Recovery of Financial Markets and Institutions and Challenges in the Post-Crisis Era - Term Paper Example

RECOVERY OF FINANCIAL MARKETS AND S AND CHALLENGES IN THE POST-CRISIS ERA Introduction The impact of global financial crisis started dominating in the middle of 2007 and into 2008 and the world stock markets were fallen as a result of the collapse of large financial institutions. The governments of wealthiest nations introduced many rescue packages to bail out their financial systems (Shah, 2010). According to the World Investment Report 2010 presented by United Nations Conference on Trade and Development, the world economies have recovered from the global financial crisis (UNCTAD, 2010). The aim of this report is to study the recovery of financial markets and institutions and challenges which these institutions are facing in the post-crisis era. In this research essay, the impact of financial crisis on three major stock markets of the world including FTSE-100, NIKKEE and DOW has been studied. Moreover, the underlying factors contributing to the downturn of the stock markets have also been discussed. The report also highlights the recovery process and the performance of the stocks in the post-crisis era. In this report, the prospects of financial regulatory reforms and financial sector and economic growth have been discussed. Finally, the new trends on the financial landscape and changes in institutions have been discussed. Impact of Recent Financial Crisis on Stock Markets With the intensified banking crisis, the UK markets have suffered the most during the financial crisis and stock markets have been suffered from its worst fall in the history when FTSE-100 index of the big Britain giants declined by 391.06 points (Winnett, 2008). The following chart shows the FTSE-100 performance from 2007 to 2011. The table shows that the stock points declined very sharply at the end of year 2008 when stock markets were facing a huge impact of financial crisis. The index started declining around the mid of 2008 and in 2009 they touched their lowest level in the history. Figure I: FTSE-100 Index Historical Performance of Five Years Source: Yahoo Finance The following chart shows the DOW Index performance from 2007 to 2011. The table shows that the stock points declined very sharply at the end of year 2008 when stock markets were facing a huge impact of financial crisis. The index started declining around the mid of 2008 and in the first quarter of 2009 the index reached to its lowest level in the history. Figure II: DOW Index Historical Performance of Five Years The following chart shows the NIKKIE 225 Index performance from 2007 to 2011. The table shows that the stock points declined very sharply at the end of year 2008 when stock markets were facing a huge impact of financial crisis. The index started declining around the mid of 2008 and in the first quarter of 2009 the index reached to its lowest level in the history. Figure III: NIKKIE Index Historical Performance of Five Years Underlying Factors Contributed to the Decline of Stock Markets The global financial markets are strongly integrated markets thanks to the rapid process of globalisation. One of the major factors that lead to the current financial crisis is the real estate bubble. Actually 80 percent of the U.S. market is securitised because excess capital globally has been pushed into the U.S. mortgage market (Stock Market Investors). Before the financial crisis, the world was facing the greatest expansion of leveraged debt and greatest explosion in the prices of the equity markets. All kinds of financial markets such as NASDAQ 100, Platinum futures, oil prices or gold stocks, started demonstrating the power of trend-following crows on the up and down sides of the markets and in this way the four-hundred years of market history destructed and with the unwinding of leveraged debt, the prices and confidence of investors destroyed (Wakefield, 2008). The financial crisis penetrated into the world’s stock markets because stock market is one of the major activities in the corporate world. Dash & Mallick explain that the indices of the stock markets are the primary indicators of the economic activities and their movement determine the future economic outlook which means that a falling stock demonstrates the declining investment climate and a rising stock reflects stability and confidence of economy. When financial crisis hit the real activities, the stock markets got more vulnerable to the crisis and the financial investments declined. Actually the reduction in financial investments directly influences the real investments and with the decline in the real sector activity, the entire world economy got affected. Therefore, the major factor that contributed to the downturn of stock market was the confidence and expectations of the investors in the real investment and financial sector of the economy. Recovery Process and Performance of Stock Markets in Post-Crisis Era Economists have found a significant relationship between the stock markets and monetary and fiscal policies. European stock market has long term elasticity with Federal Funds Rate and the value of elasticity is +0.001 percent which means one deviation increase in Federal Funds Rate increases the European Dow Jones Stock by 0.001 percent. A positive relation has been also observed between NASDAQ and Federal Fund Rate (Anaraki, 2010). Therefore, the world stock markets have been influenced by the changes which have