capital into banks and greater credit management were adopted as remedies. The market’s relationship to the financial institution has to be strengthened but with efficacy and care.

Tips and comments:

 Direct purchase of assets by the government proved to be one cure. In this way assets were made accessible to investors without the involvement of the bank, hence ruling out the leverage exercised by the banking elite. The lessons were unavoidable but simple. Credit provision must be regulated and default must be prevented by collateralization instead of securitization. For this, economic accountability has to be made rock-solid. With firm credit conditions and heavily monitored financing, the monetary and fiscal policy can be balanced while being kept independently functional. Governments have to cover the recession’s track by helping financial institutions and markets by actual liquidation instead of loaning; in this way all economic activities can be lawfully conducted and that too with the minimum amount of risk. It is safe to say that the world is recovering from the havoc wreaked by the Recession of the recent years; however, it is essential to note that Business Cycle upheavals are an inescapable whirlwind, the absolute control over these upheavals is a matter of questions, the answers to which change with perhaps every generation. Here’s to hoping, that such events are few, well-spaced and easily combatable.