In the past two years or so, the financial markets, institutions, and world economies at large have been affected by a financial turmoil of unrecorded magnitude. The situation in the world financial market and other financial institutions has positively begun to improve. Nevertheless, there is a need for investigation into what went wrong and how the wrongs are being corrected towards a more stable future. It is important to look into trends in the world market and frame sources of financial risk. in addition to understanding the most significant trends that have, for the last two years or so, affected these markets, institutions, and the world economy at large, it is crucial to understand how effects of the financial crisis in given countries trickle down and thus affect the whole world.
Of key interest in this report are the financial bubbles that have been at the center of financial crises. These financial bubbles comprised of speculation in housing, currencies, and commodities through complex monetary tools, where suitable prices could not be factored out. Appreciating that repulsive financial turmoil continues to impact heavily on the day-to-day economic activities the world over; this paper emphasizes the need for proper financial risk management to avoid future predicaments.
Financial Risk Management
According to Sharma (2006, p.11), financial risk management is the way of coming up with economic worthiness in a corporation by making use of monetary tools to control the chances of business organizations being open to the elements of risks; particularly credit peril and market threat. In addition, Sharma (2006,p.11) notes that financial risk control can be both qualitative and quantitative, and usually demands the recognition of the source of the perils, quantifying as well as coming up with ways and approaches of addressing them. The existing world’s financial turmoil according to the writer cannot be ascribed to the disappointment of the risk management applications in isolation, but to a certain extent, the lack of implementation of the financial peril management at all. By the time these speculative bubbles were bursting in the current world’s financial tragedy, the hard activities, which portrayed the speculative situation, had gone unchecked.
Financial deregulation directed by the entrusted faith in virtues of the market permitted diverse options of financial advances, which were not attached to the dynamic actions of the major segment of the economy (Sharma, 2006, p.12). Such instruments act in support of speculative actions that mount confidence on the actual persuasive information that is a bit more of a speculative tendency into the coming prospect. Sharma (2006,) additionally observes that speculation on the exorbitant returns can partly support itself, but sooner than later the realities of slow economic growth finally dawn on the illusion of harmless tentative finance.
Causes of Financial Crisis
The simultaneous downfall of speculative situations all over the world’s financial markets could have partly been ignited by not only the failure of risk management practices in financial institutions and the world economy at large but due to other bubbles, such as the United States mortgage bubbles. In this particular instance, the cost of housing in the US alone had overblown, as many residents had flooded the bank’s halls in attempts to finance their mortgage. Many politicians and policymakers who had advocated for the need of people to own homes had ignited this high turnout of home seekers. Without the required financial advice, the upsurge in demand for mortgage coupled with the greed of many banks to make exorbitant profit from loans awarded to un-creditworthy borrowers caused the first ripples on the would to be world’s second-worst financial turmoil since the great depression of the 1930s. The financial policymakers did not put into consideration the consequences of such trends (Sharma, 2006, p.14).
The other bubbles, as noted by Sharma (2006), incorporated speculations on financial markets the world over and mostly that of the world’s currencies. This particular speculation involved the trading of world currencies on various stock exchange markets. With many people anticipating good performance on different world currencies, various investment worlds over resulted in mass investment on the stock exchanges.
There were other causes of the financial crisis, which were facilitated by the world commodity prices such as that of oil. These oil bubbles, according to Sharma (2006, p.16), could still have popped out even without necessarily being triggered by the actual US mortgage mayhem. On the oil situation, Sharma remarks that the price of oil has remained a record high compared to the last 5 or 10 years. The world energy cost has had a very negative impact on the majority of the working class, making their life unbearable and mostly in world big economies such as USA and Britain. For the poor in developing countries, the cost of living has similarly not been friendly and mostly in connection with the food prices which has remained devastating. The sum of all these phenomena has dealt a blow on many world’s economies, heavily affecting major economic activities in their prime productive sectors such as the level of employment and the rate of investment both within and outside the economies.
Padmalatha (2010, p.3) observes that without the aspect of greed, the current financial turmoil would not have erupted with the impact it did. The author further remarks that with effective practical policies from competent and relevant authorities, such greed and visual impairment in coming up with strategic policies can easily be handled. Padmalatha (2010, p.4) notes that financial markets do not operate efficiently without well-planned and implemented guidelines. The financial participants not only lack the fundamental knowledge on equilibrium but also tend to propel the economic cost analytically away from stability. On the other hand, the author argues that specialized knowledge, such as that provided by competent risk management practitioners should be sought because even the government’s ability to master the economic equilibrium is still questionable.
Role and failures of risk management practices
In as much as an accusatory finger may be pointed to inefficient risk models that were used by risk-management practitioners, it should as well be noted that the whole blame on the financial crisis which had crippled the world economy. The blame should squarely be shouldered by the entire risk culture worldwide (Karen, 2006, p.16). Karen further points out that the center of the crisis was a brainchild of investors, who were out to seek exaggerated yields, in the company of loans disbursers who as well pioneered in the race to accommodate the less-creditworthy recipients.
Consequently, they disbursed credit without retaining any interest on the loan given out. Similarly, the author argues that the other participants in the financial turmoil who should equally share the blame are credit rating bureaus. Regardless of what is demanded of them, they failed to regulate their ranking models even though moments, which demanded such measures, were prevalent. Second on the line of blame according to Karen (2006, p.17), are the banking institutions that conspired to reflect their loans as equally profitable in comparison to those disbursed by their competitors in the same industry. In an actual sense, the advance was not as lucrative, because the banks did not collect any interest from them (loans disbursed).
