Financial crisis

 

What similarities (2007-2009 crisis) exist between experiences in Canada, USA and the host country (Australia)?

Financial crisis in 2007-2009 has been the worst economic disaster that has created a great recession throughout the world. The Great Recession has caused a loss of more than $2 trillion and global economic growth has dropped by 4%. This financial crisis has been caused due to reduction in housing prices and affordable housing programs in the United States. The foreclosure rate has been increased and the “Community Reinvestment Act” of the US has pushed the banks to make investment at subprime level (Tangpornpaiboon&Puttanapong, 2016).  Highdelinquency and default rates with subprime credit, mortgage, credit, hedge fund and “collateralized debt obligation (CDO)” are highly responsible for the housing bubble. The United States has faced this crisis at a high point due to its lack of regulation and fraudulent practices that have increased debt burden.

Housing investment has seen a massive inflow of foreign investment in the US and the GDP deficit of the country has reached 6%. The regulatory structure of the U.S. regulatory structure helped fuel the housing bubble and it has undermined the effectiveness of its regulation of financial conglomerates. The financial crisis has cost an estimated $648 billion to the US because of slower economic growth as per Congressional Budget Office (CBO). The U.S. lost $3.4 trillion in real estate in 2008-2009 (Pewtrusts.org, 2020). Alongside, $7.4 trillion has also been lost by the US in stock wealth that has $66,200 on average per U.S. household. It has caused high unemployment that has been 5.5 million. Mortgage loan companies namely Fannie Mae and Freddie Mac have also been responsible for this global crisis because the housing market has collapsed due to their guarantee of the majority of mortgages. Declining housing prices reduces the level of wealth and spending and for this reason, the US households and banks have lost about $5,800 in income.

Figure 1: Effects of crisis on GDP of Canada and the US

(Source: Canadian encyclopaedia, 2020)

Though almost similar conditions have been identified in Canada and this country has not experienced bank failures like the US. However, the lower interest rate has made it easier for households to carry large mortgage debt in Canada. Lack of confidence in bank solvency, low credit availability and low investor confidence has led to plummeting stock prices.  The housing markets of Canada have suffered and unemployment is reached to the peak at June 2008 resulting in foreclosures and evictions. The unemployment rate has been fluctuated around 6% in 2009-2009 whereas the US unemployment rate has reached 9.8% (Canadian encyclopaedia, 2020). It has closed imports and exports and according to Capital Expenditure Price statistics, the residential price index has reduced.

Figure 2: Changes in the US and Australia stock prices

(Source: Treasury.gov.au, 2020)

On the contrary, Australian housing market has not experienced a bubble and this country has recorded better growth outcomes due to resilience in Australian financial system. The housing construction has never exceeded demand and there has been less competition in the financial services market. However, the local economy's financial market has faced issues and the unemployment rate has increased by 5% in 2009. There have been large declines in equity prices that have reduced wrath in Australian households by 10% in 2009 (Australian Bureau of Statistics, 2020).  Australian dollar has also depreciated rapidly and declined by 30% in 2008 as well as enhanced liquidity rate according to Reserve Bank of Australia (RBA). Lehman bankruptcy occurred and foreign exchange market became illiquid.

What lessons were learnt from the financial crisis of 2007-2009 and what steps have been taken to date regarding the improvement of the banking regulatory systems?

Financial crisis has slowed down the economy that has tightened credit and declined international trade. The housing prices have dropped more than the price during this period. The banking sectors have changed their business models and market structure as well as assess the stability requirements and market efficiency. The evolution and stability of banking sector includes,

●      Changes in the market structure and capacity by introducing capacity metrics and expanding in large emerging market economies (EMEs).

●      Shifting in bank business model with less capital-intensive activities and commercial banking (Bell &Hindmoor, 2018)

●       Bank profitability or return on equity has declined across countries

●      Resilience of the banks have been increased to gain stability for the future risks by implementing new monetary policies

Changes in the bank's asset portfolio are observed and the US becomes more selective in international banking activities. A regulatory reform has been identified after the crisis because banks of the US and the European countries have faced sluggish revenues and legacy costs associated with misconduct. Accommodative monetary policies have been taken by the banks worldwide to strengthen their risk management. It has been identified that the Federal government of the US has spent $700 billion of taxpayer money to mitigate the financial crisis and stabilize the market through the “Troubled Asset Relief Program (TARP)” according to the CBO (Chen et al., 2016). This is approximately $2,050 per U.S. household on average. It focuses on buying troubled assets from large financial firms to restore confidence of credit markets. 

