Regulatory Responses to the Current Financial Crisis (US, UK, China, Canada, India) - Research Paper Example

?Running head: REGULATORY RESPONSES TO THE CURRENT FINANCIAL CRISIS Regulatory Responses to the Current Financial Crisis Insert Insert Grade Course Insert Tutor’s Name February 17, 2012 Contents Abstract…………………………………………………………………………………………..3 Introduction ………………………………………………………………………………………4 US regulatory response to economic crisis……………………………………………………….5 UK regulatory response to economic crisis………………………………………………………8 China’s regulatory response to economic crisis………………………………………………….10 Canada’s regulatory response to economic crisis………………………………………………..12 India’s regulatory response to economic crisis…………………………………………………..13 Conclusion ...…………………………………………………………………………………….14 Abstract The current global crisis began in 2007 and spread in 2008. It had varying impacts on the financial systems of various countries depending on the initial stability of the system and its exposure to the credit derivatives that accelerated the crisis. The effects were severe in the developed countries like US as compared to the developing nations like India. In this regard, different countries reacted to the crisis identifying the opportunities and the associated challenges. The countries in the OECD advocated for a joint effort to have international standardization of regulatory policies. The main concerns are stimulation of demand in a given economy, improving liquidity, preventing foreclosures of mortgages and improving access to financing by for the SMEs and giant investors. There is a focus in risk reduction through investment in insurance. Regulatory Responses to the Current Financial Crisis Introduction Financial crisis refers to a wide category of situations in which the large financial institutions or assets lose large proportion of their value. The current global crisis began in 2007, in some countries, and deepened in 2008 (OECD, 2009). Some of the factors that may contribute to financial crisis include application of similar operational strategies by players in the market, changes in the banking business, excessive leverage, changes in regulations and corporate governance, and failure of government policies on the financial sector (Blundell-Wignall, Atkinson, and Lee, 2008). Government policies regulate the financial sector within in a country and the operations with a global business partner. The failures in some of these policies could have contributed greatly to the current situation. To fix the situation and mitigate for future crises, various governments have enacted some monetary and fiscal policies. The current global financial crisis had other related problems like food crisis especially to the developing countries as was, and continues to be, witnessed in the horn of Africa (Canuto, 2011). The financial reforms to manage the crisis must then focus on the other financial instruments controlling the economy of the country. The problem that has been encountered in the management if the crisis is that economists and the policymakers do not have a proper understanding of the relationship of various components of economic policy and regulation (Tamirisa, 2011). It is important to understand the interaction between monetary and macro-prudential policies in enabling financial stability. Designing a successful macro-prudential policy requires the government to understand the risks of the new financial instruments it is putting in place (Tamirisa, 2011). Focusing on the monetary policy is insufficient in the management and mitigation of financial crises. This paper focuses on the regulatory responses that have been given by five different countries in relation to the current global financial crisis. It focuses on the regulatory responses in the UK, the United States, Canada, India, and China. US regulatory response to economic crisis In the US, the current financial crisis began in 2007 and deepened in 2008 even though attempts were made by the Central Bank to restore financial stability (Jickling, 2010). Various views have been given by economists and financial analysts concerning the causes of the current crisis. The last Congress created the Financial Crisis Inquiry Commission to investigate the factors that led to the crisis in an attempt to develop solution. Members of the commission differed on their views and several factors were raised. In one line of argument, it was observed that the government made an unnecessary intervention into the housing market through Fannie Mae and Freddie Mac (Thomas, Hennessey, and Holtz-Eakin, 2011). The move led to an inflation of housing bubble that culminated into the crisis. The other argument, supported by the majority of the members of the commission, is that large banking institutions serving their interests took control of the financial and political system in Washington to their advantage (Thomas, Hennessey, and Holtz-Eakin, 2011). The greedy banks manipulated the operations of large real estate and mortgage investors increasing the risks in the global financial system. The third argument brings together different factors. Here, it is pointed out that the economic forces on the global scene as well as the failure of the US government to develop good policies and ensure proper supervision contributed to the current situation (Thomas, Hennessey, and Holtz-Eakin, 2011). The last observation had been partly supported earlier by some financial analysts. It had been earlier pointed out that the crisis occurred due to the ‘distortions and incentives created by past policy actions’ (Blundell-Wignall, Atkinson, and Lee, 2008, p.2). Jickling (2010) also cites a combination of several factors including imprudent mortgage lending, housing bubble, global imbalances, securitization, deregulatory legislation, and rating agencies among many others as the key factors. While the discussions continue, the US Congress has shown commitment to prudential