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Financial Crisis
One of the main factors for the genesis of the crisis can be levied on the
dependency of many of the world nations on the US. The high rates at
which liberalization and globalisation took place in the past decade led the
way to sustained growth phase with the development of global markets.
Establishment of the global regulatory and supervisory structures such as
IMF have further facilitated the growth. The crisis that the world has been
facing has mainly occurred because of the ‘Subprime mortgage crisis’ that
had happened in US which showed its effect on many of the world nations
which perform business with them. Income through the outsourcing
(mainly to US) has been a major part of the GDP for many of the
developing nations. The subprime crisis mainly resulted in the liquidity
crisis in the US markets as many of the borrowers who had borrowed
money in order to invest in the real estate i.e.; mainly the housing loans
began to default their payments. As we all know that high default rate will
result in an increase the ‘Risk Aversion’ rates of the investors who began
to invest in the ‘risk-free’ securities to protect their money and this
resulted the market borrowing rates to increase to the new levels which
were so high for people to borrow money. This first started off with the
home loans but since it’s not possible to segregate financing of the
sectors the rate began to reflect also for those loans which were borrowed
for the other purposes and thus resulted in the beginning of the financial
crisis in US. Since a long time US has been the nation with the highest
number of business opportunities for not only the developing but also the
developed countries which resulted in the spread of the crisis to the other
world nations thus resulting the global financial crisis. The other factors
for the crisis also include the negligence shown by the authorities in the
financial systems as they had been functioning well during the period
before the crisis and no alternative measures had been developed to
suffice if there had been problems with the financial systems they had
with them at that time. A number of micro and macroeconomic factors
have been listed in the literature as the proximate causes of the crisis –
role of easy money, financial innovations and global imbalances on the
one hand to regulatory loopholes both at the national and global level on
the other. Resemblance can be found in the factors of the current financial
crisis when compared to those that had happened in the past. The factors
such as globalisation and liberalization which were the factors for the
rapid growth happening in both the developed and the developing nations
are also the main reasons for US financial crisis leading to the Global
financial crisis affecting not only the advanced economies but also the
developing and emerging economies. The main reason for the crisis is the
excessive leverage combined with inadequate regulation and flawed
credit ratings.
The order in which the crisis affected the markets was:
1. Interbank markets
2. Money markets
3. Banks and financial institutions(Investment banking industry)
4. Equity markets
5. Commodity markets(prices began to rise at first and then there was
a sharp decline)
Apart from these even the forex markets had faced a huge blow as many
of the developing nations banks which had most of their money invested
in the risk-free government securities were able to lessen the effects of
the crisis up to a certain level and this resulted in the changes in the forex
markets mainly the exchange rate which began to depreciate based on
the levels of exposure of the particular nation to risky and risk-free
investments.
The affect of the crisis was experienced by all the sectors in the global
financial markets, though to varying degrees. Interbank markets in
advanced economies were the first one to be affected by the crisis – this
market segment suffered from a severe liquidity crisis as banks became
reluctant to lend to one another for fear of counterparty risks.
Subsequently, the crisis spread to the money markets as manifested in
the abnormal levels of spreads, shortening of maturities, and contraction,
or even closure, of some market segments. In the wake of credit and
money markets witnessing a squeeze and equity prices plummeting,
banks and other financial institutions experienced erosion in their access
to funding and capital base, owing to accumulating mark-to-market
losses. The pressure on financial markets in addition with the credit
spreads widening to record levels and equity prices crashing to historic
lows, leading to widespread volatility across the market spectrum.
Domestic interbank markets in EMEs, however, did not seize up as
severely as their counterparts in developed countries, although they
experienced some liquidity strains largely due to the ‘knock-on’ effects of
the crisis. Stock markets in EMEs, on the other hand, bore much of the
heat of the crisis as equity markets all over the world witnessed high
volatility, sharp declines in prices, turnover volumes and market
capitalisation. Finally it resulted in affecting the commodity prices
throughout the world.

International Responses: The crisis resulted in the banks giving more

preference for collateralised lending by which they felt that the risk faced
by them because of defaults would get reduced. High scale responses
were taken with respect to:
 1. Regulatory
2. Supervisory
3. Monetary
4. Fiscal
The responses also included those which affected more than authorities.
The order in which the responses took place was:
1. Aggressive monetary easing.
2. Massive bailouts and capital injections by the governments.
3. Counter-cyclical fiscal policy.
4. Strengthening the standards governing bank capital, liquidity, risk
management, incentive compensation, and consumer protection.
While developed economies were busy looking out to find ways to bring
back their financial conditions to the normal state, ‘Emerging economies’
began to become the most favourable locations for investments. The
other reason was also that the global crisis had affected in varying levels
to the advanced economies and the emerging economies (E.g: India was
the second least country that was been affected with the crisis).
Responses by India: India has been one of the most attractive locations
for many of the MNC’s because of the huge talent pool that it has and the
cheap labour which is the main cost in many of the production processes.
Outsourcing had been become a huge source of income for many of the
people because of which both the MNC’s and Indians were getting
benefitted in the way that more employment opportunities for Indians and
cost-reduction for the MNC’s. Inflation was also low and stable during this
period. Introduction of “albeit bank-based” which is the rule-based fiscal
policy that reduced the public sector’s drag on private savings and
forward looking monetary policy that balanced the short-term trade-off
between growth and inflation on a continuous basis, while also pursuing
the objective of financial stability. Additionally, the phased liberalisation of
the economy to trade and capital flows along with a broadly market driven
exchange rate regime enhanced the role of external demand in
supporting the growth process, simultaneously exposing the economy to
the forces of globalisation. This exposure resulted in India becoming
highly integrated with the world economy and maintaining financial
stability assumed importance in the hierarchy of public policy; in fact, it
emerged as an important objective of monetary policy in India even
before the current crisis. This is evident from the counter-cyclical
monetary policy and macro-prudential financial regulations that were in
force during the boom phase just before the crisis. The main way by which
had been affected due to the crisis was not directly but through ‘trade,
finance and confidence’. Despite of all these India’s financial markets -
equity market, money market, forex market and credit market - all came
under pressure from a number of directions.
Measures to be taken to avoid similar situations in future:
• Improvements need to be done in efficacy of the existing
institutional framework
• Functioning of financial markets and institutions, in particular their
capacity to price, allocate and manage risk has to be done
efficiently.
• Devising a calibrated exit from the unprecedented monetary
accommodation globally.
• Business cycle synchronization and monetary policy
synchronisation.
• For emerging economies they need to reduce their excessive
dependence on any single developed economies for employment
opportunities and trade.