The transformation in the banking system in the lead-up of the Global Financial Crisis - Essay Example

?Strategic Banking Issues This paper discusses the transformation in the banking system in the lead-up of the Global Financial Crisis. The study gives particular attention to the changes in the banking system that occurred in New Zealand. This research tries to find an answer to the question “to what extent has the Global Financial Crisis caused these changes to be unwound?” with a special focus on New Zealand. Global Financial Crisis: The Global Financial Crisis of 2007-2008 has been one of the most devastating financial crises of all time. The Global Financial Crisis has been described by many economists as the worst financial crisis after the Great Depression of 1930s. The financial crisis has also been named as the Great Recession by economists and business experts. The Global Financial Crisis started with the collapse of biggest (in terms of financial status and business of these companies) financial companies of the world, including Merrill Lynch and Lehman Brothers. The crisis situation became worst in 2007 when financial intermediaries like banks of USA were in a position to announce themselves as bankrupts. In this time the US government intervened into the matter and provided the necessary financial support to these banks and financial intermediaries and slightly controlled the crisis situation. The financial crisis situation occurred because of the strategy of those financial intermediaries to provide various types of loans, such as house loans, car loans etc., to individuals and business organizations. The crisis situation became worst when these loans or hedge funds have been circulated to different layers in the banking transactions all around the world. Increase in the layers of providing loans to different sections of the world economy has caused these financial intermediaries to suffer from greater risks of default of loans. The risk has been at high because default of one of the person or organization could have resulted in the default of the entire system of circulation of loans. In the mid-2007 this has actually happened and the entire financial system of the country collapsed. This crisis situation eventually transferred into several other countries of the world, including developed countries like United Kingdom, Australia, New Zealand, Japan, and developing countries like India and China (James, 2011, pp. 19-22). With significant disturbance in the housing markets of USA economic and financial systems of countries across the globe has been disturbed and financial companies started to reduce their economic as well as financial activities which in effect reduced the level of economic activities across the globe. In the beginning of 2008, greater liquidity crisis in the US financial market and in the US banking system caused countries across the globe to suffer from severe financial crisis situation. The reduction in housing prices and real estate prices across the US caused many large financial intermediaries and banks to suffer from loss of capital and funds. These have eventually reduced the amount of investments made in the process of developing world economies and hence countries started to suffer from severe financial crisis as well as debt crisis. During this time most of the effected countries tried to implement various policies and strategies to transform the banking system to reduce the effects of the Global Financial Crisis (Campbell, 2011, pp. 217-219). Transformation of banking in New Zealand: After the introduction of the Global Financial Crisis in the period of 2007 and 2008, many countries started to implement various macroeconomic as well as various microeconomic policies in order to reduce the intensity of the crisis to affect these economies. New Zealand also affected badly like other developed nations of the world by the Global Financial Crisis and hence, the government of New Zealand took several policies to transform the financial system of the country into more financially stable and operationally strong position. The financial system and the banking system of New Zealand have been tested in recent few years by several negative effects of the Global Financial Crisis. These negative effects included volatility in global commodity prices, the end of explosion of domestic housing, the resulting decline in the volume of investments made in countries across the globe (including New Zealand), the resulting decline in economic activities and hence economic developments of these countries. During the time period 2007 and 2009, the economy of New Zealand suffered from all these economic as well as financial problems (Bollard, 2011, p. 1). Unlike many countries the financial and banking system of the country remained more stable and consistent in terms of growth of the overall economy. Banks are the most important financial intermediary in the economy of New Zealand and this is comprised of 80 percent of the total asset transaction of the economy. The banking system of the country provides 90 percent of financial assistance to the entire economy of the country. Hence, the banking system and changes in this banking system creates the most important concern for economists and policymakers. During the period of introduction of the Global Financial Crisis the banking system of the country affected negatively, just like other countries of the world. The volume of financial transactions reduced during this time. Prices of different goods and services increased in this time. All