Influence of the Financial Crisis on International Business - Article Example

The current financial crisis is considered as one of the worst crisis in the history of modern financial history. The systematic collapses of the strongest financial institutions and resulting contagion effect that engulfed other sectors of the economy speaks volume about the overall severity of the crisis and its impact on the different macroeconomic variables. The current financial crisis started with the sub-prime mortgage crisis however, soon it appeared that there may be some critical reasons that caused the current crisis. It is also critical to note that the financial markets do not often work best when they are left alone and as such there shall be some intervention by the government in the form of regulations. This argument becomes more pertinent in the wake of current financial crisis which many believe is a direct result of a de-regulated and highly independent financial system. The globalization of finance therefore is something which is now considered as something which may not be entirely good for the national and international economies. There can be many reasons that have culminated into the present crisis and as such governments tackled this issue more swiftly. However, question still remains as to why such episodes of extreme crisis happened despite the fact that financial system was considered as safe and sound before the emergence of the crisis. This paper will attempt to explore the causes of the financial crisis and what steps the government of UK can take to reduce the danger and risk of any such crisis in future. Most apparent reason for the financial crisis was labeled as the sub-prime mortgage crisis which resulted into defaults by the sub-prime borrowers on their mortgage obligations with the financial institutions. The process of securitization further added the fuel to this whole drama because most of the financial institutions, through their special purpose vehicles, securitized their mortgage portfolios and tied the cash flows received from their subprime mortgage portfolio with that of the securitized securities. This mismatching of the cash flows therefore resulted into the credit crunch and extension of credit to private sector therefore was reduced causing the credit crunch and started the chain reaction for the current financial crisis. What is also significant to understand that the craze of securitization increased a lot as many countries started to use this process in potentially more speculative dimensions? The spreading of the securitization however, made this process more complicated and as such very few had the capability to understand as to how the process of securitization is interconnected with each other across the markets and what can be its impacts on the markets.(Davis,2009). However, there are other some critical reasons that need to be understood and explored in the broader context of the whole issue. The period after the Second World War witnessed rapid growth in the international trade, investment and communication flows. The rapid improvement in the technology resulted into the more efficient communication and flow of goods and services across the globe. However, the increased process of globalization also resulted into the globalization of finance which allowed money to flow more freely and integrated the markets with each other.(Hirst & Thompson,2002). However, the impact of one market over other became more vivid as adverse shocks to one market carried the capability to have serious repercussions for the other markets. What is also critical to note that the integration of the financial markets loosened the control of central banks of the world to exercise the monetary policy in its strict traditional sense? This not only creates the risks that are external to the economy but also result into the fact that the monetary policy authorities cannot control the international financial institutions.( Gangopadhyay,2005). Further, the process of globalization also resulted into a complete shift into the way traditional banking models were practiced. Finally, globalization created liberalization and hence easy flow of money from one country to another. This flight of capital however, resulted into the artificial booms and busts. The reduced cost of financing in international markets made it easier to leverage thus invariably fueling the asset prices to fluctuate more freely across the borders. (Wheeler, 2008). The circumstances that led to the failure of Northern Rock reflect upon the possibility of the regulatory failure and increased systematic risk to the overall financial system of the UK. The failure of the regulatory agencies, especially with reference to the UK, also includes the inability of the regulatory agencies including FSA to understand the latest developments that took place in the financial markets.