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Bank loans Practices
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10
Bank loans Practises
1. Introduction
The global nature of financial crisis has made it clear that while financially integrated
markets have benefits, they also have risks, with significant consequences for the real
economy. Globally, there is a need for financial sector reform. For advanced factor,
the global financial crisis has had a severe impact on the real economy as well as the
financial sector, and has led to extensive government intervention, all of which will
shape the future financial landscape and actions (Persaud, et al., 2009).
Developing countries are facing some of the same reality, and must also cope with
the added burden of significant short and medium-term challenges, including in
developing their financial systems. The impact of the financial sector failure on
activities of the real economic sectors has become increasingly evident, propagating
beyond its initial epicentres to affect other advanced economies, emerging markets,
and the Arab rich GCC countries (Stijn, 2009).
While for many GCC the effects of the crisis have been mild compared to the rest of
the world, its eventual impact may be severe, if the appropriate macro fiscal and
monetary policies are not properly implemented. Many GCC countries have made
great strides in strengthening their policy frameworks and robustness to shocks,
stimulating healthy economic growth, improving current account balance, foreign
reserve, sovereign wealth fund and the financial systems. But many remain highly
vulnerable to a deep global downturn that is so closely linked to oil price shock
(World Bank loans, 2008).
GCC financial market linkages to the reset of the world are considered strong, and a
second round effects of the economic slowdown on the financial system could be
particularly severe. Without additional fiscal stimulus, the prospect for fast recovery
may be limited for most GCC countries due to binding financing constraints and
fragile debt positions for some financial institutions, utility and real-estate
companies. This could both deepen and prolong the crisis in GCC countries, and set
back the aggressive growth agenda (Ellaboudy, 2010).
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The financial crisis
markets continue to
countries, policy-ma
with development tar
This chapter briefly o
for policy before fo
including GCC regio
2. Bank loans Standard
The global crisis has
four causal factors f
Sweden in 1991, and
have made this crisis
2.1Rising Asset Pric
As with the other m
particularly in the US
shown in Fig(1), the
six quarters prior to
countries similar pric
in credit, resulting in
Fig. 1. Credit and lever
11
is still evolving and policy must ensure t
perate as complements. In emerging mark
ers must also consider the compatibility o
ets and their level of institutional developm
utlines the causes of the crisis and discusses
using on the specific challenges facing de
and Kuwait state.
s
everal interconnected causes. It is helpful to
miliar to recent financial crises such as i
Japan in 1992; and four causal factors that a
nique in its breadth and depth (Brunnermei
es
jor crises, house prices rose sharply leadi
and other advanced countries such as the
S house prices rose more than 30 percent
the beginning of the crisis. In emerging
increases were observed, often associated
n escalation of household leverage (Calomi
ge growth fuelled housing price increases.
hat regulation and
ts and developing
proposed reforms
nt (Stijn, 2009).
the general lessons
veloping countries
separate them into
Norway in 1987,
re less familiar and
r Markus, 2009).
g up to this crisis
K and Iceland. As
rom 2004, peaking
markets and other
ith a rapid growth
is, et al, 2009).
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2.2The Credit Boo
Facilitating these risi
households rose rapi
historically low inter
debt servicing relati
often coincide with l
consumption, and inv
and falling below tren
For many emerging
with increases in cap
and exchange rates a
which eventually rev
lead to increased le
standards, which is
subprime mortgages i
of credit booms led
Further, the longer th
Levchenko, 2009).
Fig. 2. International fin
12
ng asset prices was a boom in credit. In th
ly after 2000 which driven largely by mor
est rates and financial innovation. Despite
e to disposable income reached record hi
rge cyclical fluctuations in economic activi
estment rising above trend during the build
d in the unwinding phase (Mendoza and Ter
arket economies, these credit booms had
tal inflows. Credit booms also drive increa
s seen in the US and Eastern Europe respe
rsed and were a catalyst for this crisis. As
verage of borrowers and lenders and a
ow all too obvious to point out, particul
n the US. In this way, while it is the case t
to a financial crisis, they do increase the
e boom persists, the greater the probability
ancial integration for credit booms.
e US, financing to
gages outstanding,
low interest rates,
ghs. Credit booms
y with real output,
p phase of a boom
ones, 2008).
clear relationship
ses in house prices
tively and both of
well, credit booms
ecline in lending
rly in the case of
hat only a minority
likelihood of one.