these affected negatively the overall economic structure of the country by reducing the level of investments made in the country (Christensen and L?greid, 2007, pp. 139-141). During this time the country’s banking system were engaged in various economic as well financial activities, such as providing loans to households and the rural sector of the country, providing financial assistance to business organizations for the purpose of production of goods and services in the economy etc. After the onset of the Global Financial Crisis the banking system of the country started to witness decline in the lending standard of the baking and financial structure of the country. According to Dr. Alan Bollard, “however, New Zealand’s conservative application of the regulatory capital regime (under both the original Basel I and the new Basel II frameworks) helped to promote sound risk management and the banks appear to have steered clear of the dubious lending practices evident in parts of the non-bank sector” (Bollard, 2011, p. 1). In the face of the Global Crisis, the banking system, in particular, and the financial structure of the country, in general, required the supports from the public sector. These supports were comprised of financial assistance as well as financial security. The government of New Zealand in effect implemented policies including both retail as well as wholesale funding guarantees for the purpose of providing greater confidence to the banking system of the country. The Reserve Bank implemented various policies during this time. Among these policies the most important one was expansion in liquidity facilities provided to different banks and other financial intermediaries of the country. This policy was implemented by the central bank of the country in order to keep the banks and other financial intermediaries remained liquid as well as well-funded. The lead-up of the Global Financial Crisis economists and policymakers of the country realized that the most important drawback of the financial system and banking system of the country lies in the rapid spreading out of credit during this period of time. This rapidly expanded credit policy of the banks of the country caused a tendency of the banking system of the country to increase the volume of credit in the wholesale funding of the country from offshore. In contrast to this situation, Dr. Alan Bollard argued that “unlike banks in the Northern Hemisphere, the banks’ own capital buffers proved sufficient to absorb the rise in non-performing loans and accompanying decline in profitability that followed from the economic slowdown” (Bollard, 2011, p. 1). In the country, banks and other financial intermediaries played an important role in developing the economy and also increasing the growth rate of the country. The Global Financial Crisis caused banking system of the country to learn more about the ways of executing financial transactions in the face of global crisis. ‘Under the Reserve Bank Act, the Reserve Bank has a legislative mandate to promote the “soundness and efficiency” of the 2 BIS central bankers’ speeches financial system’. In order to increase the performance of the banking system of the country it became more necessary for making changes and transformations in the banking system of the country. It became more necessary for policymakers and the government of the country to implement stringent monetary and fiscal policies in the economy (Daquila, 2007, p. 200). After the Global Financial Crisis monetary policies became the most important policies which were aimed at introducing a direct transformation of the banking system of the country. In New Zealand also monetary policies played an important role in developing the functioning of the banking system as well the financial system of the country and also to reduce the intensity of effects of the Global Financial Crisis (Bollard, 2011, p. 2). The most important role of the banking system of the country is to contribute in the development process of the concerning economy and also to improve the standard of living of citizens of the concerned country. These improvements in standard of living are done by providing a variety of services to all economic agents of the country. According to Dr. Alan Bollard, “these include clearing and settlement systems to facilitate trade, channeling financial resources between savers and borrowers, and various products to deal with risk and uncertainty”. Although these services can be provided by various financial intermediaries or banks or directly by capital markets of the country, banks are the most important source of financial transactions in any country (Daquila, 2007, p. 201). Banks are the most efficient provider of financial services for any economy. Banks provide financial services in a cost-effective way which is very difficult for capital markets or any other financial intermediaries, such as mutual funds, share markets, cheat funds etc., to achieve. Banks are specialized financial institutions which assess credit worthiness of borrowers and provide ‘an ongoing monitoring function to ensure borrowers meet their obligations’. Banks ‘are rewarded for these services by the spread between the rates they offer to the accumulated pool of savers, and the rates they offer to potential borrowers’. This procedure of performing banking transaction is the heart of the modern banking system and it is known as “maturity transformation” (Bollard, 2011, pp. 2-3). The banking system of New Zealand has been the kind of banking system where large amount of loans