To understand the main causes of global financial crisis of this decade we need to first understand few characteristics of Globalization mentioned below – To economically boost international trade, capital flows and global financial systems. To increase the number of multi-national corporations to increase global economy. To rapidly foster technological development and to boost outsourcing activities. To ease communications and lead access to Trans border data. (Web 1) There were many causes for the current Global financial Crisis.
The credit crunch or the financial crisis started when the US government started lending loans at cheaper interest rates to people like sub-prime brokers who usually are not eligible to get loans. The loans in-turn were securitized or converted to investments. Securitization involves turning an asset, such as mortgages or credit card debt, into a financial instrument that can be traded. Regular house-holds had now turned to be investors and security issuers, which in turn led to a very complex trading system. This complex system was lucrative only initially and was highly instable which led to the downfall of financial institutions. (Gerald F. Davis (2009), These securitized products were combined with other collaterals to attract more investors which gave a perception of mitigating risk at very low interest rates; however unfortunately interest rates rose steadily and this lead the sub-prime brokers to default. This was the prime reason where the financial downfall started. All the financial institutions were under serious monetary deadlock, because in the first place when borrowers defaulted, they were not able to pay back the principal amount, forget interest on principal. At the same time the housing and real-estate industry was on a boom. Borrowers who wished to purchase home were easily given loans. Massive residential re-construction took place, however borrowers as mentioned started to default and were unable to re-pay their debts and defaulted. (Web 2) The above two factors were mainly responsible for the financial crisis, or rather led to fuel and ignite the recent credit crunch.
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The banking sector also played a significant role in the financial crisis, with corporate and investment banking, bringing both significant profits but ultimately also bringing billions of pounds in toxic debt and trillions in banking bailouts around the world.( ACCA Global- Web 3). This strategy adopted by the retail banking activities to reap more profits by providing loans to people with low creditability (low credit-score), which proved to be a costly affair to the banks when customers defaulted. The UK and US markets is largely relying on consumption (personal debt) with very low savings and huge debts. Considering the current financial turmoil, savings has become a distant dream and people are currently become debtors because of their ways of expenditure. (Web 3) Thus the retail bankers gave consumers a dream of luxurious life-style by offering them loans which were been utilized and got converted to bad debts.
According to Suetin. A (2009) ineffective corporate governance is also a major factor for the financial crisis. The organizations have forgotten and not taken a responsibility to protect their share-holders because of the lack of governing body for organizations. Lending from the financial institutions have now stopped lending to other banks which has led to the credit-markets to disintegrate, which in turn has led share-holders the lack of confidence to invest and since investors seem disinterested to buy shares, the share-market has dropped significantly. Suetin. A(2009) RISING OIL AND COMMODITY PRICES is also a major factor for the current financial crisis. According to Sarkar, Mitali (2009) the rising oil and commodity prices which have led to inflation and low consumer spending is also a major factor for the global financial crisis. Borrowers became defaulters because of all these above mentioned factors joining hands at the same time, worsening time and again, and one factor adding woes to another by effecting borrower at the same time.
The financial crisis can also be described as a combination of banking, debt and currency crisis.
One of the method UK government could take to reduce the financial crisis is by adopting Euros. Euros when it was launched across Europe it was just 0.6 the value of pound, however it came close to equaling pound as illustrated in the graph below. The reason behind the loss in value of pound was due to the lack of confidence by the investors in the GBP due to the recession. (Web 4) EURO/ GBP Graph since January 1999
According to Davis, G. F. (2009) UK government has invested billions of dollars of pounds to bail-out banks that have faced financial crisis. The UK government also lifted guarantee for deposits considerably to £100,000. Even after major bail-out packages to the crisis financial banks and organization seems to have been of less significance.
