Research Paper (undergraduate), 2009
22 Pages, Grade: 3
1.1 Background of the Current Financial Crisis on Banking Sector
1.2 Impact of the Current Financial Crisis on Banking Sector
1.3 Impact of Banking Crisis on Industries
2 Financial Stability after Financial Crisis
2.1 Role of Central Banks in stability of Banking Sector
2.2 Approaches to stabilize the Banking Sector
2.3 Approaches to stabilize the Banking Sector with Bail out Packages
2.4 Importance of Risk Management
3 Future o/Banking Sector
Figure 1.-U.S. and European Sank and Insurance Company Market Capitalization, Writedowns, and Capital Infusions (In billions of U.S. dollars, and of period)
Figure 2: Non-Borrowed reserves of Depository Institutions
Figure 3: Developed Europe: Bank Losses
Figure 4: World Industrial Production and world trade in goods
Banks are thought to be central to business activity. But the banking sector faces some time severe crisis due to decline in credit and growth. The after effects of banking crisis are very dangerous. Therefore, when they experience financial distress or financial crisis, governments usually come to the rescue, offering emergency liquidity in the form of bailout programs.
The main purpose of this research topic is to get overview of current Banking crisis and their effects on global Banking and other Sectors. There are some questions regarding the financial crisis like What are the roles of Central Banks and governments in making strategies to stabilize the Banking, a major sector of the economy? What are the new rules and regulations have been introduced or proposed to stop the next Banking disturbance? and we will try to find their answers in this research work.
In 1st part we give some background of the current Financial Crisis in banking sector and especially the impact of current financial crisis on Banking Sector in main regions of the world. In the end of 1st part we will see also the impact of Banking Crisis on different industries.
In 2nd Part, we will see the roles and approaches of Central banks and governments for stabilizing the Banking Sector. What are the benefits and importance of bailout packages and Risk Management in financial institutions?
In 3rd and final part, we will analyze what the future of Banking Sector? in the light of different proposals and suggestions of analysts and economists.
We all know very well that mortgage market has experienced a real boom in the United States during the last few years due to extremely attractive mortgage loan terms. But this boom end with start of severe financial crises. There was lot of hidden risks and mistakes in the mortgage market boom. Banking sector are vulnerable to many forms of risk which have triggered occasional systemic crises. These include liquidity risk, credit risk, and interest rate risk. Banking crises have developed many times throughout history, when one or more risks have materialized for a Banking Sector as a whole. The main reason on which all agreed upon it, was high leverage ratio combined with increased maturity mismatch that led to a weak situation. To be more particular, leverage can cause a risk-shifting problem resulting in excessive risk-taking. Hence lenders, who look forward to excessive risk taking, and cut back their funding. The lack of new funding is however no problem if existing funds are secured with long-term debt contracts, since no new funds need to be raised in the interim. New funds are needed only when debt matures earlier than the assets pay off, i.e., if there is a maturity mismatch.
According to Dr Alexander Dibelius, head of the Investment Banking Division at Goldman Sachs “The roots of the problem are to be found in the systematic failure to measure and price risk properly over the years that affected virtually all riskier asset classes in the financial markets.”
According to IMF Report April 2009, the impact of Financial Crisis on Banking Sector is very deep and since the start of the crisis, market capitalization of global banks has fallen by more than half from $3.6 trillion to $1.6 trillion, while the value of preferred shares and subordinated debt has also fallen sharply, underscoring concerns about the size and quality of capital cushions (See following Figure).
Figure 1: U.S. and European Bank and Insurance Company Market Capitalization, Writedowns, and Capital Infusions (In billions of U.S. dollars, and of period)
Figure 1.28. U.S. and European Bank and Insurance Company Market Capitalization. Writedowns, and Capital Infusions
illustration not visible in this excerpt
In the following subsections provides an overview of distressed banks in different regions:
After the initial indication of Liquidity crisis in August, 2007, the U.S. banking sector got a red alert signals in which banks one by one fell down (including closed, M & A, nationalized etc.).
