Comprehensive Notes on Financial Crisis

1. Financial crisis refers to disruption in financial markets – stock markets, crashes, bond markets collapse – resulting to credit flows constraints and contractions adversely affecting the smooth operations and growth of real economy.

2. In mid-2007, sub-prime mortgage markets suffered heavy losses resulting into creating disturbances throughout the global financial system.

3. It was anticipated when rapidly rising trend of economic prices stopped suddenly in 2006.

4. Since July 2007, a wide range of financial institutions were adversely affected even though, many of them had no direct exposure to the sub-prime mortgage market in the US.

5. Hedge funds, credit swap, money market funds, bond insurers, consumer lenders, issuers of commercial papers and securitization of loans, jumbo mortgage, small European banks and government investment funds among many others come into the financial troubles.

6. Regulators and the government failed to stabilize financial market condition world over.

7. The root of the problem was seen by some in valuation risk involved in allied matters, such as:

i. The use of complex financial instruments.

ii. Risky financial speculation accounts moved off the books, thus, and no transparency of deals.

iii. The borrowed funds are used to show capital based and potential profitability by the financial institutions.

iv. Structural Investment Vehicles (SIVs) cash flows where managed through buying a long-term debts assets – e.g., mortgage backed bonds-interest incomes. These assets were purchased by issuing short-term debt, such as commercial papers.

v. The liquidity crunch faced by the SIVs because they failed to sell the commercial papers to support their assets 2007 onwards.

vi. There was underestimation of the financial risks by the SIVs.

vii. The US authorities recognised deteriorating: financial markets in 2007 as the major threat to the economy.

viii. The US government purposed to provide new capital to financial institutions.

ix. The Fed extended credit to Bear Stearns – a large investment bank to avoid its collapse in March 2008.

x. Asymmetry of information and over speculation in the markets relate to the genesis of the financial crisis. Grid and speculation are enrooted to the current global financial crisis.

xi. When the speculator failed, the cost is widely spread throughout the financial system.

xii. A stricter financial supervision and moderation is required in the course of the future direction.

8. The global financial crisis of2008 has provoked the world leaders to radically reform the architecture of the global finance and the structure of the governance.

9. The IMF, the World Bank and even the WTO have no enough power and teeth to deal with global financial crisis. There is a need for reforms in their structure and working with a new mode of economic governance based on the rules, regulation and restrictions.

10. In the global economic and financial system, neo-liberalism and the Keynesian logic of deficit financing under the unrestrained market system lead to global financial crisis. That means neo-liberal globalization has failed. Some feels capitalism has failed so that, socialism should come back. Keynes’s ideology of managed and regulated capitalism rather than free market norms need to be reasserted if the revival of socialist thinking is to be encountered.

11. An acute phase of global financial crisis began with the bankruptcy of Lehman Brothers on 14 September, 2008.

12. The US economy and the UK economy have entered into the recession phase which is projected to last at least for 3-4 quarters.

13. Assets- liability mismatch, regulatory failures, fraud, greed, lack of transparency, contagion – financial crisis spreading from one institution to another-among other factors are the major causes pertaining recent global financial crisis.

14. Financial fragility in the characteristic feature of capitalism.

15. Those responsible for the financial crisis have been bailed out by the governments. European nation’s government have increased or fully granted depositor’s savings. The burden is thrown on the tax payers.

16. In 2009, the world may witness rising of China as super economic power and the declining US super economic power.

17. The US Bank: Federal Reserve Bank cut down lending rates from 6% in 2000 to 1% in 2003-2004.

18. In two years raised from 1% in 2004 to 4.75% in 2005-2006 measuring a 500% rise. The US government proposed to inject USD700 billion to increase market liquidity. These are virtually no simple financial model containing cause and effect analysis, such as:

i. Homeowners with adjustable rate mortgage will not be able to make payment

ii. Housing prices will collapse dramatically

iii. Home-owner will default on loan repayment

iv. Banks will suffer losses

v. Lending will stop

vi. Bank will collapse

vii. Wall Street will exit

viii. Panic

19. Even process technology mat not be very useful in solving the core problem of the recent globa) financial crisis.

20. The financial turmoil in the global market of advanced countries began around mid 2007.

21. The recent financial crisis implied the collapse of major global financial institutions adversely affecting the real economies of the advance nations.

22. India has shown some resilience.

23. India’s current account (receipt and payment) amounting to over 50% of GDP in 2007- 2008.

24. India’s current account has been opened up fully.

25. The capital account and financial sector is not fully opened.

26. India put some regulation on and moderating of debt flows occurring in the form of external commercial borrowings.

27. Indian financial sector, bank in particular is subject to prudential regulations about capital as well as liquidity.

28. The RBI keep a watch on the incremental credit deposit ratio of banks.

29. The Asset Liability Management (ALM) guidelines have been provided to deal with asset- liability mismatches.

30. The norms of capital are adequacy ratios and prudential limits are now met by the Non- Bank Financial Companies (NBFC) as well.

31. In short, the Indian approach towards opening the domestic financial and external sector has been gradual, phased and calibrated.

32. India has made an ample forex reserves that can enable the country to survive against global turbulent.

33. There have been increasing trend in FDI inflows. While, portfolio investment outflows are decreasing.

34. The Indian equity markets has been adversely affected by the global financial crisis. The sensex dropped to 11,326 in October 2008 from the peak of 20,873 in January, 2008.

35. India’s software industry has an adverse impact.

36. India has also experienced a pressure on the exchange rate.

37. Indian banks have no direct exposure to the sub-prime in the market in the US.

38. The RBF uses its monetary policy for active demand management of liquidity.

Globalisation of Financial Markets: International Finance Hub

39. The emerging market economies (EMEs) have exhibited some relative resilience against the financial turmoil’s.

40. Asian banking sector comprises relatively smaller percentage of foreign banks.

41. Foreign remittances to the EMEs may slow down.

42. Commodity prices may go out.

43. Demand for commodities would rise as a source of hedging against depreciating US dollar and higher inflation.

44. Global growth rate, trade flows, investment flows declined.

45. The volatility in the financial markets occurs due to the deepening and widening of the global financial crisis.

46. Financial stability in India is attributed to:

i. Prudential banking and finance policies

ii. Preventing exercise risks taking

iii. Preventing financial market from extremities and turbulence.

Britain has urged China and substantial oil-rich Golf countries preferring to substantial reserves to contribute to the new IMF fund which is meant to help the LDCs threatened by contagion from the recent global financial crisis. The British Prime Minister Gorden Brown felt that the IMF’s current 250-billion-dollars bail-out fund is insufficient and needs more resources.

Indian industrial and IT sector has decided to cut down nearly 25% work force owing to the ongoing financial crisis. India is already wading through double digit inflation over 10% phenomenon.