(DellAriccia, and
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2.3Marginal Loans and Systemic Risk
The boom in asset prices and household credit and the marked decline in lending
standards were associated with the creation of marginal assets whose viability relied
on continually favourable economic conditions. As with the subprime market in the
US, several eastern European countries had their own form of vulnerability to a
downturn. Similar to the 1997/8 South East Asian crisis, large fractions of eastern
European domestic credit including to household were denominated in foreign
currency, such as Euros, Swiss francs, and yen. While lower interest rates relative to
local currency made these loans more affordable, borrowers ability to service these
loans and their creditworthiness depended on continued exchange rate stability.
Favourable conditions also spurred large-scale derivative markets such as
collateralised debt obligations, with pay-offs that depended in complex ways on
underlying asset prices. The pricing of these instruments was often dependent on
increasing house prices that in turn would facilitate the refinancing of underlying
mortgages (Chauffour, et al, 2009).
2.4Regulation and Supervision
Throughout this period, regulatory approaches prudential oversight of financial
innovation were simply not up to speed. As in the past but this time in the advanced
countries, a significant part of the financial sector operated outside of the bank
loaning regulations. This bank loaning system, while providing important avenues for
intermediation, grew without sufficient oversight, creating enormous systemic risks.
As in previous crises, the focus of authorities remained primarily on the liquidity and
insolvency of individual institutions rather than on the resilience of the whole
financial system. A key challenge for policy-makers is to take what we know now
and design a system that would have made it possible to know all this before the
financial global crisis (Claessens, et al, 2009).
2.5Mortgage Loans
In contrast to previous crises, the current crisis largely originates from overextended
households particularly as a result of subprime mortgage loans. Mortgages defaults
complicate efforts to mitigate the crisis. Unlike in the corporate sector, there are
limited established best practices for how to deal with large scale defaults, moral
hazard problems and equity and distribution issues involving households (Acharya, et
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al, 2009). In the US,
disappearing securiti
refinance mortgages l
the increase in defa
pressure on house pri
US house prices we
negative equity and
household credit also
increases in leverage
As real estate prices
intermediaries at risk
involvement of so m
predecessors. It is un
house prices, but wh
(Acharya, et al, 2009)
Fig. 3. Housing price
14
a vicious cycle of rising foreclosures, fallin
sation markets quickly developed. The
eft vulnerable borrowers with higher month
lt rates and foreclosures in turn placed a
es. As shown in Fig (3) for the first time si
e declining nationally and many mortgage
incentives to leave from their mortgages.
expanded rapidly in the run up to the crisi
nd vulnerabilities (Adrian, et al, 2008).
fell, the quality of loan portfolios decline
especially in markets where values grew
ny homeowners makes this crisis far more c
clear how to deal with the added complexi
t is clear is that it will make the recovery
.
and loan portfolios.
g home values and
educed ability to
ly payments, while
further downward
ce the Depression,
s faced substantial
In several cases,
s, leading to sharp
d putting financial
rapidly. The direct
omplicated than its
y of sharply lower
eriod much longer
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2.6Financial Marke
Financial integration
international risk sh
transmitting financial
major cause of the c
origins of the crisis l
simply because of th
assets represent abou
reserve currency asse
markets has significa
Fig. 4. Increasing rates
A major reason for
securities and other
economies and by g
Wealth Funds in se
associated funding prthose that had heavily
15
ts Interconnection
as increased dramatically over the past dec
ring, competition and efficiency, but als
shocks across borders. Financial integrati
isis, but it has made this crisis global. In a
ie in the US, there would have been wides
size of the US economy. As Shown in F
t 31% of global financial assets and the U
ts is about 62%. But the greater interconnec
tly increased the global severity of this crisi
of the international financial integration.
