Banking In Emerging Markets in the Aftermath of Global Financial Crisis

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Paper outline

  1. Synopsis
  2. Introduction

III.        The quality of central bank supervision and support during GFC

  1. How Global financial crisis was managed
  2. Bank lending and non-performing assets
  3. Bank Structure – ownership

VII.      Bank performance in emerging markets

VIII.     Rating of banks in emerging economies

  1. How banks in emerging market fared as compared to western banks during and after GFC
  2. Effects of GFC on risks management

XII.      Vulnerability of banks to crisis

XIII.     Reference List

Synopsis

This essay discusses the Global Financial Crisis (GFC) in emerging markets in the world. The essay utilizes several references that discuss the causes of GFC and the impacts on the economies of the emerging markets. The essay explores the differences in financial sectors between the emerging markets and the developed world with a view of ascertaining the differences in the degree of the impacts of GFC on both economies. The essay studies why emerging markets are more prone to GFC as compared to developed economies. The key issues discussed by the essay are the severity of GFC, how GFC was managed, bank ownership structure, and the regulatory environment in the financial sectors of emerging markets.

 

 

Banking in Emerging Markets in the Aftermath of Global Financial Crisis

Introduction

The background of the causes of global financial crisis (GFC) dates bank in mid 2007 in the United States of America. The collapse of subprime assets in the summer of 2007 triggered by liquidity crisis in the banking sector in the United States (Kapsis, 2012) was the origin of the most recent GFC. Lending was restricted due the exposure of the financial sector GFC due to the collapse of the subprime market. Banks that depended on interbank lending were worse hit by the crisis leading to solvency problems. According to Kapsis, the most hit banks, Northern Rock, and Bradford & Bingley were crippled by the insolvency problem in the early stages of the crisis. The daily operations of the banks were slowly shuttered by the financial menace that made the central banks react. The central banks intervened through offering liquidity support to the banks that were worse hit by liquidity problem. Furthermore, the government and other regulators intervened by brokering mergers of insolvent banks with banks which were more stable (Kapsis, 2012).

Though the intervention by the government and the central bank seemed to have had significant success, the impact of the crisis was far from over. The subprime market multi-linkages among the banks spread the crisis further. According to Kapsis, the deeper effects of the crisis manifested further when Lehman Brothers was hit by the crisis in the year 2008. The crisis spread to various regions in the world when investor started to liquidate their positions as more banks in the United States and Europe experience insolvency threats (Kapsis, 2012).

 

The world economy was in jeopardy due to these financial crises. Banks were reluctant to lend companies and consumer dues the turmoil. This pushed so many countries into economic recession. The United States and the European countries fought hard to contain the crisis that threatened to plunge the whole world into economic depression like the one witnessed after the First World War in early 1930s. Though the crisis was significantly contained its effects were far reaching consequences on the world emerging market economies. Moreover, the crisis still re-occurred in 2010 in Europe and threatens to spread to worldwide (Kapsis, 2012).

The quality of central bank supervision and support during GFC

According to Vies (2006), the structure supervision of the banking sector tends to be weak. Financial supervisors in emerging market lack legal protection exposing them to demands from lobbies. Furthermore, the regulatory authorities lack enough resources hence exposing them to influence from government or foreign bodies that fund them. Banks in emerging markets are less developed exposing them to government inflationary debt because of dependence on government bonds (Vies, 2006). The government regulations in this scenario, weakness the financial sector in emerging markets (Vies, 2006). The structure of banking in emerging markets is further weakened by lack transparency in the regulation and supervision.

The central banks as a financial sector supervisor played a major role in the mitigation of the financial crisis in emerging economies. Though the primary role of central banks is issuing currencies in the economy, management of external and internal currencies, credit regulation, and acting as a fiscal agent, it went beyond its mandate during the financial crisis to manage it effectively. During the GFC, the vulnerability of the banking system in emerging economies rendered the quality of supervision and regulation by the central banks (Vies, 2006). This caused information and system asymmetry in the economy thereby catalyzing the crisis. According to Vies, to enhance quality regulation and supervision of the financial sector in an emergency there is a need to undertake rigorous examination of bank books. This enables central banks to draw up policies to maintain stability in the financial sector (Vies, 2006).

