Financial Crisis

Contents

Introduction        2

Part A        2

Main Risks        2

Liquidity risk        3

Credit risk and insolvency risk        4

Systematic Risk        4

Part B        5

Basel III        5

Qualitative measurements of risk        5

Liquidity and risk levels        6

Risk level and capital requirements        7

Increase in Capital ratios        7

Supervisory Review Process        7

High Quality Assets        8

Part C        8

Balance sheet changes for Four Australian Banks        8

General Analysis of the Four Banks        10

Liquidity risk analysis        10

Loans and leverage positions        11

Capital Requirement and adequacy        11

Loans        12

Asset decline and deposit growth        13

Conclusion        13

References        15

Key words: Financial crisis, Risk, Risk Management, Financial Regulation

Introduction

        There were various risks associated with the financial crisis during the 2007-2008. The crisis was one of the most fatal after the great depression of the 1930s and suggested it had one of the worse effects (Turner 2009).According to (Turner, 2009) the financial crisis is said to have happened at a time when the financial risk was managed, especially by the developed nations. This is because if more risk management measures were taken, especially on scenario analysis of the situation, the crisis could have been avoided. This essay paper will try discussing the risks issues which caused the financial crisis to happen. The factors are discussed as from the below.

Part A

Main Risks

There were many factors which led to the financial crisis. The risk impacted negatively on the performance of many financial institutions which led to financial crisis which occurred in 2007/2008.Risk was a major factor to blame for the financial crisis. Many major research analyses have argued that risk factors played a major role in the financial crisis. Major Banks and financial institutions collapsed due to risks issues which could have been avoided or likely to have been mitigated. The regulator had major weaknesses which enhanced the risk levels for the financial crisis to have happened. The level of risk exposure was ultimately high in the period given that there was a global crisis impacting mostly those financial markets and institutions which were not properly regulated or else proper measures were not put into place to mitigate the risks. Some of the major risks issues were liquid risk, systematic risk, credit risk and insolvency risk. This are but a few but one of the major risks which were the causative factors of the financial crisis.

Liquidity risk

Liquidity risks are very fundamental in maintenance of the cash position of the banks and financial institutions. It is defined as chances of a bank to suffer financial shock to its liquidity levels. According to Berger and Bouwman (2009), banks may suffer shocks which may affect the banks liquidity position, which in effect affects the provision of the liquidity. The balance position is very critical in measuring the liquidity position of the banks. Banks shocks which will ultimately affect the balance sheet are very critical in affecting the liquidity positions of banks. The process comes into effect in the process that customers places deposits in the bank. The alleged liquidity limit is the banks should be able to manage its liquidity levels to the extent that when customers want to withdraw fund the bank can remain with enough funds for short term and long term obligations requirements (Berger and Bouwman, 2009).Therefore it is very prudent for banks to manage their liquidity levels to needs of the customers.

Berger and Bouwman, (2009), stated that banks can face two types of liquidity risk, idiosyncratic and aggregate liquidity risk. Idiosyncratic comes into effect when the bank the customers may have less or more liquidity needs at a specified bank. Aggregate liquidity is when the all banks face liquidity risk at the same time. Banks should therefore hedge themselves against liquidity risk in case it occurs. There was a major liquidity risk of banks in the financial crisis period which affected most banks. This is because many customers withdrew funds for fear of the high interest rates occurrence and financing of other investment vehicles. The balance in the cash position fell within the limit and therefore banks suffered major aggregate liquidity risks. Measures were taken into effect by the regulator to enhance the liquidity position of the banks afterwards and during the financial crisis period. But the move proved to be late and most banks had already suffered financial crisis.

Credit risk and insolvency risk

Credit risk undoubtedly affected major banks and financial institutions during the crisis period. This included major Australian banks which had limited credit control policy.The financial crisis witnessed during period was enhanced by the level of credit risk facing many banks. Credit risk is one of the major factors which caused the crisis. It arises from poor management of loan whereby many customers’ default. Bonds, derivatives and short term debt obligations are also sources of credit risk. Credit risk occurs from customers do not settle their credit obligations. It I therefore prudent for banks to effectively manage their credit policies and use effective methods in managing the credit risk (BIS, 2000)/Banks will be able to limit exposure to such risks and mitigate them first hand. Financial crisis period banks especially in Australia were facing credit exposure (APRA, 2012).When banks manage their credit risk levels losses are also reduced. The shareholders value is and return is increased. Banks should therefore be very keen and vigilant in monitoring, identify and measure the credit risk levels. Proper controls should also be put into place (BIS, 2000).There was a major relaxation on banks which exposed them to credit risk exposure during the period.