the rapid spread of this crisis is that man
S-originated instruments were held widely
vernments through foreign exchange reser
veral emerging markets. From these dir
oblems, spillovers quickly arose. Emergingrelied on external financing, and paradoxica
de bringing greater
a higher risk of
n is not in itself a
ny event, since the
read repercussions
g (4) US financial
S dollars share of
edness of financial
(Gorton, 2008).
mortgage-backed
in other advanced
ves and Sovereign
ct exposures and
markets especiallylly those with more
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liquid markets, were affected through pressures on their capital account and bank
loans funding (Claessens, 2009).
2.7Opaque and Complex Financial Instruments
Schuermann has also burgeoned in the last decade, with more than 70% of
nonconforming mortgages in the US being securitised by 2007, up from less than
35% in 2000 (Schuermann, et al., 2008). This expansion of the originate and
distribute model exacerbated agency problems; risk assignments became murkier and
incentives for due diligence worsened, leading to insufficient monitoring of loan
originators and an emphasis on boosting volumes to generate fees (Gorton, 2008).
The resulting opaqueness of balance sheets made it difficult to separate healthy and
unhealthy institutions. This uncertainty contributed to the freezing of the interbank
loans markets and forced further sales of securities to raise funds, turning a liquidity
crisis into a solvency crisis (Ghosh, 2009).
2.8High Leverage of Financial Institutions
Historically high leverage has limited the systems ability to absorb even small
shocks and led to the rapid decline in confidence and increase in counterparty risk
early on in the crisis. Historically high loan-to-income values in the US left
households highly exposed and forced some high loan-to-value mortgage holders into
negative equity. In advanced countries' financial sectors, high leverage meant that
initial liquidity worries quickly deteriorated into serious solvency concerns. While
initial recapitalisations were relatively large and rapid these were limited to only a
few bank loans and often fell short of losses (Brunnermeier, 2009).
Most of advanced economies are suffering a decline in industrial production and are
considered in recession; on the other hand, export sector which is considered to be
the vehicle for economic growth in emerging and developing economies is slowing
dramatically. The continuation of deleveraging by the bank loaning sector and sharp
declines in consumer and business confidence has triggered a dramatic drop in
domestic demand across the globe (Ashcraft, 2008).
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3. Bank loanss Loams Functions
With the causes outlined, we turn to the short-run agenda and the direct lessons from
this crisis. The large government interventions raise many complex issues regarding
exit. While these interventions have generally had the desired effect of restoring
stability, by their nature they distort the sector and this should be of acute concern to
policy-makers in the short run. In terms of structural reforms, a number of areas are
being investigated (Claessens, et al, 2009). First, this crisis has exposed weaknesses
in national financial architecture particularly with the treatment of systemically
important financial institutions, the assessment of risks, and the framework for
resolving financial distress. But also fiscal and monetary policies have come into
questions. The crisis has also highlighted how the international financial architecture
has failed to keep up with the rapid pace of integration (Gupta,et al., 2008).
3.1 Intervention Governments Plans
The scale of the policies implemented to counter the global recession has been
substantial, amounting to double digit percentages of GDP for many advanced
countries. On top of more accommodating monetary and fiscal measures, these
policies include liquidity provision, support for short-term wholesale fundingmarkets, guarantees of liabilities, purchasing of illiquid assets and capital injections
to bank loans. It is generally agreed while serious risks remain and these may provide
a justification for continued policy intervention, the distortions resulting from these
interventions should be removed as quickly as possible as economic and financial
condition allow (Kamara, et al., 2009).
The perverse long-term consequences of state-owned bank loans are well-
documented and, while most countries are likely to avoid the worst effects,
distortions are likely. Policy measures aimed at encouraging bank loans to lend, for
example, have often had a bias toward local lending, putting international operations
at a disadvantage. Policy interventions have also affected international capital flows
and financial intermediation. When a country such as Ireland issues guarantees on
deposits and other liabilities, this has quickly had beggar-thy-neighbour effects,
forcing other countries to adopt similar measures. Many emerging markets, unable to
match such guarantees, have suffered from capital outflows as depositors and other
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creditors seek the safer havens. If the unwinding of interventions is not coordinated
internationally, it can aggravate still weak confidence, create new distortions, and can
potentially be anti-competitive. Government unwinding therefore needs to be
coordinated as well as reform (Claessens, et al., 2007).