How Global financial crisis was managed

The global financial crisis caused panic across the world, and this made government and financial regulators take a number of measures to manage the situation. Some of the major measures that were taken by governments and regulators included the use of deposit insurance, bailouts, and bankruptcies. Some countries especially in the emerging economies also opted to use foreign reserves to manage the situation since it was believed that the volatility in the foreign could further catalyze the crisis.

Deposit insurance was implemented in many countries to protect bank deposits from losses due to the inability of the banks to pay their debts (Turner, 2006). This acted as a safety net by the central banks to ensure financial stability of several banks that were indebted. The crisis created anxiety among depositors, and this prompted some authorities to increase the coverage of the insurance of the deposits. Deposit insurance adoption helped to prevent the debt of the financial institution from being transmitted to depositors (Turner, 2006).

 

Bailouts were also used to salvage banks that were greatly affected by solvency and liquidity problems. The United States government passed a bill in the year 2008 that allowed the government to bailout banks that were on the brink of collapse due to the financial crisis (McAfee & Johnson, 2010). In Europe, the European Union committed to guaranteeing bank financing by spending $ 1.8 trillion and purchased banks shares to prevent collapse. The United States government further agreed to purchase equity ownership in major banks and purchased less of the toxic mortgage debts (McAfee & Johnson, 2010).

Bank lending and non-performing assets

The recent financial affected banking sectors across the world. However, the impact of the crisis was unevenly felt across different banking sectors in the world. Financial crisis has an effect on credit growth thereby causing standstill and drop in the growth of loans and assets (Middle East Economic Digest, 2010).

The banking sector usually experience liquidity problems during GFC meaning that banks cannot afford to offer credit to companies during this period because of the probability of loan defaulting. It is generally acknowledged that companies are usually in dire need of credit during GFC.

Non-performing assets, according to Yang, can be defined as accounts are assets or accounts that are held by borrowers that the bank classifies as doubtful. During GFC, many companies become bankrupts due to liquidity and solvency problems. This translates to an increase in bank non-performing assets because of the high levels of defaulting caused by the crunch of companies affected by the GFC (Middle East Economic Digest, 2010).

Bank Structure – ownership

Types of banks in emerging markets are classified as government owned, private domestic, and foreign. According to Mian (2003), these banking structures differ significantly from one another. Majority government banks are characterized by lack poor cash-flows. Private domestic banks on the other hand have high cash-flows incentives, and clear separation from the ownership. Mian points out those foreign banks are only differentiated from private domestic bank by the organizational structure of the top management. These types of banks are equally distributed across the emerging markets across the world.

Many emerging market economies have banks that are either directly owned by the government or indirectly controlled by the government. It is due to this reason that the governments play a major role in the regulation of financial sector in many emerging economies. In his analysis of the political influence on bank ownership in emerging countries, Dinc finds out that government ownership of banks is very common in emerging markets. It is further noted that the government holds large stakes in banks that it controls (Dinc, 2005). Government owned banks tend to bigger and older than the private domestic and foreign banks (Mian, 2003).

Private domestic banks are more aggressive in terms of lending as compared to government and foreign banks. Private domestic banks in developing economies hold less of liquid assets and more in the form of loans as compared to foreign banks. Furthermore, private domestic banks give out loan at a higher rate than the foreign counterparts (Mian, 2003)

 

Foreign banks have significantly gained way into the emerging market for a couple of decades ago. The entry of these banks into these economies is attributed to financial liberalization that took effects after the financial crisis. According to Arena, Reinhart, Vazquez (2010), the volume of global merger and acquisition targeting banks increased between the year 1990 and 2000. This has greatly changed the bank ownership structure in the emerging economies across the world. Arena, Reinhart, Vazquez (2010), give Mexico as an example whereby foreign bank has control of the banking systems assets has increased from two percent by the year 1990 to over eighty percent by the year 2004. Barclays Bank and Standard Chartered Bank are examples of foreign banks operating in emerging economies.

