The Impact of the Global Banking Crises 2007/8

Question 1

What is Systematic Risk?

Answer 1

The risk of collapse of an entire-financial system or entire market with far-reaching consequences:

• Financial system instability
• Cluster of entities can cause a cascading failure
• Widespread insolvencies
• Crises of confidence across markets

Question 2

What EU body oversees Systematic Risk?

Answer 2

The European Systematic Risk Board is responsible for the macro-prudential oversight of the financial system within the EU:

• Collection and analysis of information
• Identifying and prioritising systematic risk
• Recommending remedial action
• Coordinating actions with other international financial organisations

Question 3

What were the weaknesses within financial firms that led to the crises?

Answer 3

1. Failure by boards to manage an acceptable level of risk
2. Reward schemes conflicting with firms’ control objectives
3. Inadequate technology infrastructure hindering risk management
4. Institutional arrangements that conferred status and influence on risk takers at the expense of independent risk managers and control personel

Question 4

What were the principal learning points resulting from the crises?

Answer 4

• Banks relied on excessive short-term financing e.g. Northern Rock
• Some firm’s business models relied on excessive leverage e.g. Bear Sterns
• Securities dealers became over reliant on the Repo market e.g. Lehman Brothers
• Complex corporate structures hindered contingency funding

Question 5

What were the fallout and effects of the financial crises?

Answer 5

1. Central banks – have held interest rates at record low levels to stimulate economic growth
2. Quantitative easing – introducing more money into the economy to stimulate growth
3. Rating agencies – deemed too slow to react to the crises and were errant in their analysis
4. Short-selling – was banned in 2008 but did not stop security prices from falling
5. Regulation – Dodd-Frank in the US and Basel III have been devised in response
6. US monoline insurers – bond insurers such as MBIA had to be rescued by the US government
7. Western Markets – in 2008 $1,600 billion was cut from the global market capitalisation of banks
8. Financial Job Cuts – 130,000 jobs have been cut by international banks
9. Fortis Bank – was rescued by the Dutch and Belgian authorities in 2008
10. Lehman Brothers – one of the largest Wall Street firms collapsed in September 2008

Question 6

What measures did the Basel Committee reach to strengthen banking regulation?

Answer 6

1. Raise the quality, consistency and transparency of Tier 1 capital base. Main form of tier 1 capital should be common stock and retained earnings
2. Issue recommendations to reduce systematic risk associated with the resolution of cross-border banks
3. Introduce a minimum global standard for funding liquidity, underpinned by a longer-term structural liquidity ratio
4. Introduce a leverage ratio as a supplementary measure to the Basel II risk-based framework
5. Include a framework of countercyclical capital buffers above the minimum requirement

Question 7

How has the future of the European Monetary Union been jeopardised by the crises?

Answer 7

• 2-speed Europe – allowing some members to remain in the EMU while weaker countries exit and revert back to their own currency
• Political leadership – has been perceived as poor and action has been seen as being too little too late
• Pensions time-bomb – there is an imbalance in pension commitments between the various states

Question 8

What are the Monetary solutions for the EMU?

Answer 8

1. Support fund – is likely to be around 1 trillion
2. Sovereign bonds – can be used as collateral for loans
3. Guaranteed collective Eurobonds – would not have AAA status

Question 9

What are the Fiscal solutions for the EMU?

Answer 9

1. Transfer of funds – from stronger to weaker countries
2. Common tax system – resulting in central control of expenditure
3. Fiscal union – would be hard to define in the current EMU legislation