Essays on Relationship between the Capital Base of Banks and the 2007-2010 Global Financial Crisis Assignment

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The paper "Relationship between the Capital Base of Banks and the 2007-2010 Global Financial Crisis" is a good example of a management assignment. Basel III is part of the G-20s’ agenda on financial reforms (Chouinard & Graydon 2014). It builds on the previous Basel II requirements that regulated how financial institutions conducted business. Basel III requires banks to build a capital base by holding capital/ funding such that it matches the level of their medium to long term lending. It is aimed at curbing the reliance on short term credits during booms and encourages a closer analysis of risks.

In addition, Basel III calls for additional measures of leveraging risk-based capital requirements in addition to requiring banks to reveal their off-balance sheet risks. The leverage ratio requirement will prevent build-ups of leverage and subsequent deleveraging processes that destabilize financial markets. Discuss the relationship between the capital base of banks and the 2007-2010 global financial crisis. Using your own research, cite at least two examples of real-world financial institutions. The financial crisis of 2007-2010 originated from the US and European markets and had its effects being felt all over the world (Gambacorta & Marques-Ibanez 2011).

It was characterized by the massive withdrawal of investors from markets as a result of reduced confidence, volatile world stock markets and reduced liquidity for banks which were unable to offer or obtain credits. Some financial institutions were facing the risk of collapse, while others e. g. the Lehman Brothers actually collapsed. In the article, The Balance of Payments Crisis in the Euro Area Periphery, Higgins and Klitgaard (2014) identified heavy foreign borrowing to finance excessive domestic consumption and housing investment as the main cause of the economic crisis.

When the crisis hit, foreign investors started withdrawing, causing deficits in the balance of payments. The financial crisis was as a result of over-optimism trade errors. Such errors usually result in losses since traders mistakenly forecast gains for unprofitable ventures. This level of optimism is so high that the pessimism levels are below the market equilibrium at which transactions avoid losses. These levels of pessimism that are below the equilibrium are characterized by numerous transactions. Due to the availability of low interest rated loans, many people had access to funds which they invested mainly in the housing and stock markets. The increased demand for real estate properties definitely increased prices.

Many investors were speculative and estimated that their investments would generate high returns that would be enough to settle the loans. This estimation was wrong and created a trader error. There was high spending on fixed asset investments and reduced income generation (Provopoulos, 2013). This created a balance of trade deficit, leading to the financial crisis. The crisis exposed the fragilities of the then financial system.

Majority of banks relied on funding from investors to finance loans and failed to build their liquid capital base. In the years preceding the crisis, foreign investors, especially from Asian economies were channelling a lot of money into the US and European markets. Banks, therefore, had the privilege of offering cheap, adjustable mortgage loans. The low initial interest rates for these loans encouraged speculators to increase borrowing so as to fund their investment in real estate. This was done under the assumption that real estate prices would always rise.

For that reason, investors thought that they would be able to offset their mortgages. The situation was made worse by the shadow financial system comprising of hedge funds and investment banks. These faced less strict financial regulation compared to commercial banks hence contributed the most to the unregulated lending and the subsequent crisis.

Reference

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