Bank performance in emerging markets

The performance of the banking sector in the emerging shows a positive trend of growth in coming years. According to Price Waterhouse Cooper, the average profitability of banks is banks in the emerging economies are notably higher than most banks in the developed world. Furthermore, Price Waterhouse Cooper (2011), projects that the banking sector in the emerging market is expected to remain profitable than the developed economies by the year 2050. Retail banking is particularly singled out by Price Waterhouse Cooper as the strongest growth point for then banking industry in emerging economies like China and India. However, the mortgage and consumer credit lending are not well developed in the emerging markets (Price Waterhouse Cooper, 2011).

 

 

Rating of banks in emerging economies

Two categories of indicators are always used by supervision bodies and rating agencies when rating banks in emerging economies. These categories include macroeconomic environment and microeconomic factors (Rojas-Suarez, n.d.). Ideally, these indicators are used to assess the strength of the bank during rating. Historically, rating of banks in emerging economies was done by analyzing various traditional indicators. These indicators include bank capitalization, equity prices, ratios of net profit income to total income, ratio of operating costs to total costs, and ratio of liquid assets to total bank deposits (Rojas-Suarez, n.d.). However, these indicators in assessing the strength of banks in emerging economies are been founds to be ineffective in hence cannot be relied on when rating banks.

Bank rating agencies have adopted alternative indicator in bank rating (Rojas-Suarez, n.d.). Rating of banks is now based on indicators such as growth of interbank debt, rate of bank growth, spread in lending and deposit rates and implicit interest rate paid on deposits. These indicators effectively bring out the strength of banks for the purpose of bank rating (Rojas-Suarez, n.d.). Alternative indicators, according to Rojas-Suarez, are important in identification of bank weaknesses and strength in the event of exposure to financial crisis.

How banks in emerging market fared as compared to western banks during and after GFC

There exist significant differences between banking systems is developed nations and emerging markets. These differences range from regulatory and supervisory to the level of influence from politician, government, and foreign financials bodies like the World Bank and the IMF. In emerging economies, the financial sectors are by some extent under the influence of the government who may intervene during the financial crisis by bailing or devaluing investor claims in private banks and companies (Vies, 2006). In contrast to emerging economies, in developed nations, government has little influence on the banking sectors and only intervenes to normalize lending in the banking sector. According to Vies (2006), it is expected that the financial sector in emerging market wills stabilize after the GFC. This is attributed to massive government bailouts of financial institution during the GFC

Effects of GFC on risks management

According Goyal (2012), the aftermath the global financial crisis contradicted the general notion that developed countries have sound risk regulations as compared to the emerging markets. Emerging markets have strengthened risks management greatly after the Asian pacific crisis in 1997 (Goyal, 2012). The emerging markets have been able to avert cross-border through proper risk management measures thereby negating the risks of the global financial crisis. Through steady market development and regulatory evolutions, India has been able to reduce the financial risks. Use of structural ratios and macro-management of lending and real estates have successfully reduced the exposure of Indian financial markets to risks.

The risks facings emerging markets banks have also triggered crafting of macroeconomic policy. This policy, according to Goyal, is meant to check the moderate in asset prices in the financial sector due to volatility in the exchange rate. To further shield the emerging market economies financial crisis, Goyal advices against the international directive to allow free float of exchange rates raise interest rates. Contradictorily, Goyal offers advice that the emerging markets need develop institutions and markets to determine the interest and exchange rates. By doing these emerging markets can effectively hedge against credit and market risks. Goyal concludes by advocating for modernization of emerging market banks and use of ideal regulatory system to minimize the influence of the global financial crisis.

The financial crisis has acted as a wake-up call for lenders in the emerging markets to undertake risk assessment before lending to individuals, and businesses. Additionally, the banking sectors have developed currency debt market to make the banks respond market shocks by adjusting their portfolios due to increase in interest rates. These measures have been important in taming market and credit risks (Bank for International Settlement, 2006).

Vulnerability of banks to crisis

The world economy integrated due to efforts of liberalization of economies across the world. Financial systems have, along with other elements of the economy, been integrated due to developments in the information and communication technologies. As a result of these, Emerging Market Economies have gained attention of the global financial markets. Emerging Market Economies financial market offer attractive global investment destination due to the high returns. According to Ozkan-Gunay and Ozkan, the financial instability in emerging markets exposes the economies to GFC. Ozkan-Gunay and Ozkan (2007) identify financial instability due to lack of appropriate regulatory frameworks, and prudent supervision greatly contribute to vulnerability of the financial market to global financial crisis.