3.1.1 Fiscal Policy
Batini in (Batini, et al., 2009) stated that separate from direct interventions such as
bank loans recapitalisation, this crisis highlights two important measurements for
fiscal policy.
First is that budget deficits were not reduced sufficiently during boom years when
revenues were high and its a policy which in some countries limits the fiscal space
available to fight the crisis.
Second is the structure of taxation. In most countries, the tax system is biased toward
debt financing through deductibility of interest payments. This skew in favour of
higher leverage increased the vulnerability of the private sector to shocks and should
be reduced.
3.1.2 Monetary Policy
The role of the asset prices in the crisis re-opened the debate over the question
whether monetary policy should be used to dampen asset prices booms. First it is
important to note that not all booms are alike. What matters is not so much the asset
price boom in itself, but who holds the assets and the risk, how the boom is financed,
and how an eventual bust might affect financial institutions (Laeven,et al., 2008). It
is clear that the mandate of monetary policy should include macro-financial stability,
not just price stability. In this sense, this crisis challenges the Greenspan doctrine that
bubbles are hard to predict and monetary policy is too blunt an instrument to deal
with them (International Monetary Fund, 2008).
In future, monetary policy should take into account bubbles, and in particular the
combination of asset bubbles with leverage. Asset price booms involving financial
intermediaries and leveraged financing clearly require a policy response, since they
imply risks for the supply of credit to the wider economy. Other booms, for example
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the dotcom bubble, can be left to run their course. It is the connection of bubbles with
leverage and the potential fallout from the bursting of the bubble that should concern
policy-makers (Reinhart, et al., 2008).
3.1.3 Importance of Bank loans
The cost of combating the global recession such as the interest rate changes,
enormous fiscal deficits and government interventions in the financial sector make a
clear case for regulatory measures offering the first line of defence against systemic
bank loans distress. The failure of this first line of defence has been a key contributor
to the financial crisis. In many ways, private market discipline failed, while public
surveillance failed to fully expose the extent of vulnerabilities and to act decisively.
At the same time, any regulatory redesign should first take account of, and seek to
avoid, the possible adverse impacts of regulation on innovation and efficiency.
Regulation can be intrusive and inefficient. It tends to lag behind financial innovation
and is vulnerable to industry capture and political influence particularly in emerging
markets and developing countries (Claessens, et al, 2009).
Further, it is crucial to recognise that early warnings are less about specifying the
definition of crises and more about identifying risks and underlying vulnerabilities
that may trigger loss in confidence and propagate a crisis. Furthermore, as the
interconnected causes of this crisis make clear, a regulatory framework needs to
recognize the complexities and be compatible with the incentives of private
individuals in a way that complements market discipline (Persaud, et al., 2009).
By observation, it found that regulation should look to provide incentives for the
private sector to take into account the risk their own activities may cause to the
system as a whole, particularly for rating agencies and for subsidiaries of
multinational financial institutions operating in emerging markets and developing
countries. Resolution frameworks, meanwhile, need to allow for the failure of
individual institutions to ensure that market discipline is effective in preventing this
outcome. Beyond incentives, the sheer scale of this crisis makes the case for a wider
informational and possibly regulatory perimeter whose remit needs to stretch across
borders an industries. Regulators must be able to proactively monitor all financial
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activities; not simply those within the financial sector; that pose systemic risks
(Claessens, et al, 2009).
This requires greater monitoring of various types of institutions, not just bank loanss,
as to their capital, liquidity and risk management. All with an increased focus on their
potential to create systemic risk.
