The financial crisis or bank crashes are not a new phenomenon; it could be impairing and harming the whole economy of certain countries and even affect the world wide economy in short period of time. In recent history, the world wide economy has been shock by several financial crisis. This show that the stability of the financial market is weak and the world still hard to prevent it to occur after undergo various financial crises in previous years. Financial crisis rarely happen in the last four decades, there’s 120 systemic banking crisis since the early 1 970 (Leaven and Valiance, 2008).
The most recent serious financial crisis was begun in August 2007, the origin of this mortgage crisis was in United State and it sent a wave of fear around world financial market. This financial crisis is the worst cases since the Great Depression 1 9305 and it causes a critical depression and recession in United State and even affecting virtually the entire global economies and financial market. According to Muckiness Mapping Global Financial Markets (Cot 2008), worldwide financial assets increase from 12 trillion USED in year 1980 to 196 trillion USED in year 2007.
However, the worldwide financial assets, economy ND other industry have shrink rapidly or affected during the mortgage financial crisis. The financial sector and the government might spend trillion of dollars to rehab or reconstruct in order to stabilize and keep banks and other business afloat. It could takes a certain period of time to recover the market after the crisis occurred, including a partial recovery in stock market. Also, they will figure out the causes of financial crisis or bank crashes in order to avoid the crises happen again in the coming days.
The causes of banks crashes / financial crises Credit Bubble There are three main categories to possibly explain the term credit bubble: global capital flows, the reprising of risk and monetary policy 1. Global Capital Flows In late 1 sass, the economies in China and other Asia countries grew rapidly, this factor influence their savings getting wealthy as well. The oil prices in global market raised sharply, the huge oil-production nations able to increase their capital and desire to invest in western country such as United States and Europe.
China, the big oil-producing nations and other huge developing countries had accumulated and form large capital surpluses. The interest rates of United States and Europe fall due to they received huge amount of loan from China, oil-producing countries and other developing countries. The reducing of credit spread causes the cost of borrowing to finance risky investments dropped significantly. The increase of investment in high-risk mortgages in United States and Europe form the credit bubble. Also, the United States’ monetary policy might one of the reasons the credit bubble formed but not the main reason.
Large amounts of inexpensive capital flew into the United States and Europe making borrowing inexpensive. American ND European used the cheap credit to make riskier investment than in the previous. The same phenomena happened in Europe. Germany saved, and their capital flew to Italy, Spain, Portugal and Italy. When there’s large rising in capital inflows to a certain economy such as United State and Europe, it will causes domestic lending increase significantly, particularly in the high-risk mortgages sector. Global imbalances are the essential cause of financial crisis or bank failure happen. . The Reprising of risk During the bull market, the optimism investors often under estimate the level of risk on what they invested. Once the market adjustment period occur, the investors will often comprehend that they’re exposing the more risk in their investments than originally anticipated. The return of investments depends on the level of risk; higher level of risk yield higher return. During market adjustment period, the relevant investment will be reprised for a certain level of extra risk. It is known as risk reprising.
When the market adjustment occurred during the supreme crisis in 2007, the mortgage- backed securities (MBPS) has rated as investment grade by the market, its way more risky than the “EBB” rated bonds. Thus, investors required higher rate of return on the bonds which tied to supreme mortgages. When the US housing market bubble crack and the financial market burst, investors reassessed the return they require for the risky investment, and what price they will pay for a risky asset. The credit spreads in every types of risk globally rising suddenly and the value of asset fall rapidly. . Monetary Policy According to Dry. John Brian Taylor (Professor of Economics at Stanford university), he said that the interest rates set by Fed are too low in year 2002 until year 2006 in United State and this low rates policy fueled the housing bubble as measured by housing starts. He believe that the housing boom and subsequent bust in the US financial crisis in year 2007 would be much smaller if the Fed rates did not followed the Taylor Rule (monetary policy formula for setting the funds rate).
Other than focusing on federal funds rate, Federal Reserve programs should concern on other instruments to reduce the cost of credit in marketplace and benefit every sector in economy such as in short term credit financing, the ability of money market mutual funds to fulfill investor requirement and the market rate in home finance as well. Although monetary policy not the essential causes in credit bubble but it might be an amplifying factor of it. In conclusion, credit bubble could consider as the essential causes of financial crisis. The global capital flows successfully lower the capital price in United Stated and some Europe countries.
The behavior of investors which prefer to invest “blindly/’ during the bull market will take a certain level of reprising risk when the market correction occurs. Lastly, the United States’ policy might not cause the credit bubble in Housing Bubble in year 2007 but it had contributed on it. The Speculative Attack The financial crisis in year 2007 – 2008 happened because we failed to constrain the financial system’s creation of private credit and money’, the former chairman of United Kingdom’s Financial Services Authority said this in Feb. 2013. Before the crisis occur, the public is simply easy to get loan from the bank.