The policy makers of Canada, big six chartered banks such as “National Bank of Canada”, “Royal Bank of Canada”, Bank of Montreal”, “Canadian Imperial Bank of Commerce”, “Bank of Nova Scotia” and “Toronto-Dominion Bank” have observed the risk behaviour. Stronger regulatory environment has been created by the Canadian banks to reduce the insolvency crisis and restore liquidity and stability in financial markets (Lombardi &Siklos, 2016).  In addition, measures like “Insured Mortgage Purchase Program (IMPP)” have been taken that have allowed banks to interchange illiquid mortgage assets with the help of bonds issued by the “Canadian Mortgage and Housing Corporation (CMHC)”. The Bank of Canada has decreased its targets for overnight rate from 3% to 2.5% and policy rate of the banks have been decreased to 0.25% in 2009. A “two-year stimulus program” has been introduced for infrastructure spending as a fiscal policy and made their federal budget in balance for economic development.

“Organisation of Economic Cooperation and Development (OECD) of Australia has adopted the “Single Regulator Model'' and “Twin Peaks Model'' to handle the financial crisis. The Australian government has undertaken an aggressive stimulus package and improved tax policies to avoid recession. Significant macroeconomic policy has been created by RBA and cut interest rates by 100 basis points in response to the financial crisis. The Government has announced a stimulus package of $10.4 billion and that has been 1% of Australia GDP to gain financial stability (Treasury.gov.au, 2020). According to the World Economic Forum, financial development is possible by creating financial stability, financial access banking and non-banking financial services as well as changing institutional, market and business environments.

 

 

References

Australian Bureau of Statistics. (2020). 1301.0 - Year Book Australia, 2009–10. Abs.gov.au. Retrieved 12 August 2020, from https://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/1301.0Chapter27092009%E2%80%9310#:~:text=The%20effect%20of%20the%20crisis,than%20in%20many%20other%20countries.&text=The%20most%20obvious%20impact%20of,per%20cent%20by%20March%202009.

Bell, S., &Hindmoor, A. (2018). Are the major global banks now safer? Structural continuities and change in banking and finance since the 2008 crisis. Review of International Political Economy, 25(1), 1-27.

Chen, Q., Filardo, A., He, D., & Zhu, F. (2016). Financial crisis, US unconventional monetary policy and international spillovers. Journal of International Money and Finance, 67, 62-81.

Lombardi, D., &Siklos, P. (2016). The Bank of Canada and the global financial crisis: quietly influential among central banks. East Asia-Arctic Relations: Boundary, Security and International Politics, 119.

Pewtrusts.org. (2020). The Impact of the September 2008 Economic Collapse. Retrieved 12 August 2020, from https://www.pewtrusts.org/en/research-and-analysis/reports/2010/04/28/the-impact-of-the-september-2008-economic-collapse#:~:text=That%20equates%20to%20an%20average,income%20for%20each%20U.S.%20household.&text=Jobs%20%E2%80%93%205.5%20million%20more%20American,the%20September%202008%20CBO%20forecast.

Tangpornpaiboon, S., &Puttanapong, N. (2016). Financial contagion of the global financial crisis from the US to other developed countries. Journal of Administrative and Business Studies, 2(1), 48-55.

The Canadian Encyclopedia. (2020).Recession of 2008–09 in Canada | Thecanadianencyclopedia.ca. Retrieved 12 August 2020, from https://thecanadianencyclopedia.ca/en/article/recession-of-200809-in-canada#:~:text=Although%20the%20effects%20on%20Canada,responses%20by%20Canadian%20policy%2Dmakers.