Further, regulatory approaches need to dampen the pro-cyclical nature of financial
markets and ensure better information disclosure and corporate governance to
facilitate improved market discipline. To achieve all this, it is perhaps obvious but
nevertheless necessary to point out that authorities will require more resources and
more power (Batini, et al., 2009).
3.1.4 International FinancialArchitecture
As recognised by the various G20 Summits, the real economic costs of this crisis
highlight the need for cooperation and action on an international scale as well. The
organisation of regulation and supervision needs greater coordination across
countries in both the design of regulation and the monitoring of systemic risk. The
collapses of Lehman Brothers and the Icelandic bank loans have shown that one
country, acting on its own, cannot deal with large, complex and globally active
financial institutions (Persaud, et al., 2009).
This includes a need for better risks assessments and better ways to deal with
financial distress. The overarching challenge is to convince country authorities to
take actions to deal with vulnerabilities, particularly during good times (Batini, et al.,
2009).
First, better risk assessment. International coordination is needed for identifying and
reducing vulnerabilities and risks. The working across borders only supported by
significant information sharing, can one hope to connect the dots between financial
institutions, markets, and countries.
To enhance their awareness of risks policymakers need to balance voluntary
assessments with mandatory compliance. Multilateral and bilateral assessments could
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be used more systematically to examine macro-prudential risks and the progress on
multilaterally agreed policies. Regardless how the framework adapts, more analysis
is needed on the linkages between financial sector and macroeconomic performance
to make risk assessment more effective (Claessens, et al, 2009).
Second, obtaining more accurate and timely information. Better information requires
enhancing the accessibility of existing data, developing new sources, and promoting
transparency and disclosure more generally.
Furthermore, data needs to cover non-bank loans financial institutions, such as
insurance companies and other non-bank loans financial institutions, and allow a
better understanding of how credit risk is transferred. Better information is needed on
the financial operations of large non-financial corporations that have significant links
in national economies and potentially across borders (Claessens, et al, 2009).
Third, better cross-border crisis management arrangements. International
coordination is needed for resolving financial distress. While there is uncertainty over
the role of global imbalances, what is certain is that gross capital flows between
countries can cause severe problems when there is no robust regulatory regime to
manage these in times of crisis. The issue which proved the essential need for
universal crisis overcome method (Gorton, et al., 2008).
Such system failure requires clear and binding rules on burden sharing for weak or
failed cross-border financial institutions. The first best solution, a global financial
regulator is unlikely to materialise soon. But a new charter for internationally active
bank loans, greater harmonisation of rules and practices, and enhanced coordination
are all possibilities, especially for closely integrated financial systems (Ghosh, et al.,
2009).
Fourth, better liquidity provision to both financial institutions and countries for
policy makers must aim to prevent spillovers becoming solvency issues by expanding
the role of lenders of last resort, particularly for cross-border bank loans. Many
international factors act as an obstacle but the expansion of Special Drawing Rights
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agreed in principle in the G20 meeting in April, represents a positive step (Persaud, et
al., 2009).
Fifth, governance changes are needed. To make this all possible, changes to the
international financial governance and representations underway in both rule-making
and decision-making bodies, such as the G20 and IMF will help. These will help in a
number of general areas for improvement (Persaud, et al., 2009).
4. Sources of Bank loans
In order to understand the reason behind how the global crisis has affected
developing countries. While many countries are better positioned than in the past to
deal with these challenges, they are still faced with a number of short- and medium
t`1erm challenges for financial sector development. World industrial production and
trade are declining sharply (International Monetary Fund, World Economic Outlook,
2009), while labour markets are deteriorating at a fast pace, particularly in the United
States. The decline in commodity prices, especially oil prices from a peak of about
$140 dollar in July 08 to around $50 in March 09, is providing some support to
commodity importers, but is weighing heavily on growth in commodity exporters
like the GCC Countries. Global growth is set to deteriorate considerably. Activity is
expected to slow down from 3 percent in 2008 to percent in 2009 before starting
to recover gradually in 2010 (International Monetary Fund, World Economic
Outlook, 2009). Advanced economies in general are facing their biggest great
depression contraction (Ellaboudy, 2010).
