The paper "Causes of the Contagion - Australian Banking System " is a great example of a finance and accounting case study. The Australian financial sector is also involved in international financial markets through the Bank of International Settlements which is an international monetary authority. Financial contagion in the banking industry is defined as a crisis or a shock within one bank that causes harmful changes to other systems. The spillover and spreads to other organizations in the financial market. The Contagion occurs due to the complex interrelationships between institutions and the nature of the exchange settlement systems.
According to Ong, Mitra & Chan-Lau (2007), the shocks of contagion in one financial institution or market can be transmitted locally or internationally due to the increased interconnections among the domestic and international financial systems. The high volumes of financial transactions can also result in a spillover that would affect the Australian market. Causes of the Contagion The main cause of the Contagion is the inter-linkages of the banks with other segments of the financial sector both locally and internationally. Banks provide various services to other industries such as giving insurers letters of credit, providing investors with services such as hedge funds, and so on.
Recently, there are a lot of cross-border lending activities and the transactions and the connections in the Australian banking system represent a probable tool for financial contagion. There is a wide range of potential conduits for contagion from various banking systems to Australia and vice-versa. The external connections could arise from direct and indirect exposure of the domestic banks in international banks or through shareholding by foreign banks. Most Australian-owned banks have significant global positions that expose them to developments in other countries. The Reserve Bank of Australia can also be a potential source of contagion during times of substantial stress.
The RBA is a major source and key controller of liquidity held by banks in the financial system. The RBA is continually expanding in size and major banks in Australia set their references for short-term interest rates locally and internationally based on the RBA policies. The Reserve Banks control the cash rate, thus influencing the whole interest rate structure in the Australian market.
The expanding links between the financial institutions indicate that a crisis in one financial institution is detrimental across the whole financial system leading to a systemic liquidity challenge. Consequences The risk of contagion is enhanced by financial integration through banking debts. However, the definite impact is dependent on the banking sector structure of the borrowing state. According to Kilic, Chelikani and Coe, (2014), direct borrowing through international banks is riskier than lending conducted through subsidiaries or branches of the global banks. The reason is that direct borrowing is substantially affected during periods of financial crises.
When the global liquidity is low and the interest rates high, there is a possibility that a bank or country with direct borrowing debt will suffer a systematic financial crisis. Therefore, the Reserve Bank of Australia must ensure there is strong international liquidity during periods of financial havoc to reduce the effects of contagion. A contagion affects both emerging markets and developed economies with robust structures such as Australia. According to Lhost (2015), the effects of a contagion depend on the information available in the market.
Emerging markets are more significantly affected by contagion because there is less accessibility to the fundamental information for the investors in those countries than in developed markets. Thereby, the financial contagion is exacerbated. Additionally, the developed markets can transmit the contagion to different emerging markets. In particular, the developed markets can act as a channel for the transmission of shocks between the emerging markets, and thus, worsening the financial crisis in those markets.
Kilic, O., Chelikani, S., and Coe, T. (2014). Financial Crisis and Contagion: The Effects of the 2008 Financial Crisis on the Turkish Financial Sector. International Journal of Applied Economics, 11(2).
Lhost, J. (2015). Future Implications of Financial Contagion. ThoughtCo. Retrieved 10 July 2017, from https://www.thoughtco.com/cause-effects-and-implications-of-financial-contagion-1146263
Lim, K. G. (2012). Global financial risks, CVaR and contagion management. Journal of Business and Policy Research, 7(1), 115.
O’connor, A. (2010). Government policy, banks' strategies and the financial crisis: Contagion through interconnectedness. Vie & sciences de l'entreprise, (3), 59-75.
Ong, L., Mitra, S., & Chan-Lau, J. A. (2007). Contagion risk in the international banking system and implications for London as a global financial center. International Monetary Fund.
Ozkan, F. G., & Unsal, D. F. (2012). Global financial crisis, financial contagion, and emerging markets.