The Northern Rock was the first bank who seeks and received a liquidity support facility from the Bank of England afterwards in January 2008 and become nationalized. The bank was UK based but left the effects to other financial institutions, specially the collapse of Bear Stearns.
The other shocking news was the takeover of Fannie Mae and Freddie Mac by Federal and subsequently the declining process moved very fast and there was big shock in September when Lehman Brothers Holding filed for bankruptcy protection. Lehman Brothers failure was arising mainly from its overexposure to troubled asset classes - in particular, mortgage- backed securities and commercial real estate.
In other major events include the acquisition of Merrill Lynch by Bank of America Corporation and partial nationalization of Fortis holding and lot of undeclared large losses in financial markets world wide throughout September and October. There are 58 small regional banks which have failed since January 25, 2008.
We can easily analyze the true situation of US banking sector through the following chart in which the non-borrowed reserves shows sudden negative trend for the first time since these statistics have been kept. It means that US banking sector have not enough reserves even for own stability and operations?
Figure 2: Non-Borrowed Reserves of Depository Institutions
illustration not visible in this excerpt
On the other hand the U.S. government says the largest U.S. banks are strong enough to survive the recession, even if it gets worse. Federal Reserve Chairman Ben Bernanke said. “Nearly all the banks that were evaluated have enough ... capital to absorb the higher losses envisioned under the hypothetical adverse scenario.”
The same crisis situation also appeared in UK banking sector and first target was the Northern Rock medium sized British based bank, when it looked for and received a liquidity support facility from the Bank of England and later on Nationalized. In other U.K. based failed banks are HSBC Holding PCL, Royal Bank of Scotland, Barclays Plc, HBOS Plc, Lloyds TSB Group Plc, Alliance & Leicester.
In the initial stage of crisis UK based banks also showed that they have adequate capital to absorb potential losses but after September 2008 major banks declared their losses one by one because there was sudden increase in the number of borrowers defaulting on loans due to decreased in commercial and residential property prices. Then Banks asked for help from government to stop the further losses on lending. The Government has taken steps to improve banks’ capital positions. It injected capital to some banks in the shape of bailout packages.
According to Bank’s Credit Conditions Survey in April reported an intention to increase the availability of corporate and secured household credit over the following three months.
Government actions should provide some support to lending over the coming year. In return for access to the APS, Royal Bank of Scotland and Lloyds Banking Group each made lending commitments. And Northern Rock has been directed by the Government no longer actively to reduce its mortgage book. Separately, Barclays and HSBC have announced an intention to expand their net lending to businesses and households modestly over the coming year.
In Europe the situation was not different from U.S. & UK since the start of Global Financial Crisis because all major European countries are integrated with U.S. in business line like Major Swiss bank UBS was involved in the U.S. asset backed securities (sub-prime exposures) balance sheet. The consequences of U.S. were automatically diverted to European Economies. The all European banks by country which was affected from crisis are as fallow:
Italy (1 bank): Unicredit SPA, Netherlands (3 banks): ING Group N.V., Rabobank, ABN AMRO Holding N.V., France (4 banks): Credit Agricole S.A., Societe Generale, Natixis, BNP Paribas, Groupe Caisse d'Epargne, Belgium (2 banks): Fortis, Dexia S.A.; Switzerland (2 banks): UBS AG, Credit Suisse Group; Germany (11 banks): IKB Deutsche Industriebank AG, Deutsche Bank AG, Bayerische Landesbank, Landesbank Baden, WestLB AG,
Dresdner Bank AG, HSH Nordbank AG, DZ Bank AG, Landesbank Sachsen, Commerzbank AG, and Hypo Real Estate Holding AG.
As showed in the following figure, that all major European countries especially UK,
Germany, Switzerland and France cruelly effected from the current financial crisis.
Figure 3: Developed Europe: Bank Losses
In Germany, of the total loss (US$56 billion as of Q2 2008), losses absorbed by the Landesbanken and IKB amounted to US$36.2 billion, against US$19.8 billion for other German institutions.
