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Probable reasons of financial crisis

Discuss about the Poverty and sustainable development in Asia.

The Global Financial Crisis (GFC, 2008-2009) is referred to as the worst economic disaster after the economic depression of 1929. The main cause behind the occurrence of such situation is the deregulation of the financial industry. GFC is seen to lead the evolvement process of the great depression that resulted in emergence of immense unemployment and huge reduction in the prices of real estate. The eruption of GFC is considered to be take place in the year of 2007 because of liquidity crisis due to the collapse of the confidence of the investors of United States regarding the value of subprime mortgages. The financial crisis became worse because of the crash of global stock market and due to high volatility of stock market in the year of 2008. GFC got initiated because of the fall of the prices of real estates and that led the fall of remittance flow worldwide from the year of 2008 to 2009 by 6% (Ojo 2016). It is seen that due to the update of International Monetary Fund) IMF, outlook economies of the developed and the developing nations were surrounded by crisis in financial sector and that lowered the global output level at 2.2 % in the year of 2009 (Attig et al. 2016). Nepal is seen to have not been affected by GFc but there is presence of some indirect impact of GFC. 

In this section of this report some of the probable causes behind GFC are mentioned:

One of the most definite reasons behind the rise in prices of the asset was current account deficit existing in United States and global saving glut. The countries that have reservedcurrent account and deficit in trades before GFC; the increase in foreign borrowing and savings were lowered in spite of becoming lender to United States. The countries that are developing were not buying and saving barge into the global capital market and this reversal led to generate global saving glut. The developed nation’s capital market were in search for the increased demands and investments that resulted in emerging prices of net assets in United States that includes real estate and stock market.

The decline in the pricing of the houses was a chief shock in economic sector that led to the global financial crisis. During the time span of 1996 to 2000, increase in the price of housing was seen because of the lower interest rates and demand pressures of the new economy. Among the middle of 2006 and 2009, the prices of the housing sector initiated decreasing and made it the biggest decline in the prices of housing sector since the year of 1987 (Balakrishnan et al. 2016). This sudden decline occurred due to the fact that mortgage lending was chiefly directed to the rich population and those were not saddle saddled to the debt burdens of huge mortgage which got increased. 

Global saving glut

The prices of the housing got further increased by the increasing tax standards of lending and the low rate of interest is related to the saving glut. The borrowers who took loans were in most cases subprime lenders and the regular standards could not be satisfied because of their lower credit worthiness. Increase of Fed rate of interest which helped to soften and made the borrowing even more costly (Dungry and Gajurel 2014). Apart from that the price of the housing estates majorly affected because of the mortgage rates that moved from lower to higher rate of market.

The vital role played by rapid credit expansion to enhance the financial crisis. The credit access developed at an immense pace that enhanced the boom in the market of real estate in the nations like United Kingdom, Spain, Ireland and some other countries under European Union. Immense cyclical fluctuations were seen within the economy because of the coinciding growth in credit. The indebtedness of Housing grew in United States after the year of 2000 though the increased credit growth was not debated and that explained the lower growth rate of credit (Bauer and Thant 2015). Increased mortgage financing, low interest rates and financial innovation all were potential contributing factors behind the expansion of indebtednessof the housing sector.

According to the business cycle theory, there is a probability of repetition of the crisis globally and it has been established that there are scope of further financial crisis because the global financial system is currently in the stage of expansion that can enhance the chances of the economy to fall and it can reach the phase of economic depression. 

The macroeconomic performances, health of the financial sector and the exposure to the capital markets of the foreign countries differ from one nation to another. The negative effect of direct investments of the foreign countries and the flows of capital negatively affects the economic conditions of nations like India. The largest fiscal and current account deficit has adversely affected the country of Sri Lanka regarding the lower inflow of capital from the foreign countries and there was an increase in the spread of bond in the country. The negative impacts of the global financial crisis were obvious on the country like Nepal too. The eonomy of Nepal is growing from lower growth situation. The drops in the prices of international fuel and food, negative effects of inflation, non-performing loans and low capital adequacy are the contributing factors of the weak economy of Nepal.

Prices of housing

Global financial crisis led to the decrease in the flow of remittance from the year of 2008 to 2009 by 6% and the nations which were least hit by the negative effects of GFC are the Asia pacific region at 2% in relation to the drop in Latin America, Central Asia, Sub Saharan Africa, North Asia and Caribbean islands along with Middle East.