Treasury.gov.au. 2020. Australia's response to the global financial crisis | Treasury.gov.au. Retrieved 12 August 2020, from https://treasury.gov.au/speech/australias-response-to-the-global-financial-crisis#:~:text=In%20Australia%2C%20the%20first%20significant,rates%20by%20100%20basis%20points.&text=The%20Treasurer%20left%20for%20the,and%20World%20Bank%20Annual%20meetings.

 

Banking management

 

Introduction

1. Write an overview of the assigned host country and include the political system of the country, for example China’s framework is socialist republic run by a Communist Party

Brazil, officially known as the Federative Republic of Brazil, is the largest South American and Latin American country. In terms of area, Brazil is also considered as the fifth largest in the world with an estimated geographical coverage of around 3.2 million square miles. Brazil has also developed immensely in the context of multiculturalism and opening its doors to the world economy. Primarily classified as an upper middle income country according to World Bank Statistics, Brazil is one of the most advanced emerging economies globally. The GDP estimates for the country as of 2020 exceeded the $3.5 trillion mark with the GDP per capita coming in at just about $17,000 (The World Bank, 2020). It is the largest producer of coffee in the word and is often considered one of the more influential regional powers in international politics.

Discussing the politics of the country, Brazil utilizes a presidential system and the form of government is aligned with a democratic federative republic. The president’s office, currently chaired by the right wing Jair Bolsonaro, is considered as both the heads of the state as well as the Union government. The organization of the country’s political administrative scenario is broken down into the Union, the different states, the Federal District and the various municipalities. Brazil has the multi party system where the decision are made and undertaken on the basis of proportional representation. It is important to note Brazil has been ranked poorly in terms of political corruption, being awarded the 106^th position out of 180 in 2019 with a total score of 35/100 (Transparency International, 2020).

2. What are the political risks of the host country? Discuss in detail.

Political risk has always been a hindrance for Brazil, especially when discussing the scope for the country to bring about economic transparency and financial growth. A recent example has been Bolsonaro’s aggressive stances regarding his handling of the COVID 19 pandemic situation that has brought about a great deal of international pressure on Brazil. The economy of the country reduced by more than -0.2% in the first quarter of 2020 (IJGlobal, 2019).  Tensions have also increased between the local and central authorities, especially in the context of how Bolsonaro has consistently criticized the actions and the policies of the Congress has further limited the leeway for political reform (McGeever, 2020). Income inequality has also been growing steadily within the South American regional power and this has further added to the host of political risks plaguing the country. It would also be important to discuss the role of the former President da Silva and the Operation Carwash, where numerous state officials and management at PetroBras were accused of taking bribes.

The involvement of the government essentially created a dent in the credibility of Brazil as an investment opportunity globally and is widely considered as one of the largest corporate government scandals in history. The presence of a diversified array of political risks in the country has also led to the development of a highly sensitive fiscal position, where barely 16% of the GDP is invested back into the economy. Exports have also fallen and the political and economic uncertainties have in turn led to a poor business environment, where the corporate payment behaviour has been affected negatively.

Examine the Financial System of the country

1.     What financial risks are present in the host country?

Financial risks are also a major source of problem for the government of Brazil and have only escalated post the onset of the pandemic situation. While the business environment within the country remains relatively stable when compared to similar economies, the transparency and the lack of institutional support systems are an immense source of burdens for companies and business. The Brazilian infrastructure suffers from massive bottlenecks, especially in the context of utilizing modern technology and ensuring a pro active approach to incorporating the advancements (Canuto, 2020). The cost of production is also very high including wages, energy expenses, and logistics and credit systems. The Brazilian economy has already suffered over the past few years with the recession hitting mid 2015 and current COVID 19 outbreak.

Disappointing corporate results and the growing pressure of both domestic and international debt has led to a majority of the country’s gains to be returned. By the end of 2019, the Real, which is the official currency of Brazil, had gone down to $0.25 in from $0.4 in 2015 (Gallas & Pallumbo, 2019). However, the International Monetary Fund has forecasted that there could be a 2.3% growth in the economy over the next year owing to cyclical recovery processes (International Monetary Fund, 2020). While the government has been riding high in this regard, the financial risks of Brazil such as anemic productivity and a saturated public sector continue to hinder the country’s growth. The interest rates have also been affected negatively, and this has in turn led to more and more capital flowing out of the country in the form of foreign debts. The Brazilian real has also suffered a great deal owing to the plethora of political and economic problems faced by the country.

