International Financial Crisis

In a financial crisis, asset prices see a steep decline in value, businesses and consumers are unable to pay their debts, and financial institutions experience liquidity shortages. A financial crisis is often associated with a panic or a bank run during which investors sell off assets or withdraw money from savings accounts because they fear that the value of those assets will drop if they remain in a financial institution. Other situations that may be labeled a financial crisis include the bursting of a speculative financial bubble, a stock market crash, a sovereign default, or a currency crisis. A financial crisis may be limited to banks or spread throughout a single economy, the economy of a region, or economies worldwide.

The most recent financial crisis was the 2007-2008 global financial crisis. It started with a subprime mortgage lending crisis in 2007 and expanded into a global banking crisis with the failure of investment bank Lehman Brothers in September 2008. Huge bailouts and other measures meant to limit the spread of the damage failed and the global economy fell into recession.

Causes of financial crisis

1. The bursting of the housing bubble

2. Lack of sufficient regulations

3. Bank managers’ failed in their fiduciary roles

4. Weak and fraudulent underwriting practices

5. Sub-prime lending rates- giving loans to people who could not repay comfortably.

6. Easy credit condition and predatory lending.

7. Increased debt burden and excessive speculation.

8. Financial innovation and complexity.

9. Stagnation of wages in the US and European markets.

10. Systematic risks.

Impact of Debt Crisis

1. Closure of financial institutions

2. Decrease in the real GDP due to decreased purchasing power.

3. High unemployment rates due to closure of financial and construction institutions.

4. Foreclosures through loss of homes.

5. Credit tightening

6. Decline in wealth through reduced pension savings and loss of housing.

7. Decrease in income distribution- the rich lost less compared to the poor.

8. The developing economies grew to replace advanced economies in global economic growth.

Strategies to manage credit exposure which could possibly avert a financial crisis

1. Carry out due diligence and credit history appraisal before lending.

2. Monitor and re-evaluate payment and borrower business.

3. Collateral appraisal and evaluation.

4. Syndicating to reduce risk.

5. Country risk analysis and profiling

Credit exposure is the risk due to potential borrowers or counterparty defaulting.

Country risk is the risk that a country can change its policies and therefore affect the ability of borrowers from those countries to honor their loan obligations.

Methods of assessing country risk

1. Use data from organizations such as IMF and World Bank.

2. For MNCs, use bank information from the subsidiary network.

3. Government contacts and websites on policy changes.

4. Frequent visits to assess policy and environmental situations.

How developing economies can avert sovereign debt crisis

1. Pay debt when due to avoid unnecessary compounding.

2. Borrow for development not recurrent expenditure.

3. Ensure borrowed funds are used appropriately.

4. Keep good credit standing and rates to obtain low funding rates.

5. Privatize non-performing public entities.