 

According to Emerald (2009), the Vulnerability of emerging markets in Europe is greatly contributed by the dependence of developing countries loans from the International Monetary Fund (IMF) and the European Union (EU). Additionally, the economic structure of the emerging market rapid liberalization of goods and capital markets exposes them to countries to the effects of global financial crisis.

Global financial crisis in world expose banks in emerging economies to unprecedented effects. Financial crisis in the Eurozone and the United States have potential effects on the developing countries due to the linkages that exist between the economies (Aizenman, Jinjarak, Park & Lee, 2012). In their analysis regarding the vulnerability of emerging market banks to financial crisis, Aizenman et al. find out that stock markets greatly exposes the emerging economies banks to financial crisis.

Conclusion

There exist substantial differences between financial sectors in the western economies and emerging markets. Whereas the developed countries have more developed and efficiently supervised financial sectors, emerging markets banking sector is characterized by weak and structurally ineffective regulatory and supervisory systems. This makes the financial sector in emerging market more vulnerable to global financial crises. Furthermore, the banking sector is more in emerging markets is more risky than developed nations thereby contributing profound effects of global financial crisis.

From the study, it is evident that emerging market financial sector is less developed making it more susceptible to global financial crisis. There is agent need to streamline the regulatory and supervisory arms of the sector in order to manage the risks exposed by the fragility of global economies. Indeed, there is a need of proper mechanism to be put in place to help the emerging markets to deal with the crisis without any form interference from the governments. To conclude, it should be recognized that the study was limited with lack of enough information about the study.

 

 

Referenced List            

Arena, M Reinhart, C, Vazquez F 2010 “The lending channel in emerging economies: are foreign banks different? “Banks and banks systems Vol. 5, no. 2 pp.20-20

Aizenman, J, Jinjarak Y, Park, D, & Lee, M 2012 Developing countries’ financial vulnerability to the Eurozone crisis: An event study of equity and bond markets Viewed September 5 2012 http://www.voxeu.org

Bank for International Settlement, (2006) “The banking system in emerging markets” BIS paper 28, www.bis.org.

Dinc, I.S. (2005) “Politicians and banks: Political influence in government owned banks in emerging markets” Journal of Financial Economics

Emerald, 2009 “Special editorial on the global economic crisis”, International Journal of

Emerging Markets, Vol. 4 no. 3, pp.-

Goyal, A 2012, “Banks in emerging markets: the need for a separate reform

Agenda” East Asia Forum, Economics, Politics and Public Policy in East Asia and the Pacific http://www.eastasiaforum.org.

Kapsis, I 2012 “Competition law and policy for the EU banking sector in a period of increased economic uncertainty”, International Journal of Law and Management, Vol. 54 no. 4, pp.284 – 301

McAfee, C, L & Johnson, N 2010, Major Financial Institutions in the Crisis: What Happened and Governments’ Responses, Viewed 5 September 2012, The University of Iowa for International Finance and development, http://blogs.law.uiowa.edu/ebook/home

Mian, A 2003, Foreign, private domestic, and government banks: New evidence from emerging markets www.worldbank.org

Middle East Economic Digest, 2010, Bad loans and failing assets hit growth: assets growth at the 20 largest banks in the GCC slowed sharply in 2009, Middle East Economics Digest, Vol. 54 p. 31

Ozkan-Gunay, E, N & Ozkan, M, 2007 “Prediction of bank failures in emerging financial markets: an ANN approach”, Journal of Risk Finance, Vol. 8 no. 5, pp.465 – 480

Price Waterhouse Cooper, Banking in 2050 (2011): How big will the emerging markets get? www.pwc.com

Rojas-Suarez, L 2011, “Rating banks in emerging markets: What Credit Rating Agencies Should Learn From Financial Indicators”, Institute for international Economics

Turner, P 2006, “The banking system in emerging markets: how much progress has been made?” Bank for International Settlement, Viewed 5 September 2012 www.bis.org

Vies, X 2006 “Banking and regulation in emerging markets: the role of external discipline” The World Bank Research Observer Vol. 21, p. 179-206.