2.     What are the responsibilities of the central bank for regulatory control with focus on the commercial and investment banking systems?

A central bank is key institution within a country entrusted with the responsibility of regulating the volumes of money and credit within an economy. The Banco Central do Brasil or BCB as it is commonly referred to as, is the central banking institution in the country. It was established in the year of 1964 and additional guidelines were institutionalized through the Federal Constitution of 1988 (Banco Central Do Brasil, 2016). Apart from the constitutional principles, a number of complementary rules and legal instruments govern the functions of BCB in the context of commercial and investment banking sections. The National Monetary Council and the National Financial System primarily govern the regulations of all the banks within Brazil including that of BCB. The key responsibilities of BCB regarding commercial banking systems relates to the maintenance of the Bank Reserves Account and the Settlement Account (Banco Central Do Brasil, 2016). They are used to liquidating results of the settlement systems along with financial transfer of guarantees and custodies. The SPB or the Brazilian Payments System was extensively restructured in 2002, after which the Department of Banking Operations and Payments System manages the Bank Reserve and the Settlement Accounts in real time.

BCB also plays important roles in managing the investment banking systems, with the SELIC or the Special System for Settlement and Custody being a key highlight. BCB governs and regulates almost all the aspects the investment banking system comprising of issuance, redemption, payment of interests and holding custody of the securities. The SELIC remains as the central custodian of governmental securities and also manages the accounts of the different clearing houses within Brazil. SELIC is managed jointly by the authorities at BCB along with the National Association of Open Market Institutions or ANDIMA (Banco Central Do Brasil, 2016).

3.     What measures are in place to protect clients in the event a bank fails in the host country?

Brazil has enforced a number of enactments post the formalization of the Constitution after the existent Brazilian financial system came to be initiated in 1964 by the Federal Law 4595/64. It sets out the key principles based on which the BCB regulates and governs the financial system of the country. Several additional enactments are also present that are aimed at protecting clients and consumers within the country with the most prominent being the the Capital Markets Law (Law 4728/65); the Securities Law (Law 6385/76); the White Collar Crime Law (Law 7492/86) and the Anti-Money Laundering Law (Law 9613/98) (Advogados, 2020). The Consumer Protection Code is also a fairly comprehensive system that defends the rights and interests of the consumers within Brazil and entails a multi level governmental intervention.

Several financial agencies and institutions also collaborate with ombudsmen to defend the interests of the consumer based on a strict Code of Ethics and under the governance of The National Ombudsman Association of Brazil (Center for Financial Inclusion, 2020). While economic and political corruption has been on the high in Brazil, client protection in the event a bank fails in the country is relatively effective and comprehensive. The legislative reforms in the form of the aforementioned acts and the institutionalization of the civil society agencies were primarily driven by the massive financial crisis during the 1980s. The difference between the liabilities and the assets were found to exceed over $800 million in 1985 as three large scale private sector banks collapsed and were involved in irregularities.

4.     Most of the country’s government debts are held in which instruments?

Brazil’s national governmental debt figures reached $1,180 billion in June 2020 and it has been on a constant upward curve right since the 1980s crisis. The record low was last seen in October of 2002, when the cumulative government debt figures were identified at $296 billion (CEIC, 2020). The responsibility for the provision of government debt in local currency in Brazil is tasked with the central bank, which is the Banco Central Do Brasil. Currency conversions are done on the basis of the values of the Federal Reserve Board average market exchange rate. In terms of the constituents, the majority of Brazil’s government debts are held in the form of Repo Operations, bonds and debentures and National Treasury Securities. The country also has a number of Treasury Bills as part of the government debts.

The per capita debt was roughly hovering around the $18,000 mark and has certainly worsened over the years when compared to globally. Poor infrastructural capabilities, political tussles and instabilities and degrading corporate performance were the key drivers apart from the bloated nature of the public sector in Brazil. The net debt to GDP ratio has also been on the rise, exceeding over the 55% mark in 2019 (Commodity, 2020). The Petrobras scandal and the debts and payments that followed have certainly been the source of the problems for Brazil in the context of government debt, involving the conviction of a former President and the trial of yet another President.

