The Global Economic Situation - Coursework Example

I. Thesis: The reasons for market failure due to failure in banking system and steps taken to overcome it. II. Market Failure A. Supervision B. Financial System C. Export Information Collection and Use in Decision-Making Customer’s Name: Course: Economic Situation 30 March 2009 Market Failure The year 2008 was marked by volatility in the world stock market due to sub prime mortgage crisis. Market fluctuations in the US markets exerted a profound influence on world markets. There were times when no satisfactory explanation could be found for the fluctuation in prices. Once the US market tumbled the markets around the world followed the suit1. The Global Crunch of 2008 Lehmann Brothers, Northern Rock are just some of many banks to go bust in the year 2008, the cash in hand is an integral part for any bank and no bank can function without cash in hand also known as equity. These are just some of the biggest names to have fallen short of equity and all this started because of the excess loans issued by the banks to the people in the US. They took it for granted that the house prices will rise and blindly invested all their money in real estate but to the dismay of many people, the house prices fell and the people who borrowed loans from the banks were left with insufficient money to pay back to the banks, hence shortage of equity occurred, this whole even is also known as the subprime crisis and this started in the US. Reason for the Failure of Banks Persistent industrial loan defaults and massive loan losses have become a regular feature in developing countries. According to Hoque (2004) and the World Bank (1993) 150 development banks in 33 developing countries have been haunted by massive debt default and loan loss2. The present subprime mortgage crisis that hit the credit markets and banking systems is due to the increase in loan defaulters, thus making the banks to bankrupt. Industrial Development Finance Institutions (IDFIs) are expected to stimulate industrial investment in both private and public sectors in developed and developing countries. It is their role not only to inject capital, but also to blend capital with entrepreneurial skills to support industrial advancement in an underdeveloped economy3. A great variety of IDFIs has been established in the developed and developing countries since 1945, many following independence in the late 1950s and 1960s of former British and French colonies, to provide both medium- and long term loans to industrial and agricultural projects. There is hardly any developing country where there is not at least one development bank. Regardless of their variations in the set and functional roles, a large number of development banks in Asia, Africa and Latin America are now jaundiced by persistent debt defaults. In fact, there are few IDFIs in developing countries like India and China, which have not been adversely affected by persistent debt defaults4 5. It has been found that debt default occurs due to borrower’s inability or unwillingness to repay debt. It may be that there are borrowers who are willing, but not able to repay debt. Again, there are borrowers who are able, but not willing to repay debt — debt default arises in both cases. However, this chapter concentrates on the borrowers’ ability to repay industrial debt, rather than willingness to repay industrial debt. The ability to repay industrial debt is influenced by a number of factors relating to industrial financing. In particular, what industrial project is financed; how it is financed; how its management from the set up stage to loan liquidation stage is helped by an IDFI is very important. As regards what type of industrial project is to be financed, the development bank must, of necessity, restrict itself to financing only those development projects that are bankable. The choice of a project lies within the developmental role of a bank. As a development institution, a commercial or an IDFI should deal with those projects with the highest ranking on the development-impact scale and as a banking institution, it should finance those projects with the highest ranking on the interest-rate scale. It means that a bankable project should satisfy both developmental and financial criteria, unlike a commercial bank that stress the financial role rather than the developmental role6. It appears from the above that debt default may arise if the development bank finances non-bankable projects that are not capable of generating enough income within a reasonable time to cover the costs of operation, repay the principal debt, meet costs of borrowing and earn enough profit to motivate its promoters to remain in operations7. The role of a development bank, particularly a public industrial development bank, is not solely confined to the supply of medium- and long-term loans and/or equity. Unlike other financial institutions such as trading or commercial banks, development banks are expected to direct and guide the use of loans, to nurse an enterprise, and to play a developmental or promotional role in addition to their financial role8. The developmental or promotional role of an industrial development bank means getting involved in the formulation, initiation and organization of industrial development; behaving like an entrepreneur who, perceiving or seeking out profitable investment opportunities, actually takes the initiative and leadership to conceive, fashion proposals and organize finance for new enterprises and actually execute them. Briefly put, it involves the entrepreneurial activity of taking the initiative of shaping up a business and getting it started9. Along with these promotional roles, development banks are expected to provide guidance to budding or new generation entrepreneurs in respect of selecting viable projects consistent with country’s industrial development objectives. While selecting industrial projects, a development bank should examine the ability and integrity of the top management of the enterprise. Financial System Changes in the international capital markets and deregulation of 1980s in US opened new possibilities for raising capital, investing and hedging risk. US have a highly developed financial sector. Historically, US were viewed as a commodity-based economy but have become a services-based economy during the past decade. The US financial market comprises banks, investment bankers, insurance industry, capital markets, foreign exchange market, equities market, debt securities market and the derivatives market. US are a key center in the world economic region for capital market activity. US markets have deep liquidity in foreign exchange, equities, debt and derivatives markets. US markets have benefited from the timely deregulation and high quality of institutional and operational infrastructure, supported by a highly skilled workforce10. Solution of this Global Problem The economy of the US is the most pivotal in determining how exactly the other major economies will be affected. Barrack Obama is in the white house now and a lot is expected from him. The stimulus package has already been planned by the president of the US and one can only hope and pray that the package works and rejuvenates all the major economies of the world. So everything depends on the stimulus package in place to deal with the various problems posed by recession. The stimulus package is expected to restore the required level of equity in the banks; this will also ensure that no such mistakes of over lending occur in the future. Conclusion The whole world is suffering because of the financial crisis; recession has badly hit the whole world. This reminds of thee 1930 great depression, people used to sleep under Hoover blankets and used to have empty pockets. That time is not far away unless something is done about this recession, the bailout package has been launched by the US, this package mainly includes providing more equity to the affected banks, and this will slowly but steadily solve this problem. It is predicted that this bad period will end soon and the good old days will be back soon. BIBLIOGRAPHY English J.W, Udell G.G. A preliminary innovation evaluation system for economic development systems. Journal of New Business Ideas and Trends, University of Ballarat, 2004, 2, 11–20. Udell G.G. Exploring the Rewards and Risks of Invention and Innovation. WIN Innovation Center, Southwest Missouri State University, Missouri. (2002). Knotts T.I., Jones S.C., Udell, G.G. Small business failure: the role of management practices and product characteristics. Journal of Business and Entrepreneurship, New Mexico State University, (2003), 15, 8–16. Kitchen, R.L. Finance for Developing Economies, John Wiley and Sons, New York. (1986). Kane J A. Development Banking, Lexiton, London. (1975). Hoque M Z. Flawed working capital loan policy and loan default : Evidences from Bangladesh, Journal of Accounting, Business and Management, Vol.11, No. 2, (2004), pp.202-213. Berger, B. The Culture of Entrepreneurship, Transnational Publishers, New York. (1991). World Bank, The. World Development Report, Oxford University Press, New York. (1993). Read More