Causes of GFC
Introduction
Global Financial Crisis (GFC, 2008-09) was considered to be the worst disaster in economy after the economic depression that took place in 1929. The primary reason for such crisis was the attribution of the deregulation in the financial industry. It also led to the start of many recessions, which resulted in the rise in number of unemployment and the decrease in the prices of houses. The start of the GFC was said to be in 2007, as there was crisis in the liquidity ratio and the confidence was also declining among the US investors in the mortgages that had subprime values. The crisis also became worse, as a result of the high volatility and in September 2008 when there was a collapse in the stock market on a global basis. It also triggered the collapse of housing properties in the US market and decreased the flow of remittance on a global basis in 2008-09 by 6 percent (Ojo 2016). It was seen that the update that was given by International Monetary Fund (IMF) regarding the economies of the developed and the developing countries were encountering financial crisis and was shrinking at a value of 2.2 percent by 2009 (Attig et al. 2016). However, Nepal did not have a direct impact for GFC but faced the impacts in an indirect manner.
Discussion
Possible causes
Saving on a global manner- One of the primary reasons for the increase in the prices of assets was the deficit in current account that was widespread in the US market and saving on a global scale. Most of the countries had a certain current account and deficits in their trade business before the crisis, which led to the increase in their saving methods and borrowing from the foreign countries was stopped, as they become lender to the US market. Most of the countries that were developing were saving up their money instead of putting it in the capital market, which led to huge amounts being saved. Most of the advanced countries were searching for investments, which resulted in increasing the demand of assets in the US regarding the stock market and housing properties.
Housing prices- There was a major decline in the price of houses, which led to the major shocks in the economy and led to the rise in the global financial crisis. During the period of 1996-2006, it was seen that there was an increase in the price of houses, as the rate of interest was low and the new economy had demanding pressures. In between 2006 and 2009 of February, there was a huge decrease in the prices of houses since 1987 (Balakrishnan et al. 2016). This was due to the fact that the lending of the mortgages was targeted towards the rich section, which led to the increase in the burden of debts.
Impact of GFC on Different Countries
Rising rate of interest and subprime lending- The price of housing went on increasing due to the lax standards of lending and the rate of interest, which was related to the saving of the money by the people. Most of the borrowers who were eligible for the loans became the subprime lenders and there was a decrease in the standards due to the lack of credit worthiness among them. It led to the increase in the interest rate, which helped in making the borrowings more costly (Dungey and Gajurel 2014). Moreover, the price of the houses had a severe impact on the rate of mortgage, which increased the rates in the market.
Credit booms- Due to credit expansions, it led to triggering of financial crisis in the market. The credit access increased at a faster rate that led to the boom in the real estate market in countries such as UK, Ireland, Spain and other European countries. The cyclical fluctuations in the economy increased due to the increase in the rate of credit. Housing indebtedness saw an increase after 2000 in the US market, which led to the acceleration of credit growths (Bauer and Thant 2015). The innovation that was financial in nature led to the increase in the financing of mortgages and the rate of interest was also low, which were all the contributing factors towards the increase in the indebtedness of the housing properties.
With respect to the theory of business cycle, there is a chance of the financial crisis to be repeated as well in the market. It can be seen that the possibility for the financial crisis to occur in the global financial system is huge, which would lead to the fall of the economy again and a stage of depression may reach in the future.
Impact of financial crisis on different counties
Effects on the financial sector- The health of the financial sector, performances on macroeconomic level and the foreign capital market exposure will differ from one country to other. The impact of FDI and the flow of capital will influence the economy of countries such as India in an adverse manner. Sri Lanka was affected through a large fiscal and current account deficit with respect to inflow of capital externally, which had seen a rise in the bond of the country as well. Nepal also felt the impact of global financial crisis, as the country was developing from a situation of low growth. There was a decrease in the prices of food and fuel, which indicated that the rate of inflation was high as there was low capital and non-performing loans that contributed heavily towards the financial sector of Nepal (Albertazzi and Bottero 2014).
Actual and Proposed Reforms to Prevent Future Crisis
Remittance impact- The rise of global financial crisis led to the decrease in the remittance flow from the period of 2008-09 by around 6 percent and the countries that did not suffer majorly were those of the Asia Pacific region, which had an impact as low as 2 percent when compared to the countries in Middle East, sub Saharan Africa, Caribbean, Latin America and Central Asia.
