This essay has been submitted by a student. This is not an example of the work written by our professional essay writers.
A credit crunch is a decrement in the entire availability of credit or loans. It can also be described as an abrupt tightening of necessary conditions of acquiring a loan from the banks. Also known as credit crisis, credit crunch is usually associated with the decrement of the credit availability impartial of an increment in official interest rates. In situations of this nature, the link between availability of credit and interest rates has altered implicitly, such that either credit becomes hard to get at a certain official interest rate, or an apparent link between credit availability and interest rates ceases to be there.
This paper is going to examine the causes of the credit crunch and the failure of corporate governance and its regulations in handling the crisis.
Major causes of the credit crunch
There are many factors that influenced the abrupt limitation of the availability of loans from banks. Some of these factors could be an exogenous alteration in monetary conditions, reduction in the collateral value used by banks for loan securing the imposition on direct controls of credit on banks by the corporate government and, an increased risk perception concerning other banks' solvency within the entire banking system (Buchanan 2008, p94).
A credit crisis is usually brought about by a continuous period of careless and improper lending which causes adverse losses for money lending organizations and leave investors with large debts when the ones lent money fail to repay back. These money lending organizations may consequently reduce the availability of loans, and raise the cost of obtaining a credit by increasing rates of interest. In some instances, the banks may fail to lend further, even if they are willing to do so due to prior losses.
On the other hand, credit crunch is also caused by a decline in market prices of formerly expensive assets and hence the crunch results from the collapse of price. As a consequence, the investors and entrepreneurs who arrived late in the market become bankrupt.
Impact of credit crunch on the regulatory environment
The global credit crisis would not have come to pass without the powerful hand of the irresponsible authorities of the corporate government. Professional economists gave a prior warning to the corporate government in the year 2007 about the foreseeable coming of the monster, but the government overlooked this warning. The entire crunch began with new century, dedicated in sub-prime credit, filed for insolvency in April 2007, which resulted in a collapse of many banks and financial institutions across the whole world.
As Savage (2008, p49) puts it, after the credit crunch has been experienced, various federal Reserves put emphasis on altering the monetary policies to secure financial institutions and banks from the crunch. The government of the United Kingdom announced an impermanent in the level of value Added Tax to 15 percent from 17.5 percent. The bank of England reduced interest rates 4.5 percent to 3 percent. This is the lowest level ever since the year 1955. The government of the United Kingdom revealed its plans to invest billions of taxpayers' money into three banks of the UK in one of the biggest nationalization of the United Kingdom.
Royal Bank of Scotland (RBS), HBOS and Lloyds TSB will get a total amount of £37 billions invested in them. The government of the United Kingdom commenced a bail out schedule by extending £400 billion to the eight largest banks of the United Kingdom. The credit crunch has had an adverse impact on the Federal and corporate government policies.
The borrowing implications on credit crunch
The current global credit crunch has had an impact on job lay offs around the globe especially in the developed economies like United Kingdom, Japan and United states. As addressed earlier one of the major causes of the crunch was excessive lending of loans by the banks. The corporate governance also contributed to this due to the imposition of direct control of the credit by the government. This implies that the banks and other financial corporations ensnared individuals to borrow loans with interest rates that were very low.
Seemingly there was 24 hours loan approval, payment of instalments that lasted over one year and many others. Such were the bad policies that were laid by banks to attract as many customers as possible many of who were from the housing industry. The banking legitimacy never bothered to check the liability of the customer to give a loan, whether the customer was in a position to pay back the loan.
According to Cooper (2008, p138), it is becoming apparent how individuals have been mortgaging the future of their children to fund their today, both in the exploitation of the finite resources of the world and financially. Considering the previous experiences of financial crisis that was felt within the last millennium, it can be said that the process of borrowing from banks will not be an easy task.
The need of restoring capital ratios and recovering of the incurred losses implies that those willing to borrow will have flexibilities that are less, less control, increase in interest rates and fees will increase to a historical level (Hooley 2002, p79). The borrowers will face a rough time as the banks will require a strict scrutiny of their documents before getting loans. Even as Mr. Tim Rawlinson, who works at Fox Chase Bank in Blue Bell as a vice president of consumer lending puts it, customers with enough credit may be required to raise more cash to get a house or car down payment. And they will also have to go through lengthy procedures to prove their income.
Lending implications on credit crunch
The current global credit crunch is due to irregularities by financial institutions and banks in offering loans to the borrowers without appropriate scrutiny of their valuable documents and confirming their liabilities. Surplus liquidity within the banks was the root cause of excessive lending by financial institutions to lure many customers. In an attempt to get more customers, they provided rewarding schemes which were immediately grabbed by the seekers. Financial crisis could not be evaded in the view of the boom in real estate marketing in the past few years which brought about irregular mortgages, unchecked loans without assessing the assets or income of the customer.
This encouraged customers to involve in frauds and accounts leveraging. A good number of loans were confirmed on house mortgage which also encouraged the booming of the real estates all over the globe. Buying and selling of estates were on spurge, with the rates remaining extremely high.
