The2007-08 financial crisis is the one of the highest economic recession in theworldafter the one called “Great depression” in the 1930s.
The fear of the bankingsector caused by the credit crunch which reached its peak in the mid-2007 followedup by the collapse of subprime mortgages and many another type of securitizedproducts are considered to be the most understandable global financial crisis (Talukder, 2017). In any economy, banks are considered to be oneof the most important players as they considerably contribute to thedevelopment of the economy through the facilitation of business activities suchas investment by providing credit.Therefore the main objectiveof this study is to tell the changes of banking system behavior during thelatest global financial crisis (2007-08). The first part will identifythe criticisms that were made against the banking sector during the financial, the second part also willidentify important changes in bank behavior (and in particular funding and risktaking), and the last we will focus on which banks perform well during theglobal financial crisis (Talukder, 2017). CRITICISMS THAT WEREMADE AGAINST THE BANKING SECTOR DURING THE FINANCIAL CRISIS: During the globalfinancial crisis one of the biggest causes the crisis was deregulation in the financial industry which allowed the banks toengage high risk investment like:Ø Hedge fund trading with derivatives which increase the demand of the mortgages Ø Securitization, suchas mortgage-backed securities. Ø Released Subprime mortgage Ø And also there is a difference between those profiting from excessiverisk-taking which are banks, and those who suffering the costs, this phenomenonis called “The Moral Hazard”.
In this part of our assignment, we will explainhow the moral hazard contributed to the global financial crisis. Before the beginning ofthe global financial crisis, one of the examples of moral hazard thatcontributes to the crisis was the financial institution’s expectation thatgovernment will not let them fail due to the organized risk that could spreadto the rest of the economy. Through financial innovation instruments such asMortgage back securities (MBS), Asset back securities (ABS), Collateralizeddebt obligation (CDOs), the bank got involved in a high-risk investment whichwas practically so complex, fundamentally non-transparent. These instrumentswere also not correctly priced, and not sold on markets and are not liquid.According to the Securities Industry and Financial Markets Association (SIFMA),there was $7.4 trillion worth of MBSs outstanding in the first quarter of 2008,more than double the amount outstanding in 2001. However, talking about moralhazard, even though banks were considered to be the ones who were taking theadvantage, but the evidence show that the banks were lost a huge amount ofmoney.
It does not really make a whole lot of sense to have the bad Behavior byinsiders and then to have the insiders get criticized as well. And that isexactly what we saw during the crash. Even before the collapses of LehmanBrothers, it appears to be the case that the insiders or banks, the ones whoare supposed to be taking advantage of, and misleading these trustinghomeowners, were, in fact, themselves losing a great amount of money.
Here isjust some summary statistics on losses during the crisis. You can see that theinstitutions are losing multiples of billions of dollars. Citigroup losing 42.9billion, UBS 38.
2 billion, Merrill Lynch 37.1 billion. Here we see, in total,20 institutions that lost, each one of them more than six billion dollarsduring the financial crisis (Talukder, Md. Abu Hasnat and Kamrul Islam, 2017). THE IMPORTANT CHANGE IN BANK BEHAVIOR DURING THE 2007-09 GLOBALFINANCIAL CRISIS: FUNDING AND RISK-TAKING In this part, we willfocus on the important changes in the bank behavior during the global financialcrisis from the perspectives of funding and risk taking. Banks use a varietykinds of financial tools, from both retail and wholesale sources of funding.Retail banks fund sources include primary customer deposits, mainly fromhousehold sectors while the wholesale banks source the funds from the privatemarkets used in addition to customer deposits to finance the bank operations (Talukder, Md.
Abu Hasnat and Kamrul Islam, 2017). A. Changes In Funding Behavior During Global Financial Crisis.
After the global financial crises which affectthe worldwide the structure the banking funding behavior has changed due to manystructural advances, in which emerged as a result of changes to the supervisoryand regulatory framework. These reasons include the strong interconnection offinancial markets and banks, globalization of financial markets, quick growthof investment banking activities in both investment banks and commercial bankswhich commanded an increasing trust. However, the last global financial crisisshowed the dark side the wholesale funding In terms of the effect of fundingstructure on bank risk, past works showed the quickly of funding amount at a fairlyat a low cost but the 2007-08 global financial crisis showed that the wholesalefinanciers have low interest to conduct costly monitoring on the basis of cheapand noisy signals As the market sources of funding deeply trusting on marketperceptions, this can initiate doubting to wholesale investors and couldfurther lead to the experience of Northern Rock Bank in the United Kingdom. The bank funding hasgone through extraordinary disturbances, due to the structural changes, duringthe 2007-2008 global financial crisis the banks promote for the majoradjustment in the operations and funding models.The financial crisesthat emerged in the United States and European banks resulted the importantchanges in the funding process of banks and they are:First: funding support from the governments both indirect and indirect funding for stabilizing the funding situations of the banks.Second: the banks reduced their interbank unsecuredliabilities and securities and provide with a steps toward using long-termsecurities of general funding, especially covered bonds.Third: the bank are limitednumber of sources of financing.
