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Can the Equity Markets Help Predict Bank Failures - Literature review Example

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In the paper “Can the Equity Markets Help Predict Bank Failures?” the author tries to answer the question: Whether the crises were predicted by different pieces of literature produced prior to the crisis? It will be evident that the era after the 1970s resulted in the de-regulation of the economic system…
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Can the Equity Markets Help Predict Bank Failures
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Download file to see previous pages Evidence indicate that the literature comprehensively provided an insight into what may actually happen due to the lending policies adopted by the banks and other financial institutions and as such if such practices continue, it may be difficult for the financial system to sustain the increasing pressures from speculative activities in which banks and financial institutions have engaged themselves into. The flight towards a less regulated market also resulted in the increased activity in speculation which further resulted in the decline in the credit quality and institutional memory loss. The lack of rational analysis of the projects, therefore, resulted in the defaults which finally drained the liquidity of the firms.
It was generally believed that the insolvencies of the banks are more threatening for the developing countries, however, the current financial crisis and resulting insolvencies of banks like Lehman Brothers is an ample example of how the financial system of the developed world can bear the heavy cost of bank insolvencies also.
This paper will discuss some of the evidence and predictions that were presented in the literature published prior to the crises and will especially focus on literature published prior to 2003.
Bank Failure
Caprio G & Klingbiel D (1996) is of the view that the bank insolvencies have increased since the 1970s and as such the losses are significant as compared to the losses that were incurred due to such bank insolvencies prior to such episodes. What is, however, significant to note that such bank insolvencies clearly indicate the misallocation of resources as banks failed to identify and book profitable projects which can self generate the cash flows to repay the loans taken against them. (Caprio and Klingebiel).
This analysis captures the real practices of the banks which continued in the 21st century also where banks continue to lend into those areas which were significantly riskier hence more detrimental to the overall health of the financial system. The lending into the subprime mortgage market is just one example of imprudent lending practices adopted by the banks in order to achieve higher profitability targets with a very limited and short term horizon. What is also significant to understand that there was a systematic shift towards achieving the short term results as compared to ensuring long term insolvency of the banking institutions.
Another analysis by Caprio G & Klingbiel D (1996) indicating that the worst affected of the crises would be Japan and other developing countries such as Argentine and Chile. (Caprio and Klingebiel). This study, however, failed to take into account the fact that such incidences can also happen into the developed world despite the fact that they have put in place a more robust and efficient regulatory framework in place. ...Download file to see next pages Read More
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