been made in the monetary and fiscal policies. The major changes which have been made include the changes in interest rates and stimulus packages. In order to cushion the economies from the impact of financial crisis, fiscal stimulus packages have been announced by various economies. For example, in Cape Verde, 17 percent increase in public spending was announced in 2009, Egypt government announced the stimulus package of 15 billion Egyptian pounds, Namibia increased public sector pay rise by 24 percent and South Africa announced $69.4 million three-year public investment programme (United Nations Economic And Social Council Economic Commission For Africa, 2009). However, there are different views of the economists about the role of fiscal and monetary policies in the recovery of the economy. Durham (2007) argues that monetary policy changes and long-run stock market performance have very weak correlation. Some new Keynesians argue that monetary policy saved the economy and the timing of the monetary policy role plays a significant role whereas, some argue that in real business cycle model, the economy had to recover regardless of the policies of the government and even if the government would not have not changed the fiscal and monetary policies, the economy would have recovered (Thoma, 2011). Steven, Arief and Chink (2011) from Asian Development Bank conducted a research on eight small open economies including UK, Australia, New Zealand, Canada, Korea, Thailand, Indonesia and Malaysia. The research findings of the authors suggest that on average one percent point increase in the interest rates of these countries result in one percent appreciation of exchange rate and one percent decreased in market indices. However, authors have found no evidence of change in the effect of monetary policy during the financial crisis in Organisation for Economic Cooperation and Development (OECD) countries and stronger effect of the monetary policy on the stock markets of non-OECD countries. The following are the three charts of three stock exchanges including FTSE-100, DOW and NIKKIE. These charts are showing the performance of three stock indices over the last one year. In other words, these charts are showing the performance of the stock indices in the post crisis era. The chart shows that from August 2010, the stock performance of FTSE-100 started improving. In the period of the financial crisis, the index reached the level of below 3500 points in 2009, however, from August 2010; the index improved and in 2011 it has reached to the level of 6000 points. The performance of the index is improving which shows a positive sign of stability of FTSE-100 in the post-crisis era. Figure IV: One year Chart: FTSE-100 Source: Bloomberg The following chart shows the stock performance of DOW index from September 2010 to present and the chart shows that the stock performance of DOW started improving. In the period of the financial crisis, the index reached the level of below 3500 points in 2009, however, from September 2010; the index improved and in 2011 it has reached to the level of 12000 points. The performance of the index is improving which shows a positive sign of stability of DOW in the post-crisis era. Figure V: One Year Chart: DOW Source: Bloomberg The following chart shows the stock performance of NIKKIE index from September 2010 to present and the chart shows that the stock performance of NIKKIE started to improve. In the period of the financial crisis, the index reached the level of below 3500 points in 2009, however, from September 2010; the index improved and in 2011 it has reached to the level of 10500 points. The performance of the index is improving which shows a positive sign of stability of NIKKIE in the post-crisis era. Figure VI: One Year Chart-NIKKIE Source: Bloomberg Prospects of Financial Regulatory Reforms and Implications for Financial Sector and Economic Growth As world economies have been able to recover from financial crisis, however, in order to prevent another crisis in future, the financial regulator reforms become very critical. Walter (2010) has presented a plan and prospects for financial regulatory reform on the behalf of Securities and Exchange Commission in California. In this plan, the prospects of financial regulators forms have been discussed and five principles have been presented. The first principle of regulatory reform is to manage the systematic risk and to protect the investors in a balanced manner. Therefore, it is expected that the reform bill will address the systematic risk through the identification and regulation of financial companies which are huge in size and interconnected and there is a risk that their collapse can threaten the financial system. The second principle focuses on restructuring of the current regulatory framework so that the gaps and weaknesses can be eliminated. Moreover, the reforms will increase the transparency of markets in order to enhance the control of regulators on the products and markets. To achieve this principles various reforms were offered such as the rules to enhance the investors’ protection in asset-backed securities. Third principle is to bring reforms that can ensure that consumers receive same level of protection on the purchase of comparable goods without considering the financial professionals. To achieve this principle, Securities and Exchange Commission may adopt the rules which will standardise the conduct of financial professionals. Fourth