and the largest part of the asset of the entire banking system is given to households and business organizations. Lowest portion of the total asset of the company has been allocated in the form of securities for trading purposes. The banking system of the country do not depend much on the international insurance markets and the main focus of this banking system has been to rely more on the wholesale market of foreign countries, mainly on the short-term funding markets (Global Financial Stability Report, October 2010: Sovereigns, Funding, and Systemic Liquidity, 2010, p. 76). However, the capital market of the country has been underdeveloped throughout the history which forced households as well as business organizations to depend more the banking system of the country. Due to this greatest dependence of all economic activities and financial transactions of the country on the country’s banking system has been creating great problems for the country. Failure of one larger bank of the country could have negatively affected the entire financial as well as economic system of the country. This could have reduced the growth rate of the economy and could have caused the economy to suffer from the Global Financial Crisis to a great extent (Bollard, 2011, p. 5). The most important role of the banking system of the country has been transformation of ‘short terms deposits into long term lending’. The banking system of New Zealand performs this task mainly for the rest of the economy. But the major problem with this banking system is that it makes the financial system of the country more fragile. According to Dr. Alan Bollard, “this process exposes banks to illiquidity or possibly insolvency given the possibility of bank runs from depositors and creditors, or deterioration in lending quality. Banks’ own practices and financial regulation have an important bearing in reducing or amplifying this risk”. Hence, after the occurrence of the Global Financial Crisis economists and policymakers of the country tried to implement policies aiming at greater integration with the world economic circumstances and also with the greater reliance on the global lending markets (Bollard, 2011, p. 5). The less-dependent nature of the banking system of the country on global financial markets has helped the country and its economy to suffer less from the Global Financial Crisis. However, the country’s banking system was largely dependent upon the transactions of goods and services in international markets through trade of various products and services. In the face of the Global Financial Crisis, international transactions of these goods and services have been reduced to a great extent and the country started to develop its own markets for different goods and services. This policy of the government helped been supported by the banking system of the country. Large amounts of loans had been provided to direct producers of various goods and services across the country. With greater volume of production of goods and services within the economy and also with greater amount of reliance on the world economic as well as lending markets the country became able to catch up with the world economic progress and economic development (Bollard, 2011, pp. 7-8). The greatest interdependence of the banking system of the country with the rest of the economy caused the country and its economy to suffer from the Global Financial Crisis. Failure in the banking system of the world forced the country’s banking system to suffer. But the less dependent nature of the banking system of the country on the global financial and banking system actually helped the country to get rid of the financial crisis situation more quickly than lots of other countries, such as United Kingdom and United States of America. The banking transactions, credit intermediation process, and generations of savings in the country were disturbed due to the introduction of the Global Financial Crisis. Hence, policymakers and the government of the country took monetary measurement policies to solve the crisis situation. These monetary changes were made in the economy of the country mainly in the face of the Global Financial Crisis (Daquila, 2007, p. 219). The most important monetary policy change which was made in the process of transformation of the banking system of the country was changes in the rates of interests. The rate of interest on the loans provided to various households and business organizations for direct consumption purposes were raises by the central bank of the country. This increase in the rate of interest forces households and business organizations to take lesser amounts of loans for direct consumption purposes. This tendency of households and business organizations helped the economy with greater amount of loans available to provide to the rest of the economy for the purpose of increasing the level of production within the economy. This greater amount of production of various goods and services were aimed at increasing the level of level of economic activities within the economy and thus to reduce the increase in prices of various goods and services (Policy Responses to the Economic Crisis: Investing in Innovation for Long-Term Growth, 2009, pp. 9-10). Global Financial Crisis commercial caused banks of the country to get instructed by the government and policymakers to provide greater amounts of loans to those business organizations which were engaged into the direct production of goods and services in the country. This policy of the country helped it to avoid the intensity of