Furthermore, Japan and the European Union have been impacted severely by the
decline in external demand, while uncertainty about the direction of the economy is
negatively affecting consumption and business investment in the United States.
Economic growth in these countries is now expected to contract by two percent in
2009, followed by a modest rebound in 2010 (International Monetary Fund, World
Economic Outlook, 2009). Economic growth in emerging and developing economies
is also slowing sharply. Financing constraints, lower commodity prices, weak
external demand, and associated spillovers to domestic demand are expected to
weigh on activity. As a result, growth is projected at 3 percent in 2009, a markdownof 3 percentage points compared with the April 2008 World Economic Outlook and
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less than half the p
(International Moneta
The possibility of c
economic activity. O
Arabia being the larg
close to set target,
countries may be c
demand and rising in
The prospect for m
demand in certain e
will be minimum pr
other commodities. In
Nations Department
risks are becoming an
4.1 Short-term Polic
Many emerging mar
the crisis. First, a sud
led to the unwinding
the global downturn a
Fig. 5. Net Flows to E
23
ce in 2007, before rebounding to around
ry Fund, World Economic Outlook, 2009).
mmodity prices recovery is small giving
EC production cuts , including members
est, could ultimately help to support oil pri
ince the possibility of expanding product
nstrained at the current price level. How
ventories will continue to impact the marke
tal price increase depends on constructi
erging and developing economies. The im
viding the less income elastic demand for
flation expectation is likely to drop below
f Economic and Social Affairs, February 2
increasing concern in some countries (Ellab
Challenges
ets and developing countries experienced t
en stop of capital inflows driven by global d
of positions. Second, a collapse in export de
s shown in Fig(5) and Fig (6).
erging Economies.
5 percent in 2010
the slowing global
f the GCC , Saudi
es if implemented
on for non-OPEC
ever, still slowing
t in the short term.
n and investment
act on food prices
food compared to
worldwide (United
09), and deflation
udy, 2010).
o shocks early in
eleveraging, which
mand as a result of
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Fig. 6. Merchandise Ex
In these circumstanc
considerably lower in
need official external
emerging markets an
macroeconomic polic
groups (Claessens, et
For their short-term
facilities from major
institutions such as
another source, both t
through credit lines (
Further, expansionarDepending on fisca
24
ports.
s, greater official financing became a cruci
flows and sometimes even outflows of priva
financing to expand their policy space. Fund
developing countries allowed them to purs
ies, including policies to protect the poor a
al, 2009).
external financing needs, some countries
advanced economy central bank loanss. Int
he IMF, through its new and existing ins
hrough direct balance of payments support a
ersaud, et al., 2009).
fiscal policy can be deployed to supportl constraints, many countries allowed n
al ingredient. With
e capital, countries
s made available to
ue such supportive
d other vulnerable
applied for swap
rnational financial
truments; provided
d as a contingency
economic activity.t only automatic
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stabilizers to operate, but can also increased discretionary spending. Conventional
fiscal multipliers may well be relatively small in emerging markets and developing
countries, and the impact of fiscal stimulus on activity is more uncertain (Batini, et
al., 2009).
Such calls for less conventional measures such as providing credit guarantees. For
countries in severe crisis, fiscal support is best geared towards maintaining financial
sector confidence and solvency. Even more so than with advanced countries,
however, it is critical that governments must have a credible exit strategy. Fiscal
expansion will often require a credible exit strategy that places government finances
on a long-term sustainable footing. Not only will this help contain the costs of
financing the short-term stimulus but it will also strengthen investor confidence and
help facilitate the resumption of capital inflows in the recovery phase (Claessens, et
al, 2009).
Global deflationary pressures and widening interest differentials compared to
advanced countries allow much room for lower interest rates, and where interest rates
are reaching zero, quantitative measures can also be required. A key question is how
much to depreciate and countries needed to weigh up their options. Those with
floating exchange rates considered the impact of a depreciation on their
competitiveness compared with its impact on their balance of payments (Persaud, et
al., 2009).