regulatory reforms in commercial banking, securities and insurance sector, and the investment banking industry (Squire Sanders, 2009). However, the intervention has not been smooth since the development of these regulatory policies by the US has to conflict with the interests and policies of other governments across the globe. The US had experienced economic crises before the 2008 crisis. In the response to these crises, the regulatory agencies focused on liquidity issues, demand stimulation, and prevention of foreclosures of mortgages (Marshall, 2009). Focusing on liquidity, the Federal Reserve lowered the interest rates in the financial institutions and developed different schemes to promote liquidity (Marshall, 2009, p.26). This was aimed at stopping occurrence of credit crisis. The other response that was given to the earlier crisis involved legislation that would see increased demand and prevent mortgage foreclosure (Marshall, 2009). Nonetheless, in as much as there were several other regulatory agencies, much of the task at this time was limited to the Federal Reserve. In March, 2008 the US Treasury released its Blueprint for Financial Regulatory Reform. The regulatory blueprint recommended the ‘organizational consolidation of the US financial regulation, including the dismantling of the Office of Thrift Supervision and the creation of federal regulator (Singer, 2008). Through the reduction of transaction costs negotiation and clarification of agency accountability, the consolidation of regulatory agencies aimed at promoting cooperation among the international regulatory agencies. The House Banking Committee chair, Barney Frank then announced the committee’s focus on developing some universal regulator before focusing on the several federal and state agencies later on. The US proposed G-20 group in a November 2008 Summit in Washington that would focus on better prudential policies, tough regulations, improved risk management and increased supervision of the financial institutions in the country (Squire Sanders, 2009). After the September 2008, other regulatory institutions like the US Treasury joined hands with the Federal Reserve to develop the Emergency Economic Stabilization Act 2008 (Marshall, 2009, p.30). The then president appealed to the Congress on the need to pass the proposal, which would see the government invest $700bn in purchasing the “toxic” illiquid assets, in order to revive the credit market. An institution was to be eligible to the program if it were regulated at the federal level (Marshall, 2009, p.31). The implementation of the program began in the President Bush era and continued into the President Obama era. Before the termination of President Bush’s term, about $350bn had been invested towards the scheme (Marshall, 2009, p.37). To improve on the equity stakes, the US Treasury injected funds into different financial institutions. Under the Systematically Significant Failing Institutions scheme, the US treasury in conjunction with the Fed gave out several bailouts to AIG, a giant insurance company (Marshall, 2009, p.37; Federal Reserve, 2008; Federal Reserve 2009). It was noted that the insurance company provided insurance cover to more than 100000 clients employing over 100 million Americans (Marshall, 2009, p.46).Its collapse would be a financial downturn. The Treasury also awarded loans to other giants in the automobile industry like General Motors. . The other response was that the Federal Reserve and US Treasury declined to bail out Lehman Brothers, an investment bank, with a shift towards Bear Stearns. The move was aimed at illustrating to the other banking institutions that they were at par and ‘that no bank was too big to fail’ (Marshall, 2009, p.38). The Federal Reserve continued with the earlier approach of lowering interest rates to increase liquidity and stimulate lending. In response to the crisis, the Securities and Exchange Commission (SEC) suspended the short selling of financial institutions (Marshall, 2009). The Fed increased penalties for naked short selling of the financial institutions. Another important response was the development of the comprehensive Homeowners Affordability and Stability Plan to enable homeowners who are at risk of foreclosure to refinance their mortgages (Federal Deposit Insurance Corporation, 2009). The Congress also passed the $787bn American Recovery and Reinvestment Act 2009 to revive demand in the US economy (National Association of REALTORS, 2012) UK regulatory response to financial crisis The UK felt the effect of the financial crisis within a very short period. In 2007, the GDP growth rate +3% and the growth rate declined drastically to -1.5% by the end of the first quarter in 2008 (Reid, 2009). The country recorded rising unemployment rates, decreased consumer spending and increased budget deficits. The budget deficits rose to ?43bn in 2008 and ?70bn in 2009 (Reid, 2009). According to the Financial Services Authority chair, the crisis developed out of interplay between macroeconomic imbalances and the developments in the financial markets intensified in the last decade or so (Turner, 2009). The global imbalances could be attributed to the high saving rates in China and other countries that led to large current account surpluses in these oil-producing countries. This saw a reduction in real risk free rates of interest with the financial system suffering low interest rates. The net effect was immense credit extension in the developed nations like UK and US (Reid, 2009; Turner, 2009). It also led to convolution in securitization market. To manage the crisis, certain areas needed to be reexamined including the deposit insurance mechanism, bank solvency regimes, liquidity risk management, and boundaries regulation. Increased sector analysis by the regulators could prove sufficient (Goodhart, 2008). The Central Banks and other regulators need to work together to amalgamate the analysis of