principle is to enhance the role of reputational intermediaries in reducing the conflicts, fostering competition and increasing transparency. The prospective reforms in this regards generally deal with increasing the regulatory control of Securities and Exchange Commission on credit rating agencies. Fifth principle is to ensure the enforcement of existing laws and regulations in a fair manner to avoid wrongdoing and misconduct. In addition, various economists have presented their views on different kinds of reforms. The mentioned prospective financial regulatory reforms are demonstrating an enhanced control of regulators. The description of the reforms shows that they have the potential to contribute to the growth and prosperity of financial and economic sector. The reforms have the potential to increase regulatory control on the large companies which directly influences the economy. The high regulatory control will also allow the policymakers to increase the market transparency thereby, giving fair opportunities to investors. New Trends on the Financial Landscape and Changes in Institutions’ Behaviour towards Risk The global financial crisis has provided various lessons to the financial institutions. The financial institutions are seeking to undergo the impact of some major financial regulatory reforms. The new trends seem to create a new financial landscape. McKinsey Global institute has identified various new trends on the financial landscape after the crisis. The report identifies that the major shift has taken place in the real estate and equity markets. The prices of the global residential real estate have declined because of the decline in the demand of the property. One reason because of which global financial crisis extended across all the world economies was the highly integrated and globalised market. However, after the financial crisis, the financial globalisation is expected to be reversed which means that the cross-border capital flows have fallen. The new financial landscape will result in less globally-integrated market. Another trend after the crisis is the slower growth in the nature financial markets. For example, private debt and equity investments will reduce because the companies and households are seeking to reduce their debt burdens. The report of McKinsey Global Institute considers the slow growth of the mature financial markets as a temporary trend in the financial sector. Moreover, in the global capital markets, the role and importance of emerging markets will increase because the global financial crisis had only created temporary interruptions in the financial systems of emerging markets. The new trends are expected to bring significant changes in the behaviour of institutions towards risk. For example, financial institutions will become more careful in making investment decisions and prioritising decisions. The institutions will become more careful in their organic growth and acquisition opportunities. To avoid credit tightening, financial institutions will become more able to improve their liquidity conditions. The investors will not aggressively invest in the equity and real estate markets which will not result in the rapid growth of these financial sectors. Based on the above discussion, it has been analysed that global financial crisis has significantly affected the financial markets of most of the economies. The current situation of the financial market is showing positive hopes however, the financial crisis has led to various new trends on the financial landscape which is expected to influence the behaviours of the financial institutions. The financial regulatory reforms are expected to increase the control of regulatory authorities on the financial institutions. Since it has been observed that the economic conditions have changed, therefore, it is also expected that the changes in economic conditions will directly influence the way the financial markets and institutions work. I am of the opinion that the new economic conditions have created various challenges and opportunities for the financial institutions and markets. As the foreign capital flows have reduced after the crisis therefore, the financial institutions will become more risk oriented. Their decisions will be largely influenced by the macroeconomic policy. The increased regulatory control will increase the accountability of these institutions towards their environment which will make them to be more careful in their financial decisions. The change in behaviour of consumers will make the financial institutions to increase their professionalism and transparency. The lack of confidence of the investors will encourage the institutions to revise and reconsider their policies. Moreover, the low growth in a few financial sectors such as real estate and equity markets may insist the financial institutions to explore other kinds of investment opportunities. Bibliography Anaraki, N. K. (2010). The European stock market impulse to the US financial crisis. Retrieved February 22, 2011, from http://www.aabri.com/OC09manuscripts/OC09012.pdf Bloomberg. (2011). Stock Market Data. Retrieved February 23, 2011, from http://www.bloomberg.com/markets/ Dash, A. K., & Mallick, H. (2008). Contagion Effect of Global Financial Crisis on Stock Market in India. Retrieved February 22, 2011, from http://www.devstud.org.uk/aqadmin/media/uploads/4ab8f3d388d84_SA7-kumardash-dsa09.pdf Durham, J. B. (2007). 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