4.2 Medium-Term Policy Challenges
As well as policies to mitigate the short-term consequences, countries must also
consider longer term measures to prevent future crisis and continue their
development strategies. The integration of emerging markets and developing
countries into the global financial system has happened very rapidly: many now
developed countries took more than 50 years after World War II to completely open
up and even today do not have the same degree of foreign bank loans presence and
offshore equity trading as some emerging markets (Batini, et al., 2009).
This rapid and comprehensive financial integration should ideally be met very
quickly by a broad range of policy adjustments. Developing countries, however,
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often lack the financial and human resources to respond quickly on a broad front, and
so unorthodox policy approaches may have a better chance of succeeding. As many
developed countries have shown historically, government has a limited yet crucial
role in ensuring financial development, especially during the intermediate and most
vulnerable stage of internationalization. A crucial challenge is that government
credibly and legitimately enforces the necessary policies which considered as a
challenge that continues to stifle development strategies (Batini, et al., 2009).
Countries need to adjust to large and volatile international financial integration.
Emerging markets have experienced an extensive internationalisation of their
financial sector in recent years: gross capital flows have surged and cross-border
entry has become more common, with foreign bank loanss holding market shares of
more than 50% in many emerging markets (Claessens, et al, 2009).
Many issues regarding cross-border financial services provision do not have clearly
defined best practises, however, and even when these do exist, implementation has
been complex. This financial crisis has provided a stark example of the lack of clarity
over the responsibility and liability for deposits of foreign bank loanss subsidiaries
and branches. This uncertainty has led to the common practice of establishing
subsidiaries instead of branches. The creation of subsidiaries generates costs,
however, as international bank loanss tie up capital inefficiently. The large foreign
presence in bank loansing and capital markets are both foreigners operating in the
local market cross-border financial services provision, and local institutions using off
shore markets, make all these issues even more important for emerging markets and
developing countries and their need to adjust more acute. Countries must consider the
broader financial sector development strategy and the role of government (Persaud,
et al., 2009).
4.3 Governments Financial Turmoil and Insolvencies Preparation
Countries with pegged exchange rates faced the same question, but must also
consider their long term exchange rate strategy which may require use of reserves to
maintain the peg. In some cases, foreign exchange reserves were used to substitute
for foreign credit lines to bank loanss enabling them to maintain domestic lending
operations. For those with pegged exchange rates, there was scope to be more
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flexible, while still ensuring the maintenance of a credible anchor for monetary
policy (Batini, et al., 2009).
Many countries needed to provide an adequate framework to facilitate rapid debt
workouts, particularly as debt restructuring reduces the fallout from exchange rate
depreciation on unsecured balance sheets, thereby giving greater flexibility to
monetary policy. Limiting risks of bank loans runs and adopting mechanisms to
mitigate the risk of systemic solvency problems has also been essential (Ghosh, et al.,
2009).
Financial integration can have negative as well as positive impacts. The large
presence of foreign bank loanss, for example, can hinder local information generation
and availability, which in turn can reduce the quality of oversight. It can also mean
that local supervisors have less access to information and know less about the state of
the local economy.
Market discipline may work more poorly as well. When the local operation
represents only a small part of the foreign financial institutions overall balance sheet
and income, local market discipline may be more limited. The ideal policy and
regulatory responses are not clear. Some countries have proposed and implemented
corporate governance requirements for subsidiaries to avoid problems in these firms
home markets affecting local markets. Others have suggested that subsidiaries of
foreign bank loanss be listed in the local markets to assure some price discovery.
While these and other proposals can have benefits, they can also generate costs that
are passed on to consumers (Claessens, et al, 2009).
The integration of capital markets can also have adverse developmental effects.
While large foreign ownership in the local market and significant trading and capital
raising at off-shore centres such as New York and London has brought many
benefits, it can also make development strategies more difficult. Some nascent capital
markets have suffered from internationalisation through declines in local
liquidity(Ghosh, et al., 2009).