Nevertheless, Nepal’s case was unusual and it did not notice any flow of remittance. Remittance flow to Nepal never got decreased between the years of 1998 to 2010. It was clearly the fifth largest recipient of remittance in relation to the global share of GDP.

The corporate sector of emerging and developing economies was majorly affected by financial crisis due to increased funding issues and the loss of foreign exchange. For reducing the general requirement of funding of a marketer, it is necessary to lower the activities regarding funding of foreign exchange of merging economies. The foreign exchange reserves of the banking system of Nepal at the time   of financial crisis slowed down because of the slowing down of the revenues from the interest and the inflow from remittance. The growth and development of the foreign exchange reserves in relation to 17.7% to 3.72 million US dollars in the year of 2008-09 and 22% to 3.03% billion US dollars in the year of 2007-08 (Abraham and Rajan 2014).

The trade stocks potentially enhanced the worsening process of the balance in the macroeconomic sector of the countries of South Asia region during after the time of GFC and when the prices of the commodity were decreasing. The current account seems to be hurt by the decrease of inflow from remittance and the revenues from the exports (Vazquez and Federico 2015). Because of the decreasing prices, there is a possibility that the earnings from the revenues will also get negatively affected.

The decreasing trend of the prices of the commodity especially in relation to food and fuel is surely one of the redeeming aspects of import. More reduction in the prices of commodities may cause because of the recession in all the OECD countries and the nations in South Asia region will get positive effects of that.

From all the real economy implications, the negative effect of the GFC is significant and direct. GFC produced a major disruption in the housing sector. Those issues are mentioned in this section. The joint effect of enhanced non-performing assets in the banks of the domestic areas and the reduction in the foreign financial aid are the main matter of concern nowadays. This will definitely owe low profiles for the business organizations which are generating products to export. The availability of local financing for getting investments got decreased and there was a sudden slowdown in the rate of domestic investment. The investment and growth in the countries of South Asia got decreased because of the slowdown of capital from foreign and the revenues from export (Boychuk et al. 2012).

Bubble burst of housing price

GFC brought in higher degrees of volatility in the stock market and transmition of volatility ranges from one particular financial market to another market in accordance with the arising stock severity and in terms of the magnitude. Crisis in United States in the year of 2009 resulted from the collapse of subprime mortgage market that steered the liquidity crisis which aggravated the collapse of the stock market.  It is seen that many nations got deeply affected by the crash of stock market and during the time of GFC, the shock that emerged from the market of United States;enhanced the volatility of the stock markets of New Zealand and Australia. The stock markets of Japan, US and Germany were marked because of the volatility transmission pattern. These countries’ stock markets were majorly influenced by the starting phase of GFC. The stock market’s volatility increases the borrowing cost that can result in loss of confidence of the potential investors and it also can affect the investment market in some specified countries (Bénétrix et al. 2015).

Nepal’s financial sector is not at all related to the global system of finance and thus they did not receive any negative impact of the financial crisis initially. The investment and share market of Nepal is not directly associated with the global market of investment and it has three rounds of repercussions in relation to the decreasing exports, additional debt servicing burden, declining tourism and loss of foreign assistance. These reasons negatively impacted the trade deficit of the nation. It is seen that the probability of getting victimized by them is higher degree of integration. The available funds in the Nepalese banks are more than it is required by the country and the vulnerability of such reserves was attributed to the indirect effects if GFC, like decreasing consumer spending and decreasing aggregate demand. (Cayon et al. 2017).

The nations and the financial system must sustain some principles to avoid the occurrence of GFC. The probability of the decline of the effects of such GFC might be done by taking up some necessary measures and those are mentioned below.

The bigger banks must have a capital planning and stress testing by looking at the future. The Federal reserve has somehow designed a yearly comprehensive capital analysis and by reviewing that they help to assess the lending capacity of the bigger banks at the time of the economic downturn to continue to lend to the business organizations sand household. It is seen that Stress testing is a regulatory regime and by conducting this test, it can help to make a futuristic and dynamic framework based on risks (Obstfeld 2015). These will surely help to create a transparent capital market in various nations. 

Increasing rate of interest and subprime lending

The capital requirements of the banks that are risk based must be heightened and they must have more equity regarding the risk-weighted assets (Haas and Lelyveld 2014). There must be higher capital standards must be based on the risks as they will be needing to have more equity capital against the assets which are riskiest.

Tools formation to facilitate reorganization and failure of complex financial firms

A specialized revolution must be created for the larger financial banks (Kemp 2015). Some regime like orderly liquidation authority, single point of entry and total loss absorbing capacity would definitely make sure that the losses are linked with the failures should borne not by the tax payers but by the holders of long term debts.

