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The effect the Global Financial Crisis had on banks

The term financial crisis is applied largely to an array of situations in which some financial institutions and assets all of a sudden lose a large part of their worth. They are mostly associated with recessions, bank runs, currency crisis, bubbles etc. When a bank experiences a sudden rush of withdrawals by its depositors it is known as a bank run. A situation where the bank run is extensive it’s called a banking panic. A situation without extensive bank runs, but in which banks are unwilling to lend, because they agonize that they have inadequate funds available, is often called a credit crunch. Since banks lend out most of the cash of their deposits by the customers, it gets difficult for them to immediately pay back all the deposits if they are demanded at once, which may leave the bank in bankruptcy. Many banks lose their customers due to this problem. In this way, the banks become an accelerator of a financial crisis.

The recent financial crisis that started at the end of 2007, caused by a liquidity deficit in the United States banking system and affected the economy worldwide, made a huge impact on majority of the banks worldwide. One of the main sources of the Global financial crisis was a boom that took place in US housing prices between the years 2002 and 2005.The International Monetary Fund anticipated that a lot of U.S and European banks lost over $ 1 trillion on bad loans and toxic assets. As a result, the crisis lead to the initiation of Basel II, which was introduced in USA over 2008 in similarity with the current requirements and applied only to the banks which were internationally active. However, in Australia it was introduced at the start of 2008.

The Global Financial Crisis drew attention towards the bank’s inconsistent approaches to their

- Definitions of capital

- The type of capital employed

- The level of disclosure provided on the nature of regulatory capital held.

After the commencement of the GFC, it was noted that various banks in the Europe and the US were involved in the setting up of central counterparties (CCP’s), mainly those to clear and decrease the notional volume of over the counter (OTC) credit derivatives. Institutions have a greater incentive to make use of the CCP’s by applying a zero per cent risk weighting to depiction with certain central counterparties.

The emergence of Sub-prime loan losses in 2007 began the crisis and exposed other risky loans and over-inflated asset prices. With loan losses mounting and the fall of Lehman Brothers on September 15, 2008, a major panic broke out on the inter-bank loan market. As share and housing prices declined many large and well established investment and commercial banks in the United States and Europe suffered huge losses and even faced bankruptcy, resulting in massive public financial assistance.

The crisis resulted in the collapse of a lot of banks and also in bank bailouts. For example:

The Northern Rock (British bank) was one of the first victims of the crisis. The high leverage nature of its transactions led the bank to ask for protection from the Bank of England. This led to investors panic and deposit withdrawals by their customers who believed that the bank might become insolvent.

The fourth largest bank of the US, Lehman Brothers filed for bankruptcy in September 2008. The reason is discussed in the next few lines. In those days there was mortgage crisis in United States due to decline in prices of real-estates. As a result, housing loans made by the bank for the people with very slight support made these loans very risky, and when interest rates were raised by these banks, these borrowers could no more repay Lehman. This led to huge losses for Lehman. It caused $60 billion loss in bad real estate loans for Lehman Bros. One of the main reason for its downfall was its poor relations with top banks of United States. They refused to do business with Lehman due to over-confidence of its CEO over the Lehman financial assets. And after big debt of $639 billion, when Lehman asked Barclays and Bank of America for acquisition, they simply rejected the offer.

There were a few banks which were not affected by the financial crisis. Japanese banks were not affected seriously by the US financial turmoil because they invested relatively small amounts of their portfolios in subprime-related financial products. Even the Islamic banks have been less affected than many conservative banks in the existing global crisis as they are forbidden from the activities that have contributed to the credit crunch such as investment in toxic assets and dependence on wholesale funds. Other banks which were least affected by the crisis were North Korean banks, Malaysian banks, Morocco’s banks and Australian banks.

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