Literature review
Financial Crisis is developed due to unconsolidated financial and fiscal polices. Where as, sudden changes in the financial system of the banking sector which includes the situation from development of the financial innovation with high risk factor to the long expansion and increments in assets price and its transformation into sudden decrease in prices of financial assets. In addition liquidation of financial assets also get started which identifies the impacts of financial crisis on global economy including all finical and non-financial institutes.
Definition and Classification of Financial Crisis
Financial crisis is a Term that refers towards a concept that can be explained after considering various factors such as evolution, causes and impacts. It is a situation that makes financial institutions unable to meet their major goals and objectives. Statutory requirements of the financial institutions became unable to perform by the financial institutions in financial crisis situations. In addition financial crisis negatively and significantly impact on the performance of the financial institutions. Financial crisis contains two situations on which its severity depends i.e. bank crisis and currency crisis. Buiter, (2012) explains that the combination of both situation cause financial crises for financial institutes that might extend to other industries. In addition, currency crisis refers towards crisis in production of currency that attacks both internal and external situations. On the other hand, bank crisis refers towards a crisis that comes with bankruptcy. It occurs because of several micros and macro economical factors which results into mergers, acquisitions of the banks by the public sectors (Aiyar, 2012).
The Role of Banks in the Propagation of Financial Crises
Financial crisis usually gets significantly appear in financial institutions of the countries. Financial institutions may include banks, insurance companies, financial intermediaries, investment companies or any other financial multinational. Even though, financial crisis is the damaging element that impacts on all financial institutes and other sectors as well (Hau and Lai, 2012). However, apart from all other financial institutes, banking sector is the most essential and deciding sector that transmits and solve financial crisis. Banks are the major source that contributes in occurrence, transmitting and solving the problems caused by financial crisis. Major role of banks in financial crisis can be seen through identifying the difference between maturity and due date of the basic elements of banks i.e. assets and liabilities. Banks are the important elements of the capital market industry (Poczter, Gertler and Rothenberg, 2013). It act as intermediary and sometimes act as founding member of clearing houses as well. Compensating role of banks enables them to get interacted with everyone within the country and an economy that enable banks to transmit crisis situations to them. Banking sector institutes act as a bridge between financial systems and its different components. In addition, banks are the key contributor that develop financial crisis and transmit them as intermediary through funds transformation from abundant to deficit (Aiyar, 2012).
Apart from this, banks also facilitate the development of the financial crisis through their financial activities that impact on interest rates of the financial markets. According to Cetorelli, Mandel, and Mollineaux, (2012) it has been identified that bank crisis could also cause financial crisis for the country which creates uncertainty in the market and for the prices of the assets. Financial crisis is the situation that includes various characteristics of banking sector such as bankruptcy of financial and non-financial institutes, fall in prices of assets, and fall in values of currency market (Cetorelli, Mandel and Mollineaux, 2012). More so, there are certain factors that determine the development of financial crisis and it includes decline in balance sheet of financial institution, continuous increase in interest rate, uncertainty enhancement in the economy of the country, and through the situation of the non-financial institutes and their volatility. Financial crisis doe not depends upon the structure of the financial institutes or systems rather it can be occurred in any sort of financial system. However, the financial crisis management situation depends upon the structures that financial institutes May follow to regain their position after end period of financial crisis (Haas and Lelyveld, 2014).
Factors that Impact on Financial Crisis
In Time Decision Making
Financial crisis occurs due to lack of effective strategies adaptation and implementation with the low quality of supervision in the banks and implementation of policies and management rules by the leadership of the banks. All of such reasons cause occurrence of financial crisis and deficiencies for the banks. Entire financial intuitions are interconnected with the economy of the countries due to which it impacts on them directly. Right decision at the right time allows banks to pre-empt any crisis situation (Niemira and Saaty, 2004). Market analysis and financial lending should be interrelated and data gathering should be undertaken to proceed with financial decisions like to increase credit financing etc.
Imbalances in the systems of the financial institutions are interlinked with the macroeconomic factors that transfer the impact of low quality management in financial intuitions to the economy of the country (Buiter, 2012). More so, macroeconomic instability is the major cause that enable financial crisis to get occurred. Besides this, Reinhart and Rogoff, (2013) identified in their study that stability of the factors of macroeconomic includes stability in prices of assets, and stability in the mandatory requirement of the banks, etc.
Investment Volatility
Fiscal policy of the country can help their financial institutions to get enhanced crediting activity and price of assets. Such efficient and effective policies can help economic conditions of countries for the long time and make them able to sustain. On the other hand, financial crisis get also be caused due to the external macro economical factors such as adverse changes in exchange rates etc. (Reinhart and Rogoff, 2013). Financial institutions i.e. banks are stable in strong financial condition till they are keeping liquid form investment in high degree. Through the strong financial condition, banks became able to handle the withdrawal system. Miniaoui, Sayani, and Chaibi, (2014) Identifies from his study that situation of financial crisis can be handled trough adaptation of effective strategies and their appropriate implementation (Miniaoui, Sayani and Chaibi., 2014). Lending process of banks also gets affected during financial crisis. Banks in all over the world reduced their lending process and started to support their domestic banks however, banks kept on lending with such financial institutes with whom they have lending associations from the long term (Cetorelli, Mandel and Mollineaux, 2012).
Credit Investments and financial Crisis
Credit loans and investment when made in an increasing pattern without restrain these situations carry a threat of financial crisis in case if the user defaults. Hence credit investments in the corporate sector are affected and are a real contributor to the economy of the state or country. It has been recorded during credit boom the credit investment were 67% in American market and reduced to 37% during crisis (Brunnermeier, 2008). Banks need to monitor credit investment decision and take full control of process where they should evaluate and lend legitimate credits.
Mortgage Loans and Financial Crisis
According to Duchin, Ozbas and Sensoy, (2010) consumers were lended mortgage loan and when they defaulted on sub prime mortgage loans the financial crisis instigated. Hence it can be stated decision making regarding when and how much to lend mortgage loans will allow to manage the financial system in a more fluent way. Ivashina and Scharfstein, (2010) define sharp increase in the financial lending is responsible for creating a situation that can convert in to all out financial crisis. Banks without proper decision making tries to increase sales that proves counter productive.
