Impact of the GFC (Global Financial Crisis) on Banking Activities
Global Financial Crisis was caused by the failure of free market forces economic ideology. In 2007, the American financial environment was thrown in to turmoil with most households finding it difficult to meet the high rates of mortgage. This was followed by tightening of credit by financial institutions as a control measure against possible bad debts (Goodhart, 2008, p. 331). The crisis later spread to Europe, Asia and Africa. Evidently, the GFC posed a great threat to financial institutions, which are dominated by banks.
Banks refer to the intermediary institutions which lend money to units with deficits and borrow from units with surplus. The units with surplus deposit their monies in banks in order to get a certain level of profit in future while protecting their investments from financial risks. Conversely, deficit units borrow with a caution of ensuring the cost of borrowing is manageable (Howells and Bain, 2005, p. 23). During the global financial crisis, these conditions are altered significantly as the risk taking preferences of banks and investors decrease.
The investors who would not mind taking financial risk during become risk averse during financial turmoil. In so doing, the banks and borrowers seek to minimize their exposures to economic risks. During the global financial crisis, banks focus their effort on closely monitoring and vetting its borrowers so as to avert or minimize chances of defaulting (DeHaas and Van Horen, 2009, p. 3). Based on the extra caution by borrowers and banks in lending money, there was a substantial decrease in loans provided by the banks (Ivashina and Scharfstein 2010, p. 319).
In addition to the drastic action by the banks to closely control and monitor their lending behaviour, regulators intervened with tight regulations for governing the lending activities of banks. In most jurisdictions, the respective regulators introduced capital constraints and tight liquidity to the disadvantage of banks’ lending capability (Barajas, Chami, Cosimano, and Hakura, 2010, p. 3).
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