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Financial Crisis and Their Possible Solutions - Essay Example

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The researcher of this essay aims to analyze the systematic risks, the role of central banks in financial crisis, and the short-term and long-term solutions to the financial crisis. Through the literature on financial crisis, it severity and effects will be established. …
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Financial Crisis and Their Possible Solutions
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"Financial Crisis and Their Possible Solutions"

Download file to see previous pages It is evidently clear from the discussion that financial crisis affected most parts of the world. It began in the US after the Difficulties in the US submarine market that had rapidly rocketed and spilled all over the world. Bordo et al find that the frequency of the financial crisis is higher than the previous one and can be comparable only to the Great Depression. It had detrimental impacts on different sectors of the economy in all countries. Reinhart, Reinhart and Rogoff have, in the past years documented the effects of the banking crisis that are typically proceeding by credit booms and asset price bubbles. They note that on average 35% real drop in housing prices stretch over a to almost six years. Equity prices fall over 55% over a period of 3 years, while output in those countries fall by 9% in two years, unemployment increases by 7% in four years while an 86% debt increase based on the pre-crisis level. Many models have documented the effects of the financial crisis. Adrian and Shin, Brunnermeier have documented a thorough review of the events preceding the financial crisis in late 2007 and early 2008. They note that the seeds of financial crisis can be traced back to the low interest rates policies adopted by the Federal Reserve and other world central banks after the collapse of the technology stock bubbles. The need for the debt securities by Asian banking institutions aided in fuelling the economic crisis. Acting as financial intermediaries, banks channel funds to potential investors. Through the process of borrowing and lending, they benefit from a diversified portfolio of risk sharing. They also act as monitors (Diamond, 1984) and streamline loans to well-organized customers (Gorton and Kahn, 1994) and other vital roles in maturity transformations. This implies that in crisis, every banking institution becomes concerned. For instance, Dell Aricia and Rajan (2008) provide that banks’ grief contributes to a decline in credit and low GDP .Further evidence provides that those sectors, which heavily depend on external financing, perform relatively dismal during the banking crises. These effects are stronger and severe in developing countries. In addition, the report note that over the last two decades, banking sector continues to be complex in its modes of operations. For instance, banks use various instruments to hedge risks. However, despite the complexity banks have remained sensitive to the panics and runs. Gorton (2008) note that holders of short-term liabilities feared to fund banks as they the anticipated losses in the sector could have in their securities. The recent research proposes two theories to give a tentative explanation on the causes of the bank panics and runs. One argues that panics are undesirable events caused by random withdrawals unrelated to the changes in the real economy. Bryant (1980) and Diamond and Dybig (1983) note that agents have uncertain needs that relates to consumption. If other depositors believe and can even further establish the slightest of evidence, then all the agents will find it rational and imperative to redeem their claims from banking institutions and will cause the panics and banks’ runs. Another theory explains that banking crises are natural outgrowth of the business cycle. An economic slump will reduce the value of the bank resources, heightening the possibility that banks are unable to meet ...Download file to see next pagesRead More
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