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World financial crisis: reasons, trends, responses and perspectives

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... invested in real estate (due to cheap money and low indebtedness of population) First signs of tightening conditions seen this spring; due to liquidity problems ... – PowerPoint PPT presentation

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Title: World financial crisis: reasons, trends, responses and perspectives


1
World financial crisis reasons, trends,
responses and perspectives
  • Mojmir Mrak
  • University of Ljubljana
  • 2009

2
The structure of the presentation
  • I. Intensification of systemic risks in
    international finance
  • II. Immediate reasons for development and
    outbreak of the financial crisis
  • III. Key phases of the financial crisis
  • IV. Responses to the financial crisis
  • V. The impact of the financial crisis on the
    countries of Central and South-east Europe
  • VI. How to proceed?

3
I. Intensification of systemic risks in
international finance
  • Instability of exchange rates
  • According to the BW system, we live in a system
    of flexible exchange rates, where coordination of
    exchange rate policies is of extreme importance
  • Coordination of exchange rate policies was
    conceptually recognized, but it is not
    operational in practice (the rising BP imbalances
    confirm this)
  • Strong US and EU pressure on the Chinese exchange
    rate policy
  • Oil countries and their exchange rate policies
  • Recent movements of exchange rates

4
I. Intensification of systemic risks in
international finance (II)
  • Large balance of payments imbalances
  • During the last years, the BP imbalances have
    increased significantly
  • US have a huge BP deficit, Asia a great BP
    surplus, euro zones BP is around zero

5
I. Intensification of systemic risks in
international finance (III)
  • Difficulties in providing international liquidity
  • Extremely strong trend of liberalization of
    capital flows in the last two decades
  • Balance of payments imbalances have been mainly
    financed by private capital marginalization of
    official capital flows
  • Frequent financial crisis, especially in EE, but
    also in some developed countries have disclosed
    problems

6
II. Immediate reasons for development and
outbreak of the financial crisis
  • Long-term upward trend of real estate prices in
    the US

7
II. Immediate reasons for development and
outbreak of the financial crisis (II)
  • Large liquidity in the world

8
II. Immediate reasons for development and
outbreak of the financial crisis (III)
  • Problematic role of rating agencies in assessing
    the creditworthiness of complex financial
    instruments
  • Weaknesses in the supervision of some parts of
    the financial system
  • Agressive leadership model of financial
    institutions governance / management

9
III. Phases of the financial crisis
  • Outbreak of the crisis in the summer of 2007
  • The financial crisis breaks out as a result of
    macroeconomic factors (such as the crises in
    1980s and 1990s), or for reasons arising in the
    financial sector
  • The current crisis has occurred because of
    problems in the financial sector, specifically
    due to the plummeting of real estate prices (that
    hindered the servicing of debt)
  • The crisis began on the "sub-prime" segment of
    the US real estate market

10
III. Phases of the financial crisis (II)
  • Expansion of the crisis in the first period
    (autumn 2007 - August 2008)
  • Step one Transfer of the crisis from the US to
    investors around the world
  • Step two Transfer of the crisis from
    institutional investors to the interbank market
  • Step three Crisis starts spreading from the
    financial sector to the real economy
  • Deepening of the crisis in the second period
    (from September 2008 onwards)
  • Systemic risk increased with Lehman Brothers
  • Stock markets plunge in all countries
  • Strong tightening of inter-bank market

11
IV. Responses to the financial crisis
  • Responses to the crisis in the first period
    (autumn 2007 August 2008)
  • Providing liquidity by central banks and
    selectively reducing interest rates
  • Very limited and case-by-case usage of public
    funds for resolving the crisis
  • Short-term measures of regulators
  • Reporting banks / financial institutions losses
  • Deleveraging of banks / financial intermediaries
  • New business models in the financial sector
  • Self-regulation of certain subjects, such as
    rating agencies, sovereign funds

12
IV. Responses to the financial crisis (II)
  • General responses to the crisis in the second
    period (from September 2008 onwards)
  • Coordinated lowering of interest rates by key
    central banks
  • A more systemic approach of tackling the problem
    of financial institutions with public funds
  • Ensuring the solvency of banks by nationalization
    (partial / comprehensive, capitalization and
    forced mergers of banks in trouble and healthy
    banks, with the participation of public funds)
  • Guarantees to unblock the interbank market
  • Guarantees to deposits (first limited, then
    overall)