(Lastra,2008). The rapid financial progress that took place in recent times was not fully captured by the regulatory agencies. Due to this reason, banks and other financial institutions often undertook risks that were beyond their individual capacity to handle. Further, lax regulatory environment also allowed financial institutions to develop the financial products that were more complex in nature and put financial institutions at more risks. (McIlroy,2008). The crisis further augmented due to the fact that due to high rates charged by the banks on their mortgage loans made it more difficult for the consumers to pay off. This also led the consumers to reduce their spending hence reducing aggregate demand which forced businesses to lay off their workers hence increasing the unemployment and making things more worse. Finally, the role of FSA was only to check or audit the legal form of financial institutions rather than their economic substance and value. This however, resulted into the widening gap between how the banking was actually practiced and how regulatory agencies conceived the banking and financial sector to work. Considering the above, following steps can be undertaken to reduce the risk of future events of this nature: Probably one of the most important steps that the UK government can undertake will be to further strengthen the role of its central bank. Central Bank shall have more role in the overall affairs of the financial institutions and regulatory role of Bank of England and Financial Services Authority shall be balanced so that central bank has more dominating role. Firstly, the government through its regulatory bodies must ensure that the banks and financial institutions shall not engage into the speculative activities and must restrict them, through regulations that they must not carry out transactions that are more speculative in nature and carry significantly more risks. Secondly, the criteria for obtaining the mortgage loans and other consumer loans specially shall be further stringent so that not only banks make more responsible lending but loans shall only be granted to those borrowers who have the required credit worthiness to borrow. As discussed above that the financial institutions focused more on the short term results and banks and financial institutions were run by the marketing people with very little or no understanding of the overall risk management practices. Thus there is a need for having more efficient management practices with focus on the development of long term sustainability of the financial institutions. Corporate governance mechanism shall be strengthened through appropriate regulatory response and as such financial institutions shall be subject to more strict rules for accounting disclosures in their financial institutions. The current financial crisis is also a result of the regulatory failure and as such there is a greater need for completely revamping the existing regulatory environment by making it more risk sensitive in nature. Some of the steps will include strengthening the role of regulatory agencies including FSA and central bank as well as allowing international accords such as BASEL II to become leading regulatory apparatus to prevent banks and financial institutions from taking excessive risks. The current financial crisis is considered as one of the most sever economic downturns in the modern history of the world. The resulting economic downturn reduced the economic output as well as increased the unemployment and caused governments of many developed nations to pour in money to save the financial system from complete collapse. There are many reasons for the crisis including the process of securitization which became more complicated as the time went by. Similarly, the globalization also resulted into the integration of the financial institutions that created strong correlation between the markets and spillover effects of one market over another became more significant. This was what exactly witnessed by the UK whose crisis was mostly borrowed from the US. Finally, the failure of regulatory agencies exposed the weaknesses of the existing regulatory environment in predicting and avoiding such episodes. Steps such as strengthening the role of central bank, improving the existing regulatory environment to make it more risk sensitive as well as improving the corporate governance can serve as the guideposts to avoid any such episodes to recur in future. Specially, the role of monetary policy authorities shall be more elaborated in nature and banks and financial institutions shall be put to strong regulatory check and balance that can ensure the long term sustainability and viability of the financial institutions of the UK in general and world markets in particular. References 1. Davis, F (2009) The Rise and Fall of Finance and the End of the Society of Organizations. Academy of Management Perspectives. 23 (3) 27 – 44 2. Gangopadhyay. , P (2008) UWS economist reveals the role of globalisation in the current financial meltdown University of Western Sydney, Available: http://pubapps.uws.edu.au/news/index.php?act=view&story_id=2344 Last accessed 23rd February, 2010 3. Hirst, P & Thompson, G (2002) The Future of Globalization. Cooperation and Conflict: Journal of the Nordic International Studies Association. 37 (3) 247–266 4. Lastra. R. (2008). Northern Rock, UK bank insolvency and cross-border bank insolvency. Journal of Banking Regulation. 9 (3), 165-186. 5. McIlroy. D (2008). Regulating risk: A measured response to the banking crisis. Journal of Banking Regulation. 9 (4), 284–292. 6. Wheeler, G. (2008). Financial Market Cycles, Globalization, and the Current Banking Crisis”. Available: www.worldbank.org/html/extdr/financialcrisis/pdf/fin_market_cycles-gw.pdf. Last accessed 26 February 2010. Read More