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In Latin America, for example, the pull of cross-listing and trading from New York
has been very strong. This can affect local capital market development in a narrow
sense, since declines in local liquidity make it more difficult for the remaining
smaller firms to trade and raise new capital; and in a broader sense, since there are
fewer local financial services such as investment bank loansing, accounting services
and trading systems (Persaud, et al., 2009).
As with bank loansing, solutions to the development of capital markets are also
complex. This is partly because one has to take into account size, location and other
aspects of the market. Smaller markets with close geographic or time-zone proximity
to large markets may be best off fully integrating, for example, whereas larger
markets further removed from financial centres may be able to pursue a more
differentiated strategy.
Although the reduced degree of sovereignty is part of globalisation and has many
benefits not least as a disciplining factor for poor governance as adjustments in both
the bank loansing sector and capital markets necessarily include a role for
government. In many now developed economies the state has historically played a
large role in financial intermediation.
As an example of the need for intervention, countries with a large foreign bank
loansing presence may find that multinational financial institutions will not
internalise the effects they have on the local financial markets and economy
compared to a smaller domestic institution. It should be noted, however, that
intervention can be difficult to implement in a transparent way given the weakness of
domestic institutions. The application and adaptation of international standards.
International standards have a natural bias towards the circumstances of currently
developed countries, including a more liberal institutional environment, and those
countries regulatory structures (Claessens, et al, 2009).
Further, standards are often too sophisticated and can assume too much in terms of
the supporting institutional infrastructure. In time, developing countries will
overcome these problems but in the meantime, inefficiencies from using the wrong
standards and new risks may arise (Ghosh, et al., 2009).
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Better prioritisation of the standards more relevant for the circumstances of
developing countries is needed. Probably the elements common to many of the
standards, regulatory governance, governance, transparency which would be key to
adopt and implement first, however, little formal analysis exists top guide policy
makers. A broader issue is how to adapt standards over time to countries
circumstances. And according to-date developing countries have had a small stake in
the global standard setting bodies (Ghosh, et al., 2009).
It is not just the relevance of standards to developing countries circumstances, but
also their legitimacy that matters. In all countries, governments and politicians
struggle to make the case for adopting better international practices and the large gap
between local and international rules makes this even more difficult for emerging
markets and developing countries. It would therefore be helpful to have some over-
representation in standard setting bodies to tilt the bargaining positions more towards
emerging markets and developing countries (Claessens, et al, 2009).
5. Conclusion
The process of standards setting, the adaptation of standards to different
circumstances, compliance, the importance of regional and global trade agreements
and the legitimacy of the global financial system are deep and complex issues on
which further analysis is required to assure that the needs of all countries are
appropriately met (Claessens and Underhill, 2005).
Throughout, it is important to point out that a key component of financial sector
reform is legitimacy and credibility, but in these countries this is made more difficult
by a number of factors.
First, some of these countries have a large institutional hurdle to overcome to reach
international standards.
Second are the constraints of existing policies, such as pegged exchange rates, and
circumstances, such as large debts.
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Finally, there are political economy constraints. These run deeper than simple lack of
capacity and low pay of supervisors, they relate to the lack of political will, lack of
accountability, and plain corruption. Overlooking these issues is dangerous. Granting
too much power to bank loansing supervisors in an environment with limited
accountability, for example, risks only misuse (Persaud, et al., 2009).
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5. References
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Sven Behrendt, When Money Talks. Arab Sovereign Wealth Funds in the Global
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Citigroup, Dubai Real Estate and Emaar. Slowdown Morel likely than the Collapse
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David Cobham, Ghassan Dibeh (ed.), Monetary Policy and Central Banking in the
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Fitch Ratings, External Debts of the Emirates, International Special Report, October
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Institute for International Finance (IIF), Regional Briefing Gulf Cooperation Council,
May 31, 2007
International Monetary Fund (IMF), Regional Economic Outlook, Middle East and
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International Monetary Fund (IMF), World Economic Outlook, Chapter II: Oil
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Stephen Jen, How Big Could Sovereign Wealth Funds be by 2015? Morgan
Stanley Research Note (May3, 2007)