Financial crises are some of the worst intractable global occurrences. The crises always differ in scale but rather exhibit similar effects on the affected populations and economies. The Global Financial Crisis (GFC) is arguably the most infamous financial crisis in recent times, only comparable to the Great Depression of the 1930s.
The crisis began in the U.S.A in 2007 as a result of subprime lending and spread to other major global economies. While writing an IMF working paper, Merrouche & Nier (2010) states that the subprime crisis spread through a combination of direct exposures to subprime assets, the gradual loss of confidence in a number of asset classes and the drying-up of wholesale financial markets.
The crisis led to the collapse of major financial institutions, bailout of banks and a great recession in major parts of the world. The major cause of the financial imbalances has been a subject of debate for a long time. Financial analysts and policy makers endlessly argue on the subject matter with no concrete agreement on the possible causes. However, most commentators seem to agree that the required supervision and regulation were lacking, (Merrouche & Nier 2010).
Merrouche & Nier asserts that there is no conclusive agreement as to whether it was the overly accommodative monetary policy from 2001 or widening global imbalances and associated capital flows that caused the build up in the financial imbalances.
Highlights of Consequences of Global Financial Crisis
The effects of global financial crisis can never be conclusively discussed; however, a highlight of the severe consequences is important. The effects spread to all sectors of the economy through a ripple effect but with a major effect on the financial market. The crisis led to the closure or if less, the failure of many businesses. The consumers were hugely affected as they experienced a great decline in their wealth. The banking sector had a very big threat of collapse that forced governments to incur huge expenses in an attempt to bail out the important financial institutions.
Despite all these, it is very interesting to note that the building and construction industry in Australia had quite a number of sub-sectors dismally affected by the global financial crisis. The first is the building materials supply that had the concerned companies remaining profitable throughout the period (Thangaraj & Chan 2012). The second sub-sector is the building contractors.
As a consequence of the global financial crisis, Australia experienced an extraordinary raise in currency demand (Thangaraj & Chan 2012). It was more evident towards the last quarter of 2007; however, the major determinant could not be immediately ascertained. This in turn created very severe, unexpected disruptions in the financial market. The RBA thus had to take urgent policy initiatives to address the ensuing problems at their formative stages.
One of the steps taken by the bank was to lower the cash rate from 7.0 % to 6.0 % per cent in October 2008 and further to 3.0 Percent in April 2009. (Cusbert & Rohling 2013). Cusbert & Rohling (2013) while making reference to a work by the RBA, explains that in addition to lowering the cash rate, the bank also undertook to lower the policy rate all designed to provide liquidity in the Australian market.
Way Forward: Australian Prudential Regulation Authority (APRA)
After the pressure and losses associated with the global financial crisis, it is important for every country, affected or not, to cut its way forward. The main reason for self evaluation is to determine the best ways of dealing with the crises in the future. It is also important to note that financial crises cannot be fully avoided but they can be managed whenever they arise. This is the basis to which the Australian prudential Regulation authority (APRA) came up with proposals on how to act in such crises to avert the possible effects.
The APRA clearly recognizes that financial crises are inevitable; however, they can be managed. The APRA regulates the banks and the general life insurance companies in Australia. The move was informed by the looming economic breakdown that occasioned the 2007/2008 economic crisis.
The financial markets in Australia had experienced the impacts of the global financial breakdown just like the rest of the global economy. However, it is important to note that the impact was not as severe in Australia as it was in other countries such as Germany, the United States, France, and Canada. Nonetheless, the little impact on the Australian markets crippled some businesses such that the government had to intervene through the formulation of policy responses.
The same was seen in nations like the USA where there was a budgetary allocation to stimulate the economy. In the attempt to recover from the looming economic crisis, the Reserve Bank of Australia conducted a Financial Stability Review FSR.
The Conduct of Monetary Policy in Crisis and Recover
The FSR was meant to determine the root causes of the financial crisis in the Australian financial markets (Thangaraj & Chan, 2012). During the review process, it was noted that the risk premium had declined and this had been the trend for several years before it reached its maximum mid 2007.
The explanation behind this trend has taken different turns with economists trying to make sense out of the events of the 2007 crises. One of the most viable explanations of this is the fact that in the past years the world had experienced a prolonged economic stability (Thangaraj & Chan, 2012). While this is a positive situation, it is detrimental to the well being of the economy.
Economists argue that the prolonged periods of economic stability can cause the investors to be extra optimistic with the market trends. In other dimensions, economical stability translates to low interest rates hence increasing the rate of borrowing. With the increased volumes of money in circulation, the demand for the same drops significantly. This translates to inflation as the currency values lower significantly. The increase in money borrowing also interferes with other economic factors such as competitive business practice amongst financial institutions and in the money market.