the Global Financial Crisis to a great extent. On one hand this increase in the rate of interest increased the volume of economic activities within the economy and also reduced the dependence of the country’s economy on the global markets for different goods and services. Again interest rates on loans given to the direct producers of various goods and services were increased during this time. This fall in the rate of interest encouraged business organizations to take loans from banks and to produce larger amounts of goods and provide better services to the economic agents of the country. This fall in the rate of interest also encouraged business organizations to implement technological advancements into the production processes and hence, the path of greater economic growth and economic development were set in during this time (inspite of greater prevalence of the Global Financial Crisis) (Bollard, 2011, p. 5). In the face of the global contagion in the banking system of countries across the globe the interlinkage of the banking system of the country with the banking system of the rest of the world caused the economy to suffer from the problem of the Global Financial Crisis. But the Global Financial Crisis could not affect much the economy of New Zealand because of the fact that the economy was not linked much with the global financial system. In Dr. Bollard’s own words, “despite a tightening in lending conditions and standards, which had a significant effect on some businesses, our banking system was largely able to maintain the confidence of depositors and creditors”. Also during this time the financial system of banks of the country was made more efficient. Banks were targeted to operate in more competitive market structure with greater volume of credits provided by the government for the purpose of increasing the level of investment in the country. All the formal and informal barriers of the banking system of the country were reduced and hence, the level of competition was increased. The Payments New Zealand (PNZ) program helped the country by shifting funds and assets from one bank to the other and thus raising the level of fund base in the economy (Bollard, 2011, pp. 5-8). Global Financial Crisis and the effectiveness of changes: The monetary and systematic changes of the banking system of the country helped the economy to a great extent to fight against the Global Financial Crisis. The level of debt crisis and lower credit ratings of the global banks also caused the country to suffer from the Global Crisis. During this time the US financial structure was rated by the financial rating agencies lower credit ratings compared to the past. This lower rate of credits provided by US banks caused many countries, including New Zealand to suffer from lack of capital and investments. However, lesser dependence of economy of New Zealand on the rest of the world’s financial system, in general, and on the US financial system, in particular, actually helped the country to suffer less from the Global Financial Crisis. Also implementation of various monetary and fiscal policies and most importantly the transformation of the banking system of the country actually helped the country to avoid the intensity of negative effects of the Global Financial Crisis (Reserve Bank of New Zealand bulletin: Volume 66, 2011, pp. 157-161). Conclusion: Global Financial Crisis of 2007-08 caused many countries of the world to suffer from lack of investment and credit, reduction in various economic activities and also from various other economic problems. New Zealand suffered comparatively less from the crisis situation mainly because of lower dependence of the economy on global financial and economic system. However, the banking system of the country was transformed into more efficient banking system to augment the path of economic development in the country. These banking transformations mainly considered monetary changes like changes in rate of interests and changes in financial activities of various banks across the country. These changes not only helped the country to avoid the intensity of negative effects of the Global Financial Crisis, but also helped the country to build an efficient financial as well as banking system within the prevailing economic structure of the country. References: Bollard, A. (2011), The role of banks in the economy ? improving the performance of the New Zealand banking system after the global financial crisis, Speech by Dr Alan Bollard, Governor of the Reserve Bank of New Zealand, to the New Zealand Shareholders Association Annual Meeting, retrieved on February 21, 2012 from http://www.bis.org/review/r110810b.pdf?frames=0 Campbell, R. M. (2011), The Politics of Postal Transformation: Modernizing Postal Systems in the Electronic and Global World, USA: McGill-Queen's Press Christensen, T. and L?greid, P. (2007), Transcending new public management: the transformation of public sector reforms, USA: Ashgate Publishing, Ltd. (139) Daquila, T. (2007), The transformation of Southeast Asian economies, USA: Nova Publishers Global Financial Stability Report, October 2010: Sovereigns, Funding, and Systemic Liquidity, (2010), USA: International Monetary Fund (76) James, C. (2011), Global Financial Crisis, USA: Cengage Learning Policy Responses to the Economic Crisis: Investing in Innovation for Long-Term Growth, (2009), OECD, retrieved on February 21, 2012 from http://www.oecd.org/dataoecd/59/45/42983414.pdf Reserve Bank of New Zealand bulletin: Volume 66, (2011), New Zealand: Reserve Bank of New Zealand Read More