It was seen that Nepal did not experience the remittance flow and it declined during the period of 1998 to 2010. The country was the fifth largest recipient of remittances on a global manner with respect to Gross Domestic Product (GDP).
Reserve of foreign exchange- The corporate sector of the emerging and the developing countries were affected due to the financial crisis in a significant manner due to the increase in the problems of funding, which led to the loss in the foreign exchange market. To lower the needs of funds in the market in an overall manner, there was a requirement of curtailing the funds from the foreign exchange activities by merging the economies. The reserves of foreign exchange in the banking system of Nepal during the period of financial crisis had decreased, as there was a decrease in the income of the interest and the inflow from the remittances. The reserves of foreign exchange grew to 17.3 percent that is USD 3.64 billion in the year 2008-09 from USD 3.1 billion that was in the year 2007-08 (Abraham and Rajan 2014).
Macroeconomic balance impact- With respect to the trading of stocks, it led to the worst balances in the macroeconomic sectors within the countries that were present in South Asia. During the time of financial crisis, the prices of the commodities were falling to a great extent and the trends that were present in current account were delay in remittances and the export earnings (Vazquez and Federico 2015). The fall in the prices indicated that the earning from the revenue would also decline.
Import- The continuous downward movement in the prices of the commodities and especially in the price of food and fuel was one of the main features with respect to the import of the product. There was a further decrease in the prices of the commodities, which was caused for the recession in the OECD countries and the countries that were present in South Asia.
Impact of GFC on housing industry
Investment- The effect of non-performing assets that were increasing in the national banks and the delay in the process of foreign funding were the major risks, which affected the growth of the investment. This resulted in lower profits for most of the companies that were indulging in exporting products. The investment had decreased due to the availability of the local financing led to the delay in the local rate of investment, which further delayed the earnings from the export as well (Boychuk et al. 2012).
Impact of GFC on share market
The global crisis that happened in US in 2009 was due to the subprime mortgages, which led to the collapse in liquidity and further collapsed the stock market as well. It can be stated that most of the countries in the world were part of the crash that happened in the stock market and the shock from the US stock market led to the increase in volatility in the Australian and the New Zealand stock market as well. The stock markets that were present in Japan, Germany and the US were treated as a high volatility pattern of transmission. The stock markets of these countries were influenced by the start of the global crisis, which led to the push in the cost of borrowing and loss in confidence of the investors, which affected the investment market in the world (Benetrix et al. 2015).
The financial sector that was present in countries like Nepal is not related closely to the global financial system, which did not create any harmful impact on their economy in the first glance. The investment and the share market of Nepal has no link in a direct manner with the market of global investment, as there were repercussion in falling exports, decline in tourism and the burden if the additional debt servicing, which led to a trade deficit in the country. The availability of funds in the banks of Nepal is more with respect to the funds that will be required by the nation, which made an indirect impact on the financial crisis by decreasing the demand on an aggregate manner (Cayon et al. 2017).
Reforms in reducing the financial crisis
Capital planning and stress testing- The banks need to have a planned capital and stress testing, which will help in designing the analysis of the capital in a comprehensive manner so that the capacity to lend capital can be assessed in a proper manner. Stress testing is a regulatory system, which helps in conducting the test based on the framework of dynamic capital (Obstfeld 2015).
Heightened capital regulations- The capital requirement that are based on risks for the banks needs to be heightened , which will help in increasing the common equity with respect to the risk-weighted assets (Haas and Lelyveld 2014). The banks need to have a higher standard of capital and the risks should be based on the regulations that are concerned with capital.
Formation of tool and failure of financial firms- The new revolution needs to be created for the large and complex financial banks (Kemp 2015). It needs to consist of a single entry point, authority for liquidation and the capacity to absorb the total loss so that it can help the holders of long-term debts and not the taxpayers.
Conclusion
Therefore it can be concluded that GFC creates an impact on all countries and the reference has been given of Nepal, as it creates an impact on the flow of remittance and the prices of commodities. The financial system of Nepal was not impacted due to the financial crisis and there was a decreasing impact of the rate of growth due to the decrease in the manufactured product in the country as well. Moreover, the stock market of the other countries had crashed, which has limited the growth of the market as well.
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