Other explanations include the failure of the financial markets to manage its risks. Lending money with low interest rates encourages high spending and people with borrowed high amounts of money. With these kind of borrowing directed to assets that do not plough back profits such as mortgages and insurances, the crisis build up was inevitable.
Economists had predicted a crisis even before it actually took place basing their concerns on the financial malpractices seen in the money markets. The RBA used very inefficient methods of managing the economy’s financial risks. We cannot conclude that all the players in the industry made the wrong decisions in regard to risk management. However, certain players can be hand picked to and blamed for their involvement in the crisis.
The models used by investors, issuers and regulators curb the risks were not effective in addressing the issue (Thangaraj & Chan, 2012). Although some of their policies were close to working right some did not work out well for the economy. The Federal Reserve banks have a responsibility to monitor and control national funds rate.
This is done to protect the constancy of the economic systems in a country (Thangaraj & Chan, 2012). Banks are required to deposit reserves in the reserve banks, a factor that sees the fluctuation of interest rates. In the event of a recession, the Federal Reserve lowers the interest rates to cushion the economy from the adverse effects of an economic melt down. In April this year, the reserve bank of Australia was resolved to leave the interest rate at 4.25 % (Thangaraj & Chan, 2012).
Lessening of the monetary policy in the year 2011 by the RBA has seen a slow production increase in Australian economy hence prompting the RBA not to think about an additional decrease in the interest rate. The sluggish growth velocity of the Chinese market as the RBA governor outlined in his speech influenced a depressive effect on the Australian dollar (Merrouche & Nier, 2010). Banks have turned down the RBA’s call for interest rate reduction in the county (Kearns, 2009). Their reasons include the anticipated effect the move could have on the financial market.
Among their concerns, the banks are arguing that cutting the interest rates could lead to the increase in the cost of borrowing from the reserves (Littrell, 2011). On many occasions banks fail to pass the full benefits of a reduced rate to the public and instead maximizing of the profits accrued from reduced reserve lending. This will definitely have a negative impact on investors especially those interested in mortgages. In addition, it will enhance the impacts of the economic meltdown on a global scale.
The RBA gave the order regarding the financial market devoid of taking into account the factors that influence the market it (Cusbert & Rohling, 2013). For banks being able to change their prices and pass on the benefits to its consumers, the rule of demand and supply has to be taken into account.
The rise in the rate of borrowing is influenced by the attempt by banking industry to cushion itself from the financial pressures and the rising cost of borrowing from the reserve. The other way to look at the issue is from the bank’s point of view (Brown & Davis, 2009). Bankers are raising a viable argument that by passing the borrowing cuts to their customers their operating cost will rise and hence the need for actions to reduce the impact of such an event. One way to deal with the bankers escalating operating cost is by reducing the number of employees hence reducing the employment.
This paper has outlined the major ways that the government of Australia used to respond to the financial crisis in 2007/2008. The paper looks at the effectiveness of financial policies that were formulated to address the issue. It also outlines the responses of the banks to these policies and the conflict that ensued between the national reserve and the key financial players in Australia.
Brown, C & Davis, K 2009, ‘Australia’s experience in the global financial crisis’, Journal of applied finance, Vol NV, no. n.i, pp. 1-7.
Cusbert, T & Rohling, T 2013, ‘Currency demand during the global financial crisis: evidence from Australia’, Research discussion paper , economic research economic research , Reserve Bank of Australia , RDP 2013-01, Reserve Bank of Australia , Australia.
Kearns, J 2009, ‘The Australian money market in a global crisis.’, Reserve Bank of Australia Bulletin, pp. 15-25.
Littrell, C 2011, ‘Responses to the global financial crisis: the Australian prudential perspective’, Enhancing financial policy and regulatory Co-operation – Responses to the Global Financial Crisis , APRA, Australia.
Massola, J., 2011, Banks may not match RBA’s interest rate cut, Australian Bankers’ Association warns. Web.
Merrouche, O & Nier, E 2010, ‘What caused the global financial crisis? —Evidence on the drivers of financial imbalances 1999–2007’, Working Paper, Monetary and Capital Markets, International Monetary Fund, WP/10/265, Karl Habermeier , Bretton woods.
Thangaraj, RK & chain, TK 2012, ‘The effects of the global financial crisis on the Australian building construction supply chain’, Australasian Journal of Construction Economics and Building , Vol 12, no. 3, pp. 7-15.