13
IV. Responses to the financial crisis (III)
  • General responses to the crisis in the second
    period (from September 2008 onwards) (cont.)
  • Spreading of the crisis from the Wall Street to
    the Main Street
  • Economic growth in the world was drastically
    reduced in autumn
  • Forecasts for 2009 are bad (recession in US and
    EU) and only a bit better for 2010
  • It has become more and more obvious that measures
    aimed solving financial sector would not be
    sufficient what is also needed are fiscal
    packages aimed at increasing economic growth

14
IV. Responses to the financial crisis (IV)
  • EU specifics in responding to the crisis in the
    second period (from September 2008 onwards)
  • Some basic problems of the EU in responding to
    the financial and economic crisis
  • Institutional specifics of the EU vs USA
  • EU does not have a serious budget at the EU level
  • EU has strongly decentralised supervision of its
    financial sector
  • Until September 2008 EU member stated had
    responded to the crisis exclusively at a national
    level
  • Broadening of the crisis has forced EU member
    states and especially euro zone countries for
    more coordination
  • Irish precedence concerning deposit guarantees
  • European Commission considers today the state aid
    much more generously than only half a year ago

15
IV. Responses to the financial crisis (V)
  • EU specifics in responding to the crisis in the
    second period (from September 2008 onwards)
  • Key elements of the package adopted by the
    European Commission the set of proposed measures
    included
  • Fiscal impetus at a member states level
    equivalent to EUR 170 bn
  • Increase of targeted investment
  • Increase the guarantee potential for bank
    financing
  • Increase of safety net expenditures
  • Temporary reduction of certain taxes
  • Temporary reduction of contributions
  • Fiscal impetus at the EU level
  • EIB loans equivalent to EUR 30bn
  • Increase of advance payment for EU cohesion funds

16
IV. Responses to the financial crisis (V)
  • Implications of the crisis on EU economy (from
    September 2008 onwards)
  • Deficits in majority of EU member states will be
    over 3 of GDP (over SGP treshhold) ratings of
    several eurozone members downgraded
  • Problems with raising funds on the international
    financial markets
  • Spreads over reference interest rates widened for
    many eurozone countries (discussion about union
    bonds)
  • Aceess limited to sovereign borrowers and
    borrowers with sovereign guarantees
  • Is it possible that an eurozone state defaults?
  • Real test for the euro
  • Increasing fear of protectionism (car industry)

17
IV. Responses to the financial crisis (VI)
18
V. Financial crisis and Central and South-east
Europe
  • Why are the CE and SEE countries more hurt by the
    crisis than other emerging country regions
  • Characteristics of the financial systems of the
    CE and SEE countries
  • High dependence of domestic banks of the
    interbank market
  • A significant number of foreign banks and thus
    much financing from abroad parent - daughter
    relations
  • Great credit expansion in the years before the
    outbreak of the crisis, much invested in real
    estate (due to cheap money and low indebtedness
    of population)
  • First signs of tightening conditions seen this
    spring due to liquidity problems of mother banks
  • It meant reduced access to capital for domestic
    banks and a significant increase of its price
  • Additional problem was the price erosion of real
    estate

19
V. Financial crisis and Central and South-east
Europe (II)
  • Why are the CE and SEE countries more hurt by the
    crisis than other emerging country regions
    (cont.)
  • The region has well defended itself against the
    financial crisis until September, despite
  • Higher price of money
  • Falling economic growth in partner countries
    especially EU
  • Deepening of the crisis after the collapse of
    Lehman Brothers the region got affected more than
    other regions because of
  • Partner EU countries enteres into a strong
    recession
  • Significant dependence on the interbank market
    which is blocked
  • Parent banks evaluate how to allocate available
    funds to its daughters (higher influence of
    country risk)

20
V. Financial crisis and Central and South-east
Europe (III)
  • Impact of the crisis on different groups of
    countries in the region Iceland has deepened the
    differenciation among countries in the region
  • The most affected are the countries with large
    balance of payment deficits and significant needs
    for foreign borrowing (the Baltic states,
    Hungary, Ukraine, Kazakhstan and Turkey and some
    of the SEE countries, especially Bulgaria and
    Romania)
  • Less risky are Central European countries, except
    Hungary, which are characterized by relatively
    lower dependence on the foreign interbank market
    (they have relatively more domestic deposits)

