FINANCIAL CRISIS, CAUSES AND REFORMS

F I N A N C I A L C R I S I S

Financial Crises Comprises of

Banking Crises

Economic Crises

Capital Market Bubbles

Currency Crises
F I N A N C I A L C R I S I S

Banking Crises

Bankruptcy

I nabi l i t y
t o pay
debt s .

OR

Run on the
Bank , Credit
Crunch

F I N A N C I A L C R I S I S

Economic Crises

An economic crisis can
take the form of a
recession or a
depression.

Economic Crisis will
most likely experience
a falling GDP, a drying
up of liquidity and
rising/falling prices
due to inflation /
deflation
F I N A N C I A L C R I S I S

Capital Market
Bubbles/Crashes

Market Price of stocks
are higher than
present value of
future Cash flows.

A dramatic decline of
stock prices in a
market. Crashes are
driven by panic as
much as by underlying
economic factors
F I N A N C I A L C R I S I S

Currency Crisis

A currency crisis
occurs when the value
of a currency changes
quickly, undermining
its ability to serve as a
Medium of exchange
or a Store of value.
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Exchange Rate PKE/US$
F I N A N C I A L C R I S I S

A Short History
Stock Market Crisis Bank Crisis
1910: Shanghai rubber stock market crisis

1929: Wall Street Crash

1980: Japanese property bubble


1980: Latin American debt crisis; beginning
in Mexico

1989-91: United State Saving & Loan Crisis
Economic Crisis Currency Crisis
2001-2: Argentine economic crisis
[breakdown of banking system]

1994-5 Economic Crisis in Mexico,
speculative attack and default on Mexico
Debts
1992-3: Speculative attacks on currencies in
the European Exchange Rate Mechanism


CAUSES OF FINANCIAL CRISIS
1. Strategic Complementarities
in Financial Markets

Successful investment requires
each investor in financial market
to guess what other investors
will do

John Keynes compared Financial
markets to a Beauty Contest
Game

Mr. George Soros an Analyst ,
has called this need to guess the
intentions of other Reflexivity


CAUSES OF FINANCIAL CRISIS
2. Leverage

It means borrowing to
finance investments, is
frequently cited as a
contributor to financial
crises

Leverage magnifies the
potential returns from
investment, but also
creates a risk of
bankruptcy


CAUSES OF FINANCIAL CRISIS
3. Asset Liabilities mismatch

This is another factor believed to contribute to
financial crises, a situation in which the risks
associated with an institutes debt and assets is
not appropriately aligned.

It is also seen as one of the reason bank runs
occur. Such as, bear Stearns failed in 2007-08
because it was unable to renew the short term
debt it used to finance Long term investment .

CAUSES OF FINANCIAL CRISIS
4. Contagion

Financial crises may spread from one institution to
another, as when a bank run spreads from a few
banks to many others, or from 1 country to
another, as when currency crises, sovereign
defaults, or stock market crashes spread across
countries


FINANCIAL BAIL OUT PACKAGE
1. Adoption of
Strengthened
Standards

Vulnerability of
Financial System
Contagion
Volatility

Role of Rating
Agencies



FINANCIAL BAIL OUT PACKAGE
2. Restructuring the Financial System

Liberalization of interest rates

Reduction of controls on credit

Encouraging the development of secondary
market for government securities

Allowing free entry of private banks
FINANCIAL BAIL OUT PACKAGE
3. Sound Corporate Governance stabilize &
strengthen good capital markets

Benefit of Corporate Governance:

Protect Shareholder rights

Robust growth of corporate sectors

Enables corporations to realize Corporate objectives

Demonstrate to the wider public about the business



FINANCIAL BAIL OUT PACKAGE
4. Legal infrastructure must be made

Bank secrecy laws should be
improved

Financial supervision & Bankruptcy

Deposit insurance scheme is needed