Before a decision that deeply involves a noteworthy amount of corporate finance is reached, several various responsible signatories should be consulted. In the wake of this financial depression, however, the boards of directors of various financial incorporation are largely blamed for ignoring or not addressing some of these pressing matters with the seriousness and magnitude they deserved to be accorded (Karen, 2006, p.17). Karen (2006) observes that the boards of directors are supposed to have a more detailed explanation on questions involving the acquisition of portfolios acquired with more than an acceptable level of risks.
If the respective directors had undertaken such care, even if not all risks associated with the financial crisis could have been avoided, largely, the damage could have been mitigated. Karen (2006, p.18) in addition incorporates the banks and the central banks in the blame list, for allowing the fund to flow cheaply. She argues that the mentioned financial institutions did not play their role of controlling the supply of money responsibly as dictated by such a demanding circumstance. According to her observations, the federal reserve of the US should have been at the forefront to prevent or lessen the damage that was caused by the financial disorder. She points out that through the implementation of the necessary instrument such as monetary and fiscal policies, the US government through the Federal Reserve could have been able to a great extent halt the development of such high magnitude depressions Karen (2006, p.18). Lastly, Karen notices the failure of relevant regulators, who even though they owned vital information desired to get a strengthened analysis of universal risk, ended up not utilizing the information, and what resulted was a depression that almost brought many economies to their knees.
Application of the risk management practices
Gallati, (2003, p.150) notes that the greatest use of risk management practices is to recognize, review and prioritize risks according to the likelihood of their occurrence or the degree of their magnitude. In the same perspective, Gallati, (2003, p.150) remarks that risk execution practices control or minimize the impact of an unfortunate event, which may be contributed by various causes such as uncertainty in the financial market. According to Gallati (2003, p.151), approaches to handle hazards through risk management practices are believed to capitalize on the realization of an opportunity.
In case of incidences such as the financial crisis that affected the world economies two years ago, the same strategies minimize its impacts on the financial markets, institutions, and the world economy at large. Gallati, (2003, p.151) notes that in addition to the failure of the risk management practitioners to identify the risks on time that resulted from the financial crisis, they as well failed to diminish the impacts of these risks not only on financial markets but also on the various financial institution associated.
There are various pieces of advice given by risk management practitioners and other policymakers in efforts to prevent the repetition of occurrences such as the financial crisis in the future. Gallati, (2003, p.152) notes that improvement should be made to the universal financial and monetary mechanism to give consent to governments to perform the necessary intercession. Similar authorities should be exercised worldwide to facilitate avoiding chances of these systems going away from equilibrium in the future. Gallati (2003, p.150), in addition, recommends that the United Nation should take a leading role in enhancing the reformation of the international monetary institutes. This, Gallati (2003) further explains, is not based on the fact that the UN is the single institution with the universality of association, as well as the credibility to ensure the legitimacy and viability of a reformed governance system. Rather, it has been proved beyond any shadow of doubt to possess the capability of unbiased examination and realistic strategy suggestions.
Pierre (2001, p.4) notes that in the case of a global financial system, involvement in the fiscal market calls for mutual aid and harmonization by State governments and dedicated organizations with comprehensible guidelines for worldwide observation. The author further notices that in case of another financial catastrophe emphasis should be placed to alleviate exchange rates through intensive government involvement. In addition Pierre (2001, p.5), also remarks that the government should not entrust the market system to handle such a crisis. Instead, the government should implement its strategic policies to radically solve the problem. Such policies the author notes should incorporate approaches such as public expenditures, taxation, bank rate policy, or the open market operations so that in case of excess money supply, the government should tax its subject more to reduce instances of inflation. The author notes that other economic cycles such as acute depressions should be tackled by injecting more resources into the economy to stimulate the economy and enhance its chances of rejuvenation.
The current financial crisis triggered the most noteworthy set of economic actions worldwide, ever since the great depression of the 1930s. Though the recent financial crisis almost brought most of the world economies to their knees, the incidence itself was an awakening call to various participants that were caught by the crisis unaware. The government itself will surely be more alert on its roles both as a formulator and regulator of economic trends in the economy. National governments should equally be more vigilant in their actions to timely regulate any financial activities that may lead to similar incidences in the future. Measures should as well be enforced where more collaborative initiatives are enforced globally, with universal surveillance of financial trends also being taken into consideration. Risk management culture was equally caught off guard by the financial wave, and therefore more efforts should be placed to strengthen the practice through enhancing more accurate and timely operations.
To best prepare for financial challenges, governments should consider several measures towards better risk management. First, the government should consider coming up with proactive taxation mechanisms that ensure progressive payment of tax i.e. the rich pay more like the poor pay what is within their limits. This will ensure more disposable income for individuals and thus less reliance on debt as the only way of maintaining consumption. Secondly, governments have to come up with mechanisms off having power over global financial speculation both through managing the capital movements and through taxation. Thirdly, instituting a widespread program of state-owned and funded residence building to shun another housing bubble is a welcome consideration. Finally, nationalization of the financial reservoirs attached with accepted control over the allotment of loans and use of savings is recommended.
Gallati, R., R., 2003. Risk Management and Capital Adequacy, McGraw-Hill Publishers: New Jersey
Karen, C., 2006. Never Saw it Coming: Cultural Challenges to Envisioning the Worst, Chicago University Press: Chicago
Padmalatha, S., 2010. Management of Banking and Financial Services, Pearson Education Publishers: New Delhi
Pierre, Y., M., 2001.The Measurement of Market Risk: Modeling of Risk Factors, Asset Pricing, And Approximation of Portfolio Distributions, Springer publishers: New York.
Sharma, A., 2008. Management of Financial Institutions: With Emphasis on Bank and Risk Management, PHI Learning Pvt. Ltd: New Delhi.