21
V. Financial crisis and Central and South-east
Europe (IV)
22
V. Financial crisis and Central and South-east
Europe (V)
23
V. Financial crisis and Central and South-east
Europe (VI)
24
V. Financial crisis and Central and South-east
Europe (VII)
  • Impact of the crisis on Western European banks
    and their states
  • Western banks have some 1,300 bn EUR of claims in
    the region the most exposed Austria, followed by
    Belgium and Sweden
  • Banks have problems raising funds on the market
    Moodys recently downgraded some of them
  • CE in SEE countries have to repay or roll over
    for some 400 bn EUR of credits in 2009
  • Due to the crisis, EBRD expects that some 10 of
    loans will become non-performing
  • High exposure of banks and states to the crisis

25
V. Financial crisis and Central and South-east
Europe (VIII)
26
V. Financial crisis and Central and South-east
Europe (IX)
27
V. Financial crisis and Central and South-east
Europe (X)
28
V. Financial crisis and Central and South-east
Europe (XI)
29
V. Financial crisis and Central and South-east
Europe (XII)
30
V. Financial crisis and Central and South-east
Europe (XIII)
  • Management of the crisis for the region
  • In the early stage (by the end of 2008)
    case-by-case approach with arrangements done for
    Hungary, Latvia, Serbia and Ukraine key role of
    the IMF in these arrangements
  • Later on (since January 2009) more talks about a
    rescue package for the region and for the western
    banks amount between 150 250 bn EUR
  • Austrian proposal for an EU sponsore package
  • Proposal for an EIB sponsored package
  • Proposal for increasing the funding potential of
    the IMF
  • 24 bn EUR package by EBRD, EIB and WB

31
VI. How to proceed?
  • Complexity of the current crisis asks for complex
    answers as in the following two directions
  • Macroeconomic policy measures
  • Measures within the financial sector
  • Macroeconomic policy measures how to make the
    crisis as short and shallow as possible
  • Monetary - further lowering of interest rates
    (FED vs. ECB) and maintaining liquidity
    (mistrust)
  • Fiscal - in addition to financial, also fiscal
    measures, to prevent the collapse of the "Main
    Street" and possibly of the "Wall Street" in the
    future
  • Price of these measures (worse fiscal position
    and less favourable ratings pressure to make
    the GSP softer pressure on ECB's independence)

32
IV. How to proceed? (II)
  • Measures within the financial sector how to
    reestablish a healthy development "lifeblood"
  • Short-term to extinguish the fire and to
    stabilize the sector
  • Measures to reestablish confidence (in terms of
    deposit savers, and interbank business European
    specifics problems with implementation)
  • Measures to ensure the solvency of banks
    (potentially negative impact to the real sector
    moral hazard problem)
  • More complete disclosure of information about the
    complex financial instruments (to systematically
    tackle the problem, it is necessary to know its
    exact scope)
  • Assisting emerging" countries without their own
    financial packages (pulled in the crisis, this
    time not by their own fault IMF vs others)

33
IV . How to proceed? (III)
  • Measures within the financial sector (cont.)
  • Long-term for systematic rehabilitation of
    national and international financial systems
    (globalization requires a new approach of global
    governance) two basic approaches
  • Idealistic establishment of a new
    international financial architecture in an
    multilateral world
  • A thorough institutional reform of the IMF with a
    substantially greater weight to emerging
    countries in its decision making (elimination of
    the US veto power and one voice for the euro
    zone countries)
  • Establishment of a framework for effective
    coordination of exchange rates and elimination of
    balance of payments imbalances (the role of
    countries with large balance of payments
    surpluses - "sovereign wealth funds")

34
IV. How to proceed? (IV)
  • Measures within the financial sector (cont.)
  • Long-term for systematic rehabilitation of the
    system
  • Realistic approach that is based on a national
    / regional level and strengthened cooperation
    between national institutions
  • To substantially strengthen the regulation and
    control over the entire financial industry (end
    of "shadow banking cooperation of national
    structures, particularly in the EU, centralized
    control of large banks central areas of
    regulation will be capital adequacy, liquidity,
    rewards danger of too much regulation)
  • Harmonization of differences in accounting
    standards for banks, regarding the valuation of
    securities
  • Improvement of risk management in banks and
    elimination of conflict of interests between
    individual banking products
  • The reform of rating agencies (the elimination of
    conflict of interests different views regarding
    regulation between the U.S. and EU)
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