macroeconomic and macro-prudential policies (Reid, 2009). In response to the financial crisis, the UK treasury sought information from various stakeholders like actuaries and economists. Her Majesty’s Treasury, the United Kingdom’s economic and finance department responsible for regulatory policies consulted the Actuarial Profession on the appropriate mechanisms of reforming the financial markets in the country (Actual Profession, 2009). In response, the Actuarial Profession advised that strict regulations would be costly for the customers and policyholders driving firms away from the UK. The agency also advised that it would be unnecessary in the subsequent periods to put further changes to prudential regulation for the insurance companies in the UK (Actual Profession, 2009). After examining the past trend and the failed approaches, FSA made some resolutions. There was need for a new capital adequacy approach and effective risk management approach (Turner, 2009). The Treasury increased the levels of bank capitals. Secondly, the country adopted new approaches to liquidity. FSA understood the need to have internationally recognized system that would enhance standardized regulation of liquidity. The other approach that was proposed and adopted is the removal of shadow banking system with strict requirements on disclosure (Turner, 2009). Just like the other approaches, this was aimed at reducing risks to restore financial stability (Reid, 2009). The Monetary Policy Committee (MPC) is responsible for stabilizing the prices to balance the economy on wider system. MPC noted the credit crisis caused by the high levels of London Interbank Offered Rates. To reduce the crisis, the MPC reduced the interest rates to 0.5% (Reid, 2009). The financial institutions had experienced freezing up between them. The other regulatory response was quantitative easing that included an injection of ?75bn to stimulate demand (Reid, 2009). The UK also participates in G-20 meetings with a focus on improving transparency, openness, and disclosure among the financial institutions. Another significant response was the Asset Protection Scheme developed in 2009. The scheme by UK government was aimed at reducing potential losses and risks to the financial institutions in an effort to stabilize the financial system of the country (HM Treasury, 2012). A number of banking institutions like the Royal Bank of Scotland agreed to participate in the scheme. China’s regulatory response to financial crisis China is on of the developing markets, and the financial crisis deterred her steady industrialization. The country suffers the crisis affecting other developed countries that are business partner like the America and the EU nation. In effect, the government and other local and global regulatory agencies have joined hands to examine the appropriate regulatory policies to be applied in the country. The National Association of Financial Market Institutional Investors (NAFMII) and the Global Financial Markets Association (GFMA) held a joint forum in Beijing on October 26, 2011 to examine the financial markets and regulations in China (NAFMII, 2011). The forum drew experts from various fields of economics and finance from within and outside the country. The discussion focused on various issues like effects of adjusting regulatory frameworks and policies in the US and European financial markets as well as the effects that the adjustments had on the Chinese market. The opportunities and challenges for the Chinese financial institutions, New Basel Capital Accord, the Renminbi offshore market, and management of risks in the financial markets were discussed (NAFMII, 2011). The main intent of NAFMII was to establish a connection to enable the Chinese financial institutions to access overseas markets. The country has applied a joint monitoring scheme that involves cooperation between various regulatory agencies. These include the China Banking Regulatory Commission CBRC), China Securities Regulatory Commission (CSRC), and China Insurance Regulatory Commission (CIRC) (Baidu, 2012) working together with the People’s Bank of China. CBRC was officially formed in 2003 and the People’s Bank of China was officially mandated with the task of overall banking supervision in the same year. The country applies mixed trends in its financial system reforms. The CBRC has developed a sound framework for prudential policies (Mingkang, 2011). The regulatory interventions may have had positive impacts in the economic recovery process in the country. China is among the developing countries that have shown some recovery from the financial crisis as witnessed in the labor market and the gross domestic product. The country recorded a growth rate of more than 9.5% for the GDP in the last Quarter of 2010 and the first Quarter of 2011 (Human Development Network, 2012). On the average, the GDP growth rate for the developing countries was 8% in 2010 and increase of imports up to 27% in terms of the US dollar (The World Bank, 2011). The rate of unemployment was relatively lower at a value less than 5% for first and second Quarters in 2010 and the first Quarter of 2011 (Human Development Network, 2012). More recently, China has had other policy reforms to adjust to the financial trends. The country’s mainland banking has continued to rise since 2005 with remarkable increase in total renminbi deposits. The People’s Bank of China has responded through increasing interest rates and deposit reserve requirement ration since October 2010 (Mr. China, 2011). In May 2011, the China Banking Regulatory Commission also issued the new regulatory procedures that are to be used in 2012. The new regulation provides that ‘the capital adequacy ratio of commercial banks shall be divided into core tier 1 capital adequacy ratio, tier 1 capital adequacy ratio and general capital adequacy ratio, with minimum requirements at 5%, 6%, and 8% respectively’ (Mr. China, 2011, para.6). It