This make the bank created large amount of money by making these loans. Based on the figure 1 below, the bank had created double amount of money and debt in the market. Figure 1: the money created by the Banks in United Kingdom The SKI banks spend the money they created between years 2000-2007 outside the financial area. Example, 31% of funds flew into residential property, it make the housing prices grew faster than wages. The consequence of pushing up the housing price affect some people cannot keep up with the repayments due to the debt increasing quicker than their incomes.
In this point, after the customer stop repaying their loans, banks realize they are in trouble of going bankrupt. These factors caused the financial crisis. The first reaction of the banks after the crisis is to limit their new lending to businesses and households. This action caused the market rice fall significantly and this shows that those who have borrow too much to speculate on rising prices forced to sell their assets so that they can repay their loans. After the crisis occur, banks usually will limit their lending due to they’re lack of confident that the loans will be repaid.
Although the banks started deduct the amount of new loans, but the public still need to keep up the repayments of debts which they already own it. This will affect the economy became more shrink and causing a recession. Conclusion The world has been experiencing so many of financial crisis cases and the uncial policy by government and the banking system have been improved every time after a crisis happen. However, none of the economist and financial analyst will provide a guarantee saying that the crisis would not happen again.
Maybe, we can limit and set a regulation to prevent the crisis to happen, however, the human greed in making more money will influence or encourage some people to break the existing rules. Example, the former chairman Of NASDAQ Bernard Lawrence Maddox Was getting caught due to scamming the client accounts for around 65 billion and other criminal charge. Even the financial market unable to prevent the crisis to occur again, but the investor can reduce the damage till the minimum point by invest in lower risk asset, capital or other investment items.
South Korea is a developed nation, high-income economy and known as one of the world’s wealthy country, it is also a member of COED (Organization for Economic Co-operation and Development). In additional, South Korea also the most industrialized COED country. The largest industry in South Korea is in Electronics; Telecommunications; Automobile Production and Chemicals. According to the MIFF (International Monetary Fund) World Economic Outlook Cot 2014, the GAP ranking of South Korea is 13th in global (about 1,449 billion U.
S Dollars) and is the 4th highest GAP country in Asia (right behind China, Japan and India) ; the ranking in GAP based on APP(purchasing power parity) valuation also is 13th in worldwide. Its inflation rate is at 1. 308% in year 2013 and the economic growth rate is at 7. 08%. After the war (Korean war, 1950), the capita income of South Korea (henceforth, Korea) was only $65 and it was one of the poorest countries in the world. In the last half century, Korea has achieved the growth rate averaging at 8% per annum and it is a great success emplace of one of the developing countries in the world history.
The Asian Tigers (Singapore, Korea, Hong Kong and Taiwan) transform their economy from the low-technology and agricultural model into high-tech economy model in just short period time. The countries such as Malaysia, Thailand, Indonesia and Philippines follow up with the Asian Tigers’ rapid industrialization. In early half of sass, the United State economy was better than ever which they achieve great growth with low inflation but the flourishing Asian countries’ economies was slowing down. In year 1 997, the Asian Financial Crisis devastates these countries badly.
Thailand, Korea, Malaysia and Indonesia are the countries which been hardest affected during the Asian Financial Crisis. History of Korea in Asian Financial Crisis in 1 997 Before the Asian Financial Crisis in 1 997, Korea already faced the degeneration of macroeconomic condition during 1995-1996. The rapid fall of demand for semiconductors in global market affect the export growth had decrease quickly in 1996 and it had a bad influence directly to the economy as well. Because of the economy are having the bad time, the stock market reflect the situation and it had fallen directly about 36% in 1995-1996 ampere with its 1994 peak.
In the summer of year 1997, the bad phenomena not yet swept away from Korea economy, the Asian Financial Crisis 1997 occurred. The Asian Financial Crisis 1997 was origin at Thailand after its economy collapse and it wave to other countries globally. No real macroeconomics distortions were inspected. The similarity factor that observed in the 5 most damaged countries (Korea, Malaysia, Thailand, Philippines and Indonesia) in this crisis were their inflation rate at less than 10 %, surplus in budgets and government foreign debt are declining.
