Risk (Term Paper Sample)

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Introduction
Global financial crisis was a wide spread period of economic disaster that impeded markets world wide. The global financial crisis started in 2007, and it began with the breakdown of the United State financial system extending spontaneously to other countries worldwide. The short run widespread of global financial crisis began to take off when basic commodity prices started to increase. These basic commodities included the price for fuel and food. On the other hand, the fertilizer prices increase caused damages to the importation of food and crop manufacturers in the developing economies around the globe. This paper work focuses on the cycles of events leading to the global financial crisis which led to bad investment decisions causing serious losses and successive crisis in liquidity hence triggering the global financial credit crisis. It also focuses on the failure of major brand organizations during the global financial crisis despite the existence of excellent risk management and mitigation methods.
Deepening of the global economic crisis in 2008 led to reduced consumer spending due to high commodity prices. Moreover, banks and financial institutions reduced spending especially on the foreign direct investments. Global financial crisis period was also accompanied by large scale reduction in production, international trade and capital investments. Unemployment and inflation characterised most of the economy’s performance. In addition, the continued increase in food and fuel prices led to starvation and increased poverty levels in the developing countries, whereas the developed and wealthy countries growth and recovery remained sluggish.
Largely, the effects of global financial crisis were felt by the developing countries and this greatly affected their GDP gross domestic products hence deteriorating economic development and growth. However, developed countries felt the effects in major sectors of the economy such as capital market, money market and the housing markets. This forced them to pull back on foreign direct investments in developing economies so as to protect the home based assets, and it further led to more troubles in the developing countries. Some of the financial analysts and economists still feel that though recovery was achieved later on, the globe still remain at risk of such other economic disturbances.
Discussion
The global nature of financial crisis in 2007-2008 was characterised by inflation and unemployment. Fundamentally, inflation is the general increase in commodity prices followed by subsequent decrease in the consumer’s purchasing power. Inflation was experienced during the global financial crisis due to rise in food and fuel prices which reduced the consumers spending in major economies of the world. On the other hand, reduction in large scale production and international trade led to increase in level of unemployment.
During the global financial crisis, both developed and developing countries experienced a series of economic downturns such as credit crunch, housing market failure, investment loss in major organizations, equity price bust, and financial assets such as options and derivatives bust hence decline in GDP output. Following the economic meltdown brought about by the global economic crisis, the subprime property and housing market especially in the United State underwent a period of unparalleled havoc. This heightened the instability of investments such as real estate. The momentum of the housing market dampened due to a series of fluctuating interest rates. Households and investment companies were not in a position to access credit from the banks hence construction of the real estate reduced and subsequent dampening the housing market. Also, the housing prices declined due to soaring global product prices. The economic downturn allied with an increased level of unemployment and concerns about job security of citizens of world economies together with tightened lending conditions undermined the housing market.
Prior to the global financial crisis, property and real estate owners enjoyed increased returns but following the global effect of financial crisis, property owners’ returns from investments on real estate declined. This is because, banks and other financial institutions extended loans to commercial property investors at low interest rates. Construction of real estate houses increased. Consequently, the supply for real estate exceeded the demand. For instance, it was estimated that, in 2009, there was 200,000 real estate housing units in excess supply in Ireland. However, the investors were unable to repay the loans. Eventually, banks were denied access to credit due to loan defaults. On the other hand, real estate reduced housing prices led to dampening of the housing markets in major developed countries like United Kingdom and United States. The combination of heightened in accessibility of credit to banks and real estate investors squeezed the circulation of liquidity leading to global credit crisis.
On the other hand, the credit crunch was a period of severe shortage of liquidity in circulation. The housing market failure was an effect of global financial crisis which later led to a credit crunch in economies of developing and developed countries. The policy makers in many developed countries like United States and the United Kingdom recognized the activities of banks and other financial institutions including providing credit to the citizens of an economy. Moreover, these activities necessitated operational risks exploited by organizations in execution of the business functions
When banks extended credit to citizens, they exposed themselves to operational risk; a risk of loss from consequential failure of internal operational systems in an organization or external factors.
However, the operation risk undertaken by the financial institutions and banks in extending loans to citizens did not have cushion apparently to absorb the huge loan defaults and investment banks made huge losses. In addition, banks pursuing credit extensions during the global financial crisis period (2007-2008) to citizens experienced huge losses due to real estate investors’ default. The defaulters denied commercial banks credit and in return it squeezed the circulation of credit in the economy and global financial crisis turned into a credit crisis. The credit crisis which lasted for a while created huge investment losses to banks and housing market due to excess supply. The financial crisis led to low production levels slowing economic growth and development. Moreover, since production was low it required fewer workforces hence the level of unemployment increased in the developing and developed nations.
Banks in the developed countries exercised credit risk by giving out loans. Following reduction in interest rates during the global financial crisis, banks attracted credit risks. These are risks associate with the bank’s losses if borrowers do not make disbursements as agreed. Commercial banks mostly exercised credit risk when they wanted to make profits. However, following widespread financial regulation failure, banks lost investable funds as a result of taking too much credit risks. The losses impacted greatly on the ability of commercial banks to lend more hence weakening the circulation of money and subsequent credit crisis.
From the above discussion, both credit and operational risks can be exercised by an organization simultaneously. In practicality organizations and companies including banks are always in pursuit of profits. This increases the appetite for credit risk. On the other hand, organizations operational risk entails losses arising from execution of functions of an entity. Therefore, whenever a bank extended loans to the citizens during the global financial crisis both the operational and credit risks were interconnected. Losses experienced by banks due to defaults were resultant effects of both operational and credit risks undertaken by commercial banks in major economies worldwide.
However, systematic risk is fear of the entire collapse of the financial system. Excessive borrowing by households during the global financial crisis was as a result of many banks and financial firms taking high risks without regulating the money market forces. This widespread, excessive borrowing and irresponsible monitoring of the financial systems led to collapse of banks and other financial institutions during the crisis. Losses experienced were resultant effects of too much of systematic risk in the organizations managed by corporate governance.
Also, during the global financial crisis most governments experienced huge public debts. Inflation intensified, and unemployment level increased. On the other hand, households and investors spending reduced due to panic of unprecedented increases in commodity prices. All these cycles of events were due to irresponsible management of the financial systems in major super power nations like United State hence causing deficits amid the surpluses of trade in China. The global imbalance of trade surpluses in China and trade deficits, in United States, was also the root causes of the global economic crisis. Banks stopped lending to other banks and refused to inject liquidity into financial markets causing damage to the global economic activity and subsequent low economic growth.
Governments did not respond to expansionary monetary policy because of the huge public debts from international monetary fund and World Bank. Combination of the commercial banks and government responses towards the world economy led to low investment levels and losses to investors. These losses were attributed to reduced consumer spending and the stepping up of savings among households. These changes among households were accompanied by loss ...