These amendments are seen to be significant steps and this takes place because of two reasons. The issues related ‘too big to fail’ shall be addressed by the implementation of such amendments and the guarantees to benefit the financial organization’s pre crisis will be decreased. It is likely that the bigger financial organizations will undergo and orderly fail got enhanced; this will definitely make the economy less vulnerable in front of the crisis (Claessens and van Horen 2015).

Conclusion

This report dealt with the reasons behind and the effects of the GFC on various countries throughout the world with special emphasis on Nepal. It is seen that GFC had affected in second and third round in relation to the flow of remittance, foreign exchange reserves, tourism and the prices of commodity. GFC made a negative impact on the Nepal’s economy that is related to the  non-investment in the productive sectors and unemployment. Nepal’s financial system did not experience any direct effect of GFC and a downward effect of the growth rate of the nation was seen because of the failing to supply the demand of manufactured products of Nepal. The nation’s service industry got also affected by the recession and a global slowdown. In addition to that, it can be said that various country’s stock markets collapsed and that limited the stock market’s growth. From the discussion above, it can be concluded that GFC affected many country’s financial sector and affected numerous medium and small organizations. the nations with high income and the developing nations seen a trauma of GFC in relation to the reduced use of long-term debt and the financial leverage of the business organizations. Thus it is important for the large corporations and the banks to take up above mentioned reforms that can potentially help them to decrease the chances of such occurrences. 

References list:

Abraham, V. and Rajan, S.I., 2014. Global Financial Crisis and Return of South Asian Gulf Migrants. India Migration Report 2012: Global Financial Crisis, Migration and Remittances, p.197.

Albertazzi, U. and Bottero, M., 2014. Foreign bank lending: evidence from the global financial crisis. Journal of International Economics, 92, pp.S22-S35

Attig, N., Boubakri, N., El Ghoul, S. and Guedhami, O., 2016. The global financial crisis, family control, and dividend policy. Financial Management, 45(2), pp.291-313.

Balakrishnan, K., Watts, R. and Zuo, L., 2016. The effect of accounting conservatism on corporate investment during the global financial crisis. Journal of Business Finance & Accounting, 43(5-6), pp.513-542.

Bauer, A. and Thant, M. eds., 2015. Poverty and sustainable development in Asia: Impacts and responses to the global economic crisis. Asian Development Bank.

Bénétrix, A., Lane, P.R. and Shambaugh, J.C., 2015. DP10325 International Currency Exposures, Valuation Effects and the Global Financial Crisis.

Boychuk, G.W., Mahon, R. and McBride, S. eds., 2015. After'08: Social Policy and the Global Financial Crisis. UBC Press.

Cayon, E., Thorp, S. and Wu, E., 2017. Immunity and infection: Emerging and developed market sovereign spreads over the Global Financial Crisis. Emerging Markets Review.

Claessens, S. and Van Horen, N., 2015. The impact of the global financial crisis on banking globalization. IMF Economic Review, 63(4), pp.868-918.

Dungey, M. and Gajurel, D., 2014. Equity market contagion during the global financial crisis: Evidence from the world's eight largest economies. Economic Systems, 38(2), pp.161-177.

Haas, R. and Lelyveld, I., 2014. Multinational banks and the global financial crisis: Weathering the perfect storm?. Journal of Money, Credit and Banking, 46(s1), pp.333-364.

IMF. (2016). IMF’s Response to the Global Economic Crisis. [online] Available at: https://www.imf.org/en/About/Factsheets/Sheets/2016/07/27/15/19/Response-to-the-Global-Economic-Crisis [Accessed 18 Jan. 2018].

Kemp, P.A., 2015. Private renting after the global financial crisis. Housing Studies, 30(4), pp.601-620.

Lib.icimod.org. (2018). [online] Available at: https://lib.icimod.org/record/26979/files/c_attachment_767_6007.pdf [Accessed 18 Jan. 2018].

Obstfeld, M., 2015. after the Global Financial Crisis. POLICY CHALLENGES IN A DIVERGING GLOBAL ECONOMY, p.383

Ojo, A.O., 2016. Corporate governance and risk management in the financial industry: changes after the global financial crisis.

Vazquez, F. and Federico, P., 2015. Bank funding structures and risk: Evidence from the global financial crisis. Journal of banking & finance, 61, pp.1-14.

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