Post-crisis changes in banking and intermediation chains

After the Great Crash in 2007, there are some changes in financial intermediaries aiming at preventing the same things from happening

1^st Approach (Shin, 2009): the intervention in regulation:

The main purpose is to make the leverage level and balance sheet structural size within a bank are under control through countercyclical capital target whose aim is to verify the expansion of leverage so that it’s bad wave effect isn’t too powerful once the burst occurs. Technically, whenever a borrowed bank is under high leverage, then its withdrawal of funding from a creditor bank will be processed by using (some) its liquid assets. Otherwise, further borrowing from other creditor banks will also be restricted. Generally, interbank relationship has been changed, in a more prudent way

2^nd Approach (Shin, 2009): “Forward looking provision”

Under the boom in banking and financial system, there is a huge amount of equity in banking system. The approach works on the equity of banks. As mentioned in part 1, in order to enhance the asset side of the balance sheet, banks tend to find a solution to release the amount of equity by finding new borrowers. So, for any amount increase in leverage levis a proportion of tax (provision) which then can lower equity level expanding in the balance sheet

3^rd Approach (Shin, 2009): Shortening intermediation chains

By using covered bonds to connect ultimate borrowers and ultimate lenders straightforwardly. Covered bonds allow longer duration which fit the life the assets.

Long intermediation chain

Shortened intermediation chains

Advantages:

·         Maturity transformation is no more a concern

·         Long intermediation chains will no longer be the main source for short funding

·         Also help banks improve the gap in leverage and balance sheet size

Part II: Winners in banking and financial crisis

Declaration of bankruptcy from financial institutions and investment bankers was the obvious consequence of the banking and financial distress. The losers are easy to observe in this battle, however, there are winners who take advantage of the mess to seize their business.

Merger and acquisition has become cheaper and more attractive. Bank of America, the largest American retail bank acquired Merrill Lynch, one of the five largest investment banks. Due to the recession, Merrill Lynch had to face the illiquidity with a huge amount of debt which led to the drop in share price. The acquisition offers bank of America a huge opportunity to jump into the investment side of banking right in the 2007 recession with lower cost based on the strong established brand name. In addition, JP Morgan is also said to be better off by acquiring more than 2300 branches of Washington Mutual with only $USD 1.9bn. The trend is spread across Asia, Vietnam is no exception, many companies which still stay strong in the market during the crisis have merged and acquired smaller ones with a good deal. Another aspect is that when banks are bailed out, any institution that banks owed will be better off.

Developing countries are also better off from the baking and financial crisis. In some cases, those countries export commodity goods, such as oil, gas etc which its price has been increasing since the 2007 crisis is also better off. Manufacturing with low costs i.e low labour cost, cheap materials will be the winning point. Therefore, those developing countries can take advantage of this point to be recover faster from the financial crisis

Part I: The origins of banking and financial crisis: The iceberg

There are many different roots leading to financial depressions and not every financial crisis has all the possible causes. The following 2 main reasons to cause the financial distress and lead to banking depression are the misleading of the prevailing market theory bubbles and poor regulatory framework

The hidden part of an iceberg: The market sometimes represents a biased picture in which the interpretation and predictions of market participants are placed on, as well as shown in market price. The market itself usually corrects these connections, however, misconception leads to a different way where the equilibrium point never meets (George, 2008)(related to the Financial crisis 08/2007 when home mortgages had increased dramatically with the prediction of long term rise in real estate price)


As well, For banks in order to enhance their balance sheet (asset side) , more securities and ( or) lending  should be improved i.e. they have to increase the amount of borrowers. Once good credit borrowers have already made certain loans from banks, and then banks should ease their lending policy to lower credit borrowers. From here the first sign of subprime mortgage bubble can be seen.(Adrian and Shin, 2009)

 That misleading is the first stage of a bubble _boom which growing gradually to come to the 2^nd stage _bust when things get to the boiling point and explode (George, 2008). This comes to the very first glimpse of the financial crisis (the floating part of an iceberg). Investments in those increasing assets will be illiquid and that’s the sign of banking crisis when depositors are panic and informed others

This is a chain effect; inter-bank system is frozen and leads to the result of the exposure of bankruptcy. Domino effect would be an ideal image to illustrate this situation. The more dominating the market, the larger the wave of a crisis would be

The transparent in regulatory framework also plays an important role in banking and financial crisis. Previous episodes on banking and financial crisis have shown that there are gaps in accounting system, which allow frauds to happen.

how the crisis go global

An Introduction

Banking and financial crisis has become a big concern in the world economy. Especially, after the biggest crisis in August 2007 since the Great Depression, there are many other events of crisis going on. The blog on banking and financial crisis will be divided into 3 parts

                       Part I : The origins of banking and financial crisis

                       Part II: who gains and losses from the crisis

                       Part III: The future of intermediaries after the crisis