5.     Explain how fluctuations in the host country’s exchange rate affect the value of that debt held by foreigners?

Fluctuation in Brazil’s exchange rate could severely impact the value of the debt held by foreigners, especially since the Brazilian economy has consistently been towards a downfall. Recent reports have suggested that the outbreak of the COVID 19 pandemic could bring down the value of the Real to as much as 5 per dollar. While the government ensued to sell over $3 billion through foreign exchange swaps, the move had a limited degree of impact on the value of debt and the currency. An emergency rate cut was also authorized by the Federal Reserve as a measure to reduce the costs of borrowing, but still the Brazilian Real was identified to be the worst performer in the current year globally, going down by over 13% (Oyamada & Batista, 2020). Market based exchange rates involving the Brazilian Real would significantly affect the debt value in the case of a fluctuation.

A drop in demand could mean the currency going down further, which would subsequently translate into higher interest rates and principal amounts. It could be detrimental for the long term economic sustainability of the economy, especially when considering he damage that the COVID 19 pandemic has already caused. A fluctuation would also increase the instability within the investment scenario, causing more and more foreign firms to limit their investments in the country. It would only further add to the economic depreciation that the country has been trying to address through numerous policies and interventions and could in essence lead to a rise in government debt.

6.     Visit the host country’s Central bank’s website, examine the movement of inflation rates and interest rates and discuss the changes in both rates

While Brazil continues to be the largest economy within South America, the recent crisis and the financial discrepancies over the past few decades have led to growing concerns regarding the future. The inflation rate during 2015 and 2016 was hovering around the 9% mark, and although there have been improvements as the figure reduced to 3.45% in 2017, the problems continued as the inflation rate soared back to 3.67% in 2018 (Reuters, 2020). The exchange rate has also been subject to a plethora of fluctuations owing to the political turmoil and government scandals. Currently standing at 5.274 (BRL/USD), Brazil’s exchange rate suffered its biggest drop during the recession period from 2015 to 2016 and poor GDP growth figures over the ensuing years did little to bring back the economy. The current account for the country also shrank considerably post the recession and the scandals from over 4% of the GDP in 2016 to barely 0.5% of the GDP in 2017.

The fluctuations in the rates were also driven by the closed nature of the economy along with the impact of the commodity prices and the terms of trade. Price regulation is rampant within the South American country and this has only led to an enhancement of the scope for manipulation for both corporate houses and the government (Araújo & Arestis, 2019). Bifurcation of the credit markets has also been a key problem along with wage indexation, and they have only become more significant with the fluctuations in the exchange and inflation rates. The volatility has been extremely high when compared to other economies, and this has further induced volatility within the policy rates.

7.     How would the Bank of Canada operate in a fixed exchange rate regime when the dollar is overvalued and undervalued? What are the effects on international reserves?

Fixed exchange rate systems can be difficult to incorporate, especially within developing economies like that of Brazil. Bank of Canada, which operates as the central banking organisation within the country, would have to undertake a number of strategies when engaging in a fixed exchange rate system with Brazil. The key objective would be to maintain the pegged ratio and stabilize the value of the currency, and any point where the dollar becomes overvalued, the quantity of currency swaps would have to be decreased.

Similarly, if the dollar becomes undervalued, the quantity of currency swaps would have to be increased. However, maintaining pegged exchange rates has also been shown to increase international reserves over time if engaged with in a controlled manner. The Chinese foreign exchange rate growth post 2010 is the biggest example in this regard, riding on the shoulders of technological advancement and manufacturing (Engel & Zhu, 2019). Selling or purchasing of Brazilian Real to stay within the stipulated band would have to be the fundamental working operative for the Bank of Canada in a fixed exchange rate system. In terms of the impacts on the international reserves, a drop in the value of dollar would lead to a reduction on the value of international reserves and vice versa.