The Government of U.K introduced the financial Services Bill and the Bill includes the below mentioned reforms as per Chancellor of the Exchequer Alistair Darling said to editors and press- Consumers will have powers to challenge the banks with the help of a consumer governing financial body and will also get privilege to free money guidance services. Firms should develop living wills by understanding the risks involved during financial crisis to make sure they can sustain future crisis. Human Resource will be ensured that the bonus and pay does not exceed the limits which are a high risk for the company’s P AND L. Financial Services Authority will be empowered and a new governing body called Council for financial stability will be created to regulate financial institutions. (Web 6)
According to Bell, Geoffrey L. (1968) UK government have taken stringent steps by tightening hire purchase controls and restricting bank lending and the Govemment also withdrew the Selective Employment Tax premiums paid to manufacturers and increased Corporation Tax.By exercising effective controls on financial institutions government is trying to mitigate the risk by implementing the above mentioned steps. Increasing tax has also become a positive aspect to generate revenues for government but it has negative feedback from organizations. The total effect of the Budget is estimated to raise revenue by about $2 billion, equivalent to 7% of total revenues. (Bell, Geoffrey L (1968). Hence all these factors to a certain extent imposed by the UK government have been effective.
According to Butler, Patrick(2009) Government of UK is trying to regulate the non-banks through a phenomenon called “shadow banking” for institutions such as hedge funds, private-equity funds and insurance companies, To save tax-payers money it is necessary to have necessary regulations in place and initiate shadow banking, however this practice is still not been implemented because of the complex mechanisms of these institutions.
The 2007-2009 crises can be described as the worst-ever financial crisis in both modern and pre-modern times. The impact of the crisis is many fold as compared to the Great Depression of 1930’s. Just because globalization is an emerging phenomenon and all the financial institutions want to make the most out of the globalization to reap huge profits, organizations and borrowers became equally responsible for the crises as discussed. Because of the lack of credibility to re-pay by borrowers and due to the generosity of lenders to lend money led to the financial crises and many more factors followed as discussed. The government of UK has provided bail-out packages, passed the budget and financial bill and much more to evade and get out of the crises, but it seems a huge task to get things back to normal. The questions to be asked is will the lenders become more sensible, so will the borrowers?. Will people start saving money rather than disinvesting and becoming bankrupt? Will there be reforms by government and measures to control any future crises?. All one can hope in the present scenario is to slowly and steadily get out of the crises and start thinking of efficient methods to avoid any future crises.
Bell, Geoffrey L. “Economic Conditions in the United Kingdom, Today and Tomorrow.” Financial Analysts Journal 24, no. 4 (July 1968): 147-150. Business Source Premier, EBSCOhost (accessed February 16, 2010). Butler, Patrick. “Learning from financial regulation’s mistakes.” McKinsey Quarterly no. 3 (September 2009): 68-74. Business Source Premier, EBSCO host (accessed February 16, 2010). Davis, G. F. (2009). Managed by the markets: How financer-shaped America. Oxford, U.K.: Oxford University Press. Gerald F. Davis (2009), “The Rise and Fall of Finance and the End of the Society of Organizations”, Academy of Management Perspectives, Volume 23, Number 3, pp. 27 – 44. Suetin, A. “Causes of the Current Financial Crisis.” Problems of Economic Transition 52, no. 3 (July 2009): 44-58. Business Source Premier, EBSCOhost (accessed February 16, 2010). Sarkar, Mitali. “Financial Crises and Economic Recession.” Vikalpa: The Journal for Decision Makers 34, no. 3 (July 2009): 117-130. Business Source Premier, EBSCOhost (accessed February 16, 2010). Globalization characteristics available online from WEB 1- https://www.experiencefestival.com/a/Globalization_-_Characteristics/id/1291173 WEB 2- https://www.asa.asn.au/Miscellaneous/CommSec_WorldFinancialCrisis.pdf WEB 3- https://www.accaglobal.com/pubs/about/public_affairs/unit/global_briefings/financial_stability.pdf WEB 4 -UK: Will the weak Sterling rescue the British economy https://www.theeuros.eu/IMG/article_PDF/UK-Will-the-weak-Sterling-rescue,2664.pdf WEB 5- https://www.tititudorancea.com/z/euro_to_gbp_exchange_rates_pounds_sterling_uk.htm WEB 6 -https://www.hm-treasury.gov.uk/press_108_09.htm -Newspaper Press Article.
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