Are the European banks riskier than the US competitors for the period 2002-2007 yang - Essay Example

The crisis was caused due to the failure of many banking sector across the world. The firms which had failed in UK allowed their businesses to overextend through risk taking and excessive leverage, over dependence on risky product streams like derivatives or buy-to-let mortgages, poor decisions of management in respect of acquisitions, over reliance on wholesale funding. The project describes the position of European banks and its US competitors during the period of global financial crisis and which banks were more riskier during that time.

Introduction Unprecedented innovation and growth have been seen in the financial sector over the past two decades as new products and higher returns have been sought by the investors in the era of low interest rates. Banks also had an obligation to understand the risks to which they are exposed. The complexity of certain financial instruments and the interconnected developed global market often did not provide well understanding of the dangers involved with the banks, its investors and boards, central banks and regulators (HM Treasury, 2009).

The risk models of banks were proved as flawed which was based on incomplete application of principles of finance. It was believed that risks had been widely distributed throughout the financial system by the method of securitisation but it proved as mistaken and risks posed by global increase in leverage were under-estimated. The remuneration policies of banks have contributed to the riskiness of financial system as they focussed too much on short term profit. Market discipline also proved as an ineffective constraint on risk taking in financial markets (Independent Commission on Banking, 2011).

There were certain deficiencies in the corporate governance of banking institutions. The board of banks failed to understand this and they got prone to the risk management processes of their firms. The senior management also did not question on the sustainability and nature of achieved higher returns. Many institutional shareholders were not able to monitor the effectiveness of senior management of banks nor did they challenge the decisions of board of bank. Generally, the banks and investors rely on the assessments of credit rating agency but they did not supplement the ratings with conclusions from the view point of their own analysis.

The central banks and regulators, commentators and other authorities underestimated the risks built up in the financial system. The banks were exposed largely to the vehicles of off-balance sheet financing and lack of transparency. Literature Review Financial crisis of US bank The global economy was experiencing unprecedented level of financial turbulence. This was triggered by a downturn in US housing market, particularly the sub-prime end of the market. The instability grew steadily following the collapse of Lehman Brothers, an US investment bank.

Initially, the investors realised that they have misjudged the risk in securities linked to low quality US sub-prime mortgages. Consequently, prices fall leading to heavy losses to the holder of assets. Then the investors became concerned about which of their counterparties are exposed to these losses and began to charge a higher risk premium to