Title: Financial Crisis
Name: Shivani Yerunkar
Literature Review:
1. Financial Crises:-
Since the 18th century, financial crises have occurred in various ways in different periods and have caused massive destruction to economies and people’s lives. Hardly had Asia stepped out from the shadow of the financial crisis of 1997 when it spread to Russia and Argentina, and disaster struck the global financial sector. In order to avoid crises, we have to know what causes them, and then take measures to avoid them. Financial crises can be caused by a variety of factors such as excessive borrowing and lending, asset bubbles, market volatility, inadequate regulation, and inadequate risk management. These factors can create imbalances in the economy, leading to a sudden collapse of the financial system .To prevent financial crises, policymakers can take a range of measures such as implementing regulations to ensure financial stability, monitoring markets for signs of instability, promoting transparency in financial transactions, and creating a robust framework for risk management. (Xingyun , 2015)
2. Understanding Financial Crises:-
Anticipating and avoiding financial crises is challenging, as they often result from a combination of factors that may be difficult to predict or control. However, early warning systems, effective regulation and supervision of financial institutions, and sound macroeconomic policies can help to reduce the likelihood and severity of financial crises. When financial crises do occur, governments and international institutions can intervene to limit their impact and restore financial stability. This can involve providing liquidity support to financial institutions, implementing fiscal and monetary policy measures to stimulate economic growth, and introducing regulatory reforms to prevent similar crises from occurring in the future. However, interventions can also have unintended consequences, such as moral hazard, where financial institutions may take excessive risks if they believe they will be bailed out in the event of a crisis. Therefore, it is important to carefully balance the costs and benefits of intervention, and to design policies that minimize the risk of future crises.(Allen et al,2009)
3. Misunderstanding of Financial Crises:-
Prior to the financial crisis of 2007-2008, economists thought that no such crisis could or would ever happen again in the United States, that financial events of such magnitude were a thing of the distant past. In fact, observers of that distant past–the period from the half century prior to the Civil War up to the passage of deposit insurance during the Great Depression, which was marked by repeated financial crises–note that while legislation immediately after crises reacted to their effects, economists and policymakers continually failed to grasp the true lessons to be learned. Gary Gorton, considered by many to be the authority on the financial crisis of our time, holds that economists .Gary Gorton In his book, “Misunderstanding Financial Crises,” challenges the prevailing belief among economists that financial crises are rare, idiosyncratic, and caused by a coincidence of unconnected factors. He argues that financial crises are inherent to the production of bank debt and that unless intelligent regulation is designed by the government, crises will continue to occur. Gorton points out that economists failed to grasp the true lessons to be learned from the repeated financial crises that occurred prior to the Great Depression. While legislation immediately after crises reacted to their effects, economists and policymakers continually failed to understand the evolution of capital markets and the banking system, the existence of new financial instruments, and the size of certain money markets like the sale and repurchase market.(Gorton, Gary B., 2012.)
4. Identifying the Symptoms of Financial Crises:-
This research explores if there are common symptoms and steps to international financial crises by examining the causes and progress of financial crisis in Latin America and South East Asia. The symptoms are a currency crisis, a banking crisis, a sovereign debt crisis and a balance of payments crisis. It will also attempt to the question as to what is the relative responsibility of the center and the periphery of the international financial system in the genesis of crises.(Batista, Blessica, 2018)
5. Accounting’s Role in Financial Crises:-
This research discusses the role accounting had in the financial crisis. It delves into how accounting helped invoke the financial crisis, what impacts the financial crisis is having on accounting and what can be done now. The research method used is literature review. The causes of the financial crisis in relation to accounting were the housing bubble and burst, shadow banking, fair-value accounting, and troubles with the GAAP model. The impacts of the financial crisis are increased financial regulations and a decrease in reputation and assurance. As for what can be done, companies need to focus on corporate social responsibility to build back reputation and a new external monitor should be created to help prevent future financial crises by identifying warning signs before the problems actually occur. The financial crisis shows that accounting needs to become even more prevalent in the field of finance.(Hitzel, 2013.)