As far as the statistics of the bank of England are concerned, total net lending to customers within the month of January last year was £1.1 billion. This was low as compared £2.1 billion that was lent to customers in December 2008. Due to this figures go from the bank of England, it can be seen that the lending of money by banks is drastically reducing due to the current credit crunch. Strict measures have been taken by banks before loaning any customer.
In a credit crunch, banks and other financial institutions cease lending money and begin hoarding cash due to the fear for mortgage defaults and insolvency. It makes the banks charge higher interest rates and only consider safe loans. For an economy that had been depending on easy borrowed money, a credit crunch brings problems to countries that require loans to carry on with their business plans. According to one economist in the UK is that the economy will slow to a halt if the consumers contracts and ceases depositing or spending money (Reisman 2003, p158).
It is all about the manner in which consumers are going to apply for, accept and make use of credit provided by various financial institutions and the manner in which these institutions are rapidly altering their credit policies. As for how it all began, many economists will blame it on the market of sub-prime mortgage.
Impact of credit crunch on profitability
Using the implications of the United Kingdom, it is out looked that the extensive economy of the UK will have a prospected growth that is slow. The consumers, for example those living in the United Kingdom are facing rough time across the whole world. The out coming low growth rates of our economy might result in high taxation rates and high inflation in the course of the government's seeking to restore revenue tax deficits.
The governments that indulge in big expenditure schedules are most likely to experience the same. For example, the forecasts suggest that deficits in budgets are likely to be felt continually in an indefinite period in the future. The budget deficit is expected to rise further. The overall outcome is to encourage the already high inflation rates to grow further. The effect on the finance sector is that it is encountering extremely high drops in the profit rates that are taxable in the United Kingdom. As a consequence, provisions for bad debts are expected to be higher.
To resolve the global credit crunch, the government can bring back the financial intermediaries together with their previous roles. The renovation of the financial processes to raise funds to restructure programmes is a very complicated task. Mainly, it is the responsibility of the financial institutions to ensure the funding of the process financial renovation.
Governments such as the United States government can consider a bail out plan. The plan is associated with instances such as where the government of the United States floated a $700 billion proposal to buy toxic assets owned by the biggest banks of the country. Such like a move assists in restoring the confidence of the financial system.
A reconstruction to come up with the plan was arrived at, reducing the pay to professionals and an option of the very government in taking stakes in the institutions that will receive the bail out. However the government's actions can result in views that are negative depending on the set up of the economy. For instance, many economists argue that the action to bail out financial institutions by offering them government banking may result to a communism way of banking (Walayat 2007, p27).
On the other hand, analysts argue that the bail out plan by the government is a mere short-term source of aid. The Federal officials also call for financial sector regulations. Through the government, England and Europe banks invested heavily in the mortgage-securitised securities which were being provided by Wall Street market.
According to one economist from Pakistan, during the early months of 2008, credit crisis had not affected the microfinance organizations at any significant extent. There is incursion of funds from both private investors and equity funds. In fact there is significant growth in the micro-finance sector. The global micro finance market is anticipated to grow over ten times by 2015. Nevertheless, it is a prior warning that the increment in monetary levels may bring about problems in the future.
Even though major financial institutions in the globe have had some rough time, the sector of microfinance continues enjoying a significant growth rate. One of the managers of microfinance in Pakistan claims that the microfinance business is highly diversified. For instance, a microfinance organization known as Dutch Okio full depends upon its funds to make capital. Until the year 2008, the institutions of microfinance had not had any alterations as a result of global credit crunch.
Response of the government and the bank of England
According to the telegraph staff (2009), the bank of England only performs its duties in controlling the economic function of the United Kingdom through the corporate government. For instance, recently in last year, the bank of England's monetary policy committee voted to call for the permission of the government to raise the levels of money surplus in the economy. Therefore, the final legitimacy toward solving the credit crisis is within the governments hands.
In a situation where the government and the bank of England fail to come up with an apt solution to the problem of credit crunch, then International Monetary Fund (IMF) will have to intervene. IMF helps in efficient economical adjustments by applying different programmes. It advocates for financial stability in the entire globe. The government can thus get the IMF aid.
The international monetary fund role promotes suitable adjustments and restores creditworthy situations. They bring about necessary conditionality and assist to preserve the effectiveness of the conditions in the financial and economic systems of the globe. International monetary fund insists on the credit availability and which must be enough to assist the members. It also speeds up loaning by its provision confidence which denotes that funds borrowers are seeking sound policies.
Securitisation as a remedy to credit crunch
Securitisation is likely to make an appearance again. There will be much focus on the management of risk with a return to insistence and quality of enhancements of credit. Securitisation is a vital tool for the financial institutions that are prudentially regulated to manage their capital needs. One important thing is that securitising a loan portfolio helps the banks to evade the credit risks of the loans. At the same time, the bank continues to get a loan management fee (Miscione 2007, p73).
Global credit crunch is a real world problem and much needs to be done by both economists and analysts to come up with effective means to cub the problem. Even though much blame is being put on sub-prime mortgages to be the major causes of the crunch, the corporate governance and poor regulations have at a great deal contributed to the crisis. If the government would have adhered to the prior warning from economists about the crunch it wouldn't be as much as it is now.