Fourth: Imbalances in thebalance sheet are developed in banking crises as the increasing diversificationand complication of funding instruments. The 2007–08 global banking crisis showed theshortcomings of business models that depended extremely on short-term wholesalefunding, such as those adopted by Northern Rock in the United Kingdom, BearStearns and Lehman Brothers in the United States (Talukder, Md. Abu Hasnat and Kamrul Islam, 2017).
B. Change In Risk Taking Behavior During Global Financial Crises. As the funding behavior of banks changes duringthe period of the global financial crisis, the risk taking the behavior of banksalso changed significantly. After more detailedresearch we know that the most important risk of banking sector are credit riskand insolvency risk.The factorsthat influencing banking risk are two groups which are called determent of risk:The firstgroup of risk determinants includes factors which specific to each bank andincludes the capitalization, deposit insurance coverage, size, competition, andregulatory quality.
The second group of determinants includes factors relating bank asmacroeconomic environment such as economic growth and inflation (Talukder, Md. Abu Hasnat and Kamrul Islam, 2017).After the global financial crises therisk-taking behavior of banks were limited, due to theØ Improvereserve capital.Ø Reducingbank failing by the concept (too-big-to-fail).Ø Screeningand monitoring Ø Enhancementsto the “securitization model.”Ø Acceptanceof principles for sound compensation practices, to avoid perverse motivationsfor risk-taking.Ø Acceptanceof principle of some types of financial transactions under U.
S. GenerallyAccepted Accounting Principles (GAAP) and International Financial ReportingStandards (IFRS). Ø SomeOTC derivatives reforms.BANK BEHAVIOR AND FINANCIAL MARKET (WHY SOMEBANKS DO BETTER DURING THE CRISIS?)The Bank productivityand statement of financial position were significantly important factors ofperformance during the crisis than the regulation and authority and also the bankswith the advanced Level and high capital are usually performed better duringthe crisis.
This analysis revealsthat the important difference in the ability of banks to sustain lendingremained during the financial crisis, and this ability is determined by thestrength of their balance sheets. There are three main results in the research.First: the heavy confidence of banks on the funding from market causedliquidity shocks during the crisis and started reducing their supply of creditmaximum than other banks. Second: this effect wasprepared of by bank capitalization in both the quantity and the quality ofcapital mattered. The disclosed banks to shocks with a good capital held moretangible common equity and decreased lending less as much as possible thanother disclosed banks to shocks. Third: capital and structuralliquidity are linked with some complementarities in the higher structuralliquidity, in which there are benefits for lending only for well-capitalizedbanks.In-nutshell after more research we knew that banks with more shareholdersperformed worse during the crisis.
And the any bank which has, Ø Reserve capital requirement Ø Independent supervisors.Ø Use portfolio management (asset diversification), are performed better during thecrises.And also found thatdeveloping countries like China, Brazil, and India systemically recoveredquickly from the crisis by generating interest in the potential modifying rolethat these banks could play during periods of financial suffering (Talukder, Md.
Abu Hasnat and Kamrul Islam, 2017). CONCLUSION:The conclusion of thisstudy is to discuss the changes and tendencies of the banking sector behaviorduring the last global financial crisis (2007-08). The study tells that thebehavior of banking sector had one of the primary causes of the globalfinancial crisis. The study also shown that the banking sector had gone throughtrends of changing behavior, and also the study identifies some the criticismsof banking sector since the start of the crisis. Moreover, the study hasidentified that banks practice a different behavior in terms of funding andrisk taking during the 2007-08 global financial crisis. In terms of bankfunding, banking crises increased as banks’ over confidence on a limited numberof sources of financing. Banks were only doing to source the fund from thewholesale trading. This brings imbalance in the balance sheet of the banks.
Inother words, banks were doing long term investments with short term sources offunds which create liquidity risks. The study alsoidentified that oddness between the short-term funding and long-term funds hadbuilt up more liquidity risks. This brings that banks change their risk-takingbehavior and invest high-risk investments to gain a higher return as a resultof low-interest rates. Finally, the study looked the bank behavior and foundthat well-capitalized banks may react less to profit shocks and their profitscould be less sensitive to the business fluctuations, as their portfoliodecisions may vary from those taken by less promoted banks (Islam, 2017). References Islam, M. A. (2017). The role of banking sector during global finacial crises (2007-2008).
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