6.Short and Long Term Growth Effects of Financial Crises:-
Growth theory predicts that poor countries will grow faster than rich countries. Yet, growth in developing countries has been consistently lower than growth in developed countries. The poor economic performance of developing countries coincides with both long-lasting and short-lived financial crises. In research, we analyze to what extent financial crises can explain low growth rates in developing countries. We distinguish between inflation, currency, banking, debt, and stock-market crises and separate the short- and long-run effects of them. Our results show that financial crises have reduced growth and that policy decisions have caused them to be worsened and/or extended.(Andersson&Karpestam,2014)
7.The Role of Central Bank in Financial Stability
The two most topical issues in current financial markets deal with the causes of the recent financial crisis and the means to prevent future crises. This research addresses the latter and stresses a major shift in most countries toward a better understanding of financial stability and how it can be achieved. In particular, the research in this volume examine the recent change in emphasis at central banks with regard to financial stability. For example: What were the cross-country differences in emphasis on financial stability in the past? Did these differences appear to affect the extent of the adverse impact of the financial crisis on individual countries? What are perceived to be the major future threats to financial stability? These and related issues are discussed in the research by well-known experts in the field — some of the best minds in the world pursuing financial stability. Following the global financial crisis, significant reforms have been initiated in many countries to address financial stability more directly, frequently focusing on macroprudential policy frameworks in which central banks play a more active role.(Evanoff et al,2013)
8.The International Financial Crises:-
The recent global financial crisis highlighted weaknesses in the global financial system, such as regulatory failures, excessive risk-taking, and market distortions. There is no set “playbook” on how to respond to systemic crises, and the optimal role of the state in dealing with crises is a subject of debate. Asset bubbles pose a risk to the stability of financial markets and can be addressed through various approaches. The governance of the financial industry is a key issue and reforms are needed to improve risk management practices, increase transparency, and strengthen regulatory oversight. Addressing systemic crises requires a concerted effort from policymakers, regulators, and industry practitioners, and reforms should focus on strengthening the resilience of the financial system.(Demirgüç-Kunt et al,2011)
9.The Causes Banking Crises:-
We add the Bernanke-Gertler-Gilchrist model to a world model consisting of the US, the Euro-zone and the Rest of the World in order to explore the causes of the banking crisis. We test the model against linear-detrended data and reestimate it by indirect inference; the resulting model passes the Wald test only on outputs in the two countries. We then extract the model’s implied residuals on unfiltered data to replicate how the model predicts the crisis. Banking shocks worsen the crisis but ‘traditional’ shocks explain the bulk of the crisis; the non-stationarity of the productivity shocks plays a key role. Crises occur when there is a ‘run’ of bad shocks; based on this sample Great Recessions occur on average once every quarter century. Financial shocks on their own, even when extreme, do not cause crises—provided the government acts swiftly to counteract such a shock as happened in this sample. Copyright Springer Science+Business Media New York 2013(Le et al,2013)
10.The Speed of Recovery from Banking Crises:-
While much research has been done on causes and effects of banking crises, little is known about what determines recovery from banking crises, despite of large variations in post-crises performances across countries. In order to identify local and global factors that determine the length of recovery (i.e. the time it takes until countries reach their pre-crisis level of per capita GDP), this research employs event history analysis on 138 incidents of banking crises between 1970 and 2013. Cox proportional hazards show that crises characteristics, specific country conditions as well as external factors affect the duration of recovery. Regarding domestic factors, simultaneous currency crises, large financial sectors and overvalued currencies are associated with later recovery. Regarding external factors, a low growth of world trade has a negative effect on recovery, and so does uncertainty in financial markets as reflected in high gold prices. Moreover, contractionary monetary policy of the US Fed as Central Bank of the international key currency has a negative effect on the length of recovery in middle-income countries. In general, the dominance of global variables as well as variables related to the exchange-rate underline that the speed of recovery is particularly constrained by countries’ positions within the global economy.(Ambrosius, Christian, 2016)
CONCLUSION :-
The research discusses financial crises and their causes, as well as measures that can be taken to prevent and mitigate their impact. It also reviews some research on the topic, such as the causes and progress of financial crises in Latin America and Southeast Asia, the role of accounting in the financial crisis, and the impact of financial crises on growth rates in developing countries. Additionally, the research addresses the current emphasis on financial stability and the reforms being undertaken to achieve it in many countries.
Reference:-
Allen, Franklin & Gale, Douglas, 2009. “Understanding Financial Crises,” OUP Catalogue, Oxford University Press, number 9780199251421.
Ambrosius, Christian, 2016. “What Explains the Speed of Recovery from Banking Crises?,” VfS Annual Conference 2016 (Augsburg): Demographic Change 145606, Verein für Socialpolitik / German Economic Association.
Asli Demirgüç-Kunt & Douglas D Evanoff & George G Kaufman (ed.), 2011. “The International Financial Crisis:Have the Rules of Finance Changed?,” World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 7865, April.
Batista, Blessica, 2018. “Identifying the symptoms of financial crises,” MPRA Paper 91559, University Library of Munich, Germany.
Courtney Hitzel, 2013. “Accounting’s role in the financial crisis,” African Journal of Accounting, Auditing and Finance, Inderscience Enterprises Ltd, vol. 2(2).
Douglas D Evanoff & Cornelia Holthausen & George G Kaufman & Manfred Kremer (ed.), 2013. “The Role of Central Banks in Financial Stability:How Has It Changed?,” World Scientific Books, World Scientific Publishing Co. Pte. Ltd., number 8720, April.
Fredrik N. G. Andersson & Peter Karpestam, 2014. “Short and Long Term Growth Effects of Financial Crises,” Dynamic Modeling and Econometrics in Economics and Finance, in: Marco Gallegati & Willi Semmler (ed.), Wavelet Applications in Economics and Finance, edition 127, pages 227-248, Springer.
Gorton, Gary B., 2012. “Misunderstanding Financial Crises: Why We Don’t See Them Coming,” OUP Catalogue, Oxford University Press, number 9780199922901.
Vo Le & David Meenagh & Patrick Minford & Zhirong Ou, 2013. “What Causes Banking Crises? An Empirical Investigation for the World Economy,” Open Economies Review, Springer, vol. 24(4), pages 581-611, September.
Xingyun PENG, 2015. “Financial Crises,” World Scientific Book Chapters, in: FINANCIAL THEORY Perspectives from China, chapter 23, pages 603-629, World Scientific Publishing Co. Pte. Ltd.