In July, the argue Korea chasubles and also the Koreans 3rd largest maker, Aka Group have facing the difficulties in rolling their debts, it failed to pay $370 million value of liabilities and it forced to ask for emergency loans. Meanwhile, 8 of the top 30 chasubles were bankrupt. Example, the Hanna Steel declared bankruptcy in January and Jingo Group in April. The serial of bankruptcy of large conglomerates lead the Korea economy to unprecedented worst position. Between yearned 1996 and Swept 1 997, the Korean won depreciated at 8 % against the dollar. At the same time, the Thai baht depreciated at 42%,
Indonesian rapid at 37%, Malaysian ringing at 265 and Philippines peso at 28%. In October, the Korean won fail to maintain its high-value position and depreciated rapidly due to others’ countries’ currencies devalued by average of 40% ( Thai baht depreciated at 14% to SAID, Indonesian rapid at 54%, Philippines peso at 33%, Malaysian ringing at 34% and Korean won at 14%). Financial Restructuring In December 1997, Korean government have been restructuring huge scale of their financial system after they started receive the support by IMPs bailout funds in order to conquer the systemic banking crisis.
This restructuring plan has classified into 4 different stages. During the first stage, the Korean government ensures every type of main savings instruments were not legally covered by deposit insurance scheme such as life insurance policies. This action is to prevent the case of “investor run” and the burst of the system. In second stage, Korean parliament approved different of laws to build a legal and institutional infrastructures immediately to build integrity of financial system.
Example, the Presidential Financial Reform Committee has benefit on this issue and working for the whole year of 1997. When contrast with Indonesia and Thailand which had to take about 1 year to originate the legal and institutional infrastructures immediately in order to bear in financial restructuring, Korean government was very lucky. Also, Korea also has the deposit insurance scheme; Thailand and Indonesia don’t have the scheme during that period. In addition, this is the reason why Indonesia and Thailand could receive support from MIFF earlier than Korea.
In third stage, after closing non-viable banks and merchant banks, the balance sheets of financial institutions has been restructure. The large mount of public funds still injected in this stage. The fourth Stage involving the operational in restructure the financial institution such as transformation of strategy, decision making, reward system and performance evaluation. These are created in order to improve the profitability and efficiency. This stage required a longer term nature than the first three stages. Currently, Korea is at the end of third stage and beginning of fourth stage.
The Korean government is introducing several of measures to assist chasubles’ restructuring and also reinstate or restore the confidence of foreign investor. Corporate Restructuring 1. Cacheable Reform When the newly-appointed president Kim Dad Jung who won the presidential election in Deck 1997, he had invite the chairmen of the 5 largest chasubles to have a meeting in order to discuss the direction and need for of cacheable reform. The agenda of agreement of 5 major reforms and agreed of other chasubles as well consisted as the following: If fully applying this agreement, it will cause the dissolution of the chasubles.
The combination in accounting system between all member firms in the cacheable group is defined by the Fair Trade Act to ensure any of the financial tenement of the firm is under control by an identical person. This is the most important tool to make sure there’s always transparency of corporate management. In Korean accounting standard of consolidated financial statement, consist only a fraction of member firms in the group due to the requirement for inclusion in consolidate statement are relatively tight.
The real picture of each intra-group will be revealed under the combine financial statement system. A further requirement forced upon to the chasubles is the impressive improvement of capital structure. Example, 30 of chasubles’ debt- equity ratio at yearned 1 997 was about 519%. It’s quite difficult for 30 chasubles to reduce their debt-equity ratio from 5:1 to 2:1 during time of low profitability. Actually, the Korea government was forced chasubles into dramatic business restructuring due to the country would probably unable to overcome the Asian Crisis and prevent any future recurrence.
Luckily, during the stock market boom in year 1999, many huge firms are able to deduct their leverage by issuing a new equity. In fact, the debt-equity ratio of four largest chasubles fallen from 352% in yearned 1998 to 174% in the yearned of 999. In addition, the Korean government alters the tax law in order to eliminate the tax disadvantage through the restructuring. Example, the sale of real estate or division is considered as tax exemption. 2. Corporate Governance Reform Based on the wide consensus of corporate governance reform cannot be delay, the corporate governance revolution occurred.
There’s three significant element or factor included in the development of such consensus. Firstly, weak corporate governance was one of the important factors that cause Korea fall into the Asian Crisis in 1997. Secondly, the skewed heavily of Korean industrial structure which is toward heavy industries and requires because a capital market-based financial system which in turn could be well developed if there’s an effective system of corporate governance was in place.
Thirdly, the increasing of portfolio investment from the foreign investors has demanded governance reform. The Koreans governance mechanism has been classified in external and internal. The most significant reform in Koreans external governance mechanisms are the completely elimination of restriction in share ownership by foreign investors and the eradication of extractions against hostile takeovers by investors from foreign and domestic. As a result, a huge different occurred in Korea stock market when the foreign investors continuing increasing their investment.
In March 2000, about 27 % of shares in Koreans listed company were held by foreign investors. Also, around 50% of shares of most of the blue chip companies are held by the foreign institutional investors as well. In the internal governance mechanism aspect, it concern in the audit reform, board reform and other reforms which focused in strengthening the right of minority shareholders. The relaxation of he requirements of shareholders’ derivative suits against board member is one of the most significant measures under corporate governance reform.