It is a well-known fact today that the financial system is one of the most important inventions of the modern society. Its primary task is to move scarce loan-able funds from those who save, to those who borrow to buy goods and services and to make investments in new equipment and facilities so that the overall economy can grow, backed by stability and at the same time increase the standard of living. The financial system determines, among others, both the cost of credit and how much credit will be available to pay for the thousands of different goods and services. As such, a ripple in this system causes a powerful impact in the health of the overall economy - regional or global.
The financial world has to be more cautious than ever before as fluctuations cannot be eliminated. A number of economies are striving hard to tackle the economic front and naturally any laxity can invite further problems.
The time is especially ripe for more updated internal risk-management processes. Newer risks have surfaced over time and the capital markets, where the banks are still the major players, cannot simply be expected to behave as per one's expectations. That is why there should be a constant watch over the trends. The regulators as well as policy makers have to remain on alert in spite of the fact that a number of corrective measures taken were reality-based and market-oriented. Breathing easier, however, is just a temporary affair, as there are many problems and there is no 'short cut' solution to prevent recurrences.
Intensive risk management efforts need to continue as early detection of new threats is better. Signs of recession, slowing down of the pace of economic growth/activity and other threats are very much alive in all countries including the big ones in Asia like India, China, Japan and Singapore in particular.
As many unknown factors are yet to be countered, how effectively and how fast the upcoming plans would be implemented still remains unclear. For example, the future of hedge funds - a major collapse of the American dollar can trigger a systematic shock. Side by side, big liabilities in the credit-default swap market are no less capable of triggering a financial accident.
That is equally true for the investment banks.
Incidentally, it may be mentioned that an investment bank is an intermediary that performs a variety of financial services including underwriting; acting as an intermediary between an issuer of securities and the investing public; facilitating mergers and other corporate organisations as well as to act as a broker for institutional clients. The unique role of an investment bank resumes with pre-underwriting, counselling and continues after the distribution of securities in the form of advice.
Goldman Sachs was founded in 1879. It became a listed company in 1999 after having been a partnership that provided securities and investment management services plus investment banking. On the other hand, Morgan Stanley was founded in 1935 and, after merging with Dean Witter, Discover & Co in 1997, it functioned in the arena of institutional securities, wealth management and asset management. These two last investment banks in the US have since changed their statuses to become bank-holding companies. This move, as part of the restructuring efforts on Wall Street, allows them to accept deposits from investors. This kind of change allows these two organisations to raise more funds by opening commercial banks and also give them access to Federal Reserve support.
Thus the transformed investment giants into licensed deposit-mobilising banks marked the end of an era for Wall Street. This radical revamping completed the biggest overhaul in high finance since the Great Depression of the 1930s. Whether Goldman Sachs, under Federal Reserve supervision, can be a more secure organisation with exceptionally clean balance sheet, as has been claimed, will be determined as time passes and monitoring of the organisation's activities continues.
In fact the financial meltdown had shaken the entire world in one way or the other. The economists in India have also been closely watching the recent development in the Euro-Zone, among others, very intensively so that the momentum of India's economic growth is not lost.
After some foot-dragging, uncertain occurrences and ominous signals, it appears that a coherent and credible approach to preventing the recurrence of collapse of the major banks of Europe and US has been reached. Given the ongoing facts and circumstances, the steps taken so far are no doubt most practical and direct solutions, apart from ideological dimensions that both the US and European economies are undergoing the recapitalisation route.
In fact, financial crisis can be caused by, among others, increase in interest rates; increases of uncertainty; asset market effects on balance sheets; problems in the banking sector and of course, government' fiscal imbalances. These lead to adverse selection and worsened moral hazards, which, in turn pave the way for declining economic activity, bank panics, unanticipated decline in price level and foreign exchange crisis.
It should not be forgotten that the factors that caused the global financial crisis is still hovering around.
Actually it is confidence that emerges as the greatest casualty of market crisis. To what extent such snap shot measures ultimately act as the saviour/shore up business confidence needs to be observed. At times the uncertainty factor becomes so strong that the leading financial institutions hesitate to give credit to smaller banks, which, in turn, fail to re-credit businesses or simply do not want to risk it. Private customers end up suffering as well.
Unless the global banking system, which happens to be the monetary circulation system for the non-financial sector of an economy, resumes higher credit business, the current economic slowdown and thereafter possibilities of recession due to the lack of confidence can become a reality.
Further meltdown can be tough, not only for the financial world, but also for households and companies. Naturally, it is high time that international cooperation and experience sharing be actively sought. If the world faces recession again, the consequences will be far worse this time.
Considering the ongoing facts and circumstances the entire process should be run very cautiously. Increased spending means increased import of capital equipments, which, in turn, leads to slim current account surpluses and reduce global imbalances.
While balancing between spending and tax initiatives needs to be maintained on one hand, on the other hand, the focus should be towards helping the poor economies through simultaneous investments that will also benefit Europe and US in the long run. The IMF is absolutely right in advising strong policy actions to mend the financial sector and macro-economic measures [monetary plus fiscal measures] so as to stimulate effective demand and by now almost all economies are pursuing these policies. 'A unified approach' to financial problems and 'strengthening the fiscal framework' requires a good bit of attention from all economies - big or small. If the government policies fail to dispel uncertainty, reduced demand for consumer and capital goods will continue to prevail as households and businesses will delay expenditure.
The ongoing situation, thus, should be monitored with coordinated global efforts. Prevention of large scale bank collapses is a must.
Dr BK Mukhopadhyay, a Management Economist, is Principal, ICFAI University,
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