The Current Global Crisis is not so much affected the Asian Economies specially EMEs because of Credit policy reforms, better structuring of banking sector debt and improved fiscal positions have also played their role making the EMEs resilient from the crisis. In addition, large foreign exchange reserves, particularly in Asia, also provide a degree of protection against possible sudden stops. Another factor that could be of relevance for this favorable situation is the relatively smaller presence of foreign banks in the Asian banking sector. This is evident from the fact that the share of banking assets held by foreign banks in these economies generally lies between 0 and 10 percent (Global Development Finance, 2008). Even China which is big emerging market for the whole world and almost all MNE are doing businesses there but still Chinese banking industry is not deeply integrated with the global financial market, and therefore it has had limited direct exposure to the subprime crisis.
In the UAE’s financial sector, including both national and international players, they have been profitable in the past and now they have huge reserves for in existence in the market and capable to absorb the losses if any. UAE banks are relatively less dependent on external financial markets. National banks and branches of foreign banks operating in the UAE are constructed on safe and sound foundations.
The banking crisis effected almost all sector of the economy especially production sectors. Their effects on the other areas, for example; rising unemployment or cut down the working hours, Consumer spending has fallen, reflecting heightened uncertainty, tight credit conditions and lower financial wealth. Business and dwellings investment have also declined, and near-term indicators point to further falls. The slowdown in activity has been significantly amplified by companies running down stocks.
In addition to the downturn in demand for highly traded manufactured goods especially autos industry, and the falls in trade flows resulting from the disruption of globalised supply chains, a reduction in the supply of credit used to facilitate international trade may also have exacerbated the decline in trade flows. One more factor underlying the collapse in world trade flows is that, during the current downturn, the more trade-intensive elements of demand have been most affected. For example, demand for items such as capital goods, motor vehicles and other consumer durables appears to have fallen
 Dr Alexander Dibelius, http://www.die-bank.de/service/internet-translation-service/facts-background-prospects
 IMF Global Financial Stability Report April 2009
 FT reporters “Lehman Brothers files for bankruptcy” Published: September 15 2008 06:04)
 Fletcher, Michael A. (February 18, 2009), "Obama Leaves D.C. to Sign Stimulus Bill", the Washington Post (Denver): A05, http://www.washingtonpost.com/wp-dyn/content/article/2009/02/17/AR2009021700221 .html, retrieved on2009-03-08
 Anthony_Cherniawski Stock-Markets / Financial Markets May 24, 2008 , http://www.marketoracle.co.uk/Article4821 .html
 Phillip Kurata, U.S. Banking System Well Positioned to Weather Recession Financial markets respond positively to bank “stress test” report, http://www.america.gov/st/business-english/2009/May/20090508151724
 HM Treasury, Bank of England and Financial Services Authority (September 14, 2007). "News Release: Liquidity Support Facility for Northern Rock plc". http://www.bankofengland.co.uk/publications/news/2007/090.htm.
 BBC News. 2008-02-17, “Northern Rock to be nationalised". http://news.bbc.co.uk/1/hi/business/7249575.stm.
 The Bank of England, Inflation Report May 2009
 Erlend Walter Nier, Financial Stability Frameworks and the Role of Central Banks: Lessons from the Crisis, WP /09/70
 Rakesh Mohan, Deputy Governor Reserve Bank of India, Global Financial Crisis and Key Risks: Impact on India and Asia October 9, 2008
 Peter Liu, 25/11/2008, “The Financial Crisis and China's Banking Industry”
 Dubai Chronicle, “The aftershock impact of the financial crisis on manufacturing, financial and real estate sectors” http://www.dubaichronicle.com/news/analysis/the-aftershock-impactof-the-financial-crisis-on-manufacturing-financial-and-real-estate- sectors-2457
 For a more detailed discussion of trade credit, see the box on page 15 of the February 2009 Report
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