 

 

References

McGeever, J. (2020). Brazil political risk looms large again over markets. Retrieved 10 August 2020, from https://www.reuters.com/article/us-brazil-markets-political-risk-analysi/brazil-political-risk-looms-large-again-over-markets-idUSKBN24020V

IJGlobal. (2019). Brazil political risk for infra investors. Retrieved 10 August 2020, from https://ijglobal.com/articles/144189/brazil-political-risk-for-infra-investors

Canuto, O. (2020). Brazil’s biggest economic risk is complacency. Retrieved 10 August 2020, from https://www.brookings.edu/opinions/brazils-biggest-economic-risk-is-complacency/#:~:text=Beyond%20low%20interest%20rates%2C%20the,foreign%20debt%20by%20Brazilian%20corporates.

CEIC. (2020). Brazil National Government Debt [2000 - 2020]. Retrieved 10 August 2020, from https://www.ceicdata.com/en/indicator/brazil/national-government-debt

International Monetary Fund. (2020). World Economic Outlook Update, January 2020: Tentative Stabilization, Sluggish Recovery?. Retrieved 10 August 2020, from https://www.imf.org/en/Publications/WEO/Issues/2020/01/20/weo-update-january2020

Gallas, D., & Palumbo, D. (2019). What's gone wrong with Brazil's economy?. Retrieved 10 August 2020, from https://www.bbc.com/news/business-48386415

Banco Central Do Brasil. (2016). Functions of the Central Bank of Brazil. Retrieved 10 August 2020, from https://www.bcb.gov.br/conteudo/home-en/FAQs/FAQ%2011-Central%20Bank%20of%20Brazil%20Functions.pdf

Advogados, P, N,. (2020). In review: consumer finance law in Brazil. Retrieved 10 August 2020, from https://www.lexology.com/library/detail.aspx?g=7b7e51cc-1a73-4859-a67e-24e212f7a730

Center for Financial Inclusion. (2020). Client Protection in Brazil. Retrieved 10 August 2020, from https://www.centerforfinancialinclusion.org/client-protection-in-brazil

Commodity. (2020). The National Debt of Brazil. Retrieved 10 August 2020, https://commodity.com/debt-clock/brazil/

Oyamada, A & Batista, F,. (2020). Brazilian Real Plunges to Record Low Against Dollar. Retrieved 10 August 2020, https://www.bloomberg.com/news/articles/2020-03-05/brazilian-real-plunges-to-4-60-per-dollar-amid-rate-cut-bets

Reuters. (2020). Brazil growth, inflation, rates outlook sink to new lows: central bank survey. Retrieved 10 August 2020, from https://www.reuters.com/article/us-brazil-economy-survey/brazil-growth-inflation-rates-outlook-sink-to-new-lows-central-bank-survey-idUSKBN2221N6#:~:text=End%2Dyear%20inflation%20is%20now,bank's%202021%20target%20of%203.75%25.

Araújo, E., & Arestis, P. (2019). Lessons from the 20 years of the Brazilian inflation targeting regime. Panoeconomicus, 66(1), 1-23.

Engel, C. M., & Zhu, F. (2019). Exchange rate puzzles: evidence from rigidly fixed nominal exchange rate systems.

Transparency International. (2020). Brazil. Retrieved 10 August 2020, from https://www.transparency.org/en/countries/brazil#

The World Bank. (2020). Data – Brazil. Retrieved 10 August 2020, from https://data.worldbank.org/country/BR

it's all in the head.

the child was born, and out he came
into a vivid darkness of pretty lights,
fallacy, betryal, all unknown,
God's chosen one, told the wisemen
and he never let them down, did he?
And then, he grew up.

a little cigarette by the backdoor,
and a cluster of psychedelia.
the boy, was now a man,
a mere shadow of the times gone by,
needing always this bit more, this little bit more than himself.

the sound of silence was what he heard,
walked on water, fed on thunderstorms,
and only but he could light a fire with snowflake.

it's all in the head, mind over matter.

the rivers have gone dry,
white hair and wrinkles are his subjects of rule,
old man, old old man,
wilting, dying.
he didn't want it this way,


he screams, "i did not deserve this."
a voice in the head, possibly an outburst,
'think again, maybe you did.'
it's all in the head, mind over matter;
but funny how it stands, when the mind itself is in tatters.