is also provided that the capital adequacy ratio for systemically important banks should be at least 11.5% and that of non-systemically important banks should be at least 10.5% (Mr. China, 2011). Canadian regulatory response to economic crisis Canada had similar regulatory response to that of the UK and US. Canada is one of the members of the OECD (Organization of Economic Cooperation for Development) countries that had signed the convention (OECD, 2009). The governments in these member countries work together in addressing the social, economic, and environmental challenges caused by globalization (OECD, 2009). The current financial crisis can be linked in part to globalization and internationalization. The OECD countries have certain policy reforms in response to the current crisis, reforms that apply to Canada. The OECD policy response to crisis focuses mainly on innovation as one of the fundamental keys to recovery from economic downturn (OECD, 2009). Canada has the best financial system in the world with reduced leverages (Government of Canada, 2012). In response to the global financial crisis, the government developed Canada’s Economic Action Plan to protect the economy from the threat and mitigate for future occurrence. The action plan addressed various financial dimensions including stimulation of spending, stimulation of house construction, improving built infrastructure, as well as supporting business and communities (Government of Canada, 2012). The government allocated billions of dollars towards these schemes. There were other regulatory measures to improve access to finance through the injection of $200bn in the Extraordinary Financing Scheme (Government of Canada, 2012). Canada has also had successful policies in the past such as a tax cut of $65bn announced in 2007. Other approaches have also been used in Canada. For instance, the availability of labor is one of the keys to economic development and a tool to counteract the crisis. Despite the crisis, Canada maintains policy on the admission of skilled and unskilled immigrant laborers in the country to manage the labor shortages (Mittal, 2008). The number of the immigrants would be monitored and reduced with time. India’s regulatory response to financial crisis In the developed countries, the economic crisis has had negative implication on all sectors of the economy including the employment worth of migrant employees. However, the financial sector in India did not suffer huge direct effects of the sub-prime crisis since the regulators in the country had put in place certain prudential policies and the country was less exposed to the global factors that triggered the crisis (Gupta, 2011). The players in the credit market in India applied models that are not used in the developed nations. The Indian government has also put restrictions to the domestic investors with strict securitization guidelines that do not guarantee profit immediately after investment (Gupta, 2011). The prudential regulations governing the financial institutions in the country focus on capital and liquidity. As such, the initial impact of the crisis was relatively small in India. Nonetheless, the global crisis affected other sub-sectors like money market, foreign exchange and the credit markets with an implication on the larger financial sector. The policy makers in India reacted positively to address arising issues like liquidity and access to credit. To achieve this, the regulators reduced policy interest rates and the quantum bank reserves in the Reserve Bank of India (Gupta, 2011). There was also a move to refinance various small to giant investors alike. Similarly, the interest rates in the deposits of foreign currency by foreigners in the country were also increased in an effort to increase liquidity (Gupta, 2011). The government allowed the Non-bank financial companies (NBFCs) in the country to have access to foreign credit. The NBFCs were also subject to other advantages like waived deadlines for the Capital Adequacy Ratios. The RBI has also set up the Financial Stability unit to focus on the future stability of the country’s financial system. The interventions have positive impacts on India. Despite the crisis, it is still expected that the global remittances to various economies will continue to rise with a projection that $593 billion will be recorded by 2014 (World Bank Report, 2012). Out of these remittances, it is expected that about $441 billion will be remitted to the developing countries. India is among the developing countries that expect large cash inflows. The total remittances to developing countries were $350 billion in 2011 out of which India received the highest of $58 billion closely followed by China at $57 billion (World Bank Report, 2012). Conclusion Different factors contributed to the current financial crisis. The global micro policies and poor regulatory framework at local and regional levels played important roles. On the global level, policies regulating liquidity led to excess leverage. Low interest rates in the countries like US and Japan, fixed exchange rates in China, and increased Sovereign Wealth Funds led overflow of liquidity reservoir. There are similarities in the regulatory responses that have been given by different countries to the current financial crisis. The responses mainly touch on enhance liquidity, management of risks, and lowering leverages. Improved insurance on investment and banking sector are other key response. The governments are mainly concerned with promoting access to finances and getting the financial institutions to penetrate into other financial markets. References Actual Profession. (2009). Actuarial Profession response to the HM Treasury Consultation on Reforming Financial Markets. Retrieved from http://kan.actuaries.org.uk/sites/all/files/documents/pdf/AP_HMT_FinancialMarkets_20090928_resp.pdf Baidu. (2012). 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