Emerging Markets during the Crisis - Literature review Example

Banking in Emerging markets in the aftermath of Global Financial Crisis Synopsis The Global Financial Crisis (2007- 2011) left economies in emerging markets of the world dented with its effects still being felt five years later. This financial crisis can be regarded as a lesson for financial institutions across the world. As a result of this financial crisis banks in emerging markets instituted structure policies to cushion their economies from the shock and the negative financial effects of the global financial crisis. Furthermore, a considerable number of these banks put in place different framework on which preparedness mechanisms can be tailored in the event of recurrence in future of a financial crisis such as the 2007- 2011 global financial crisis. Introduction At its onset in 2008, the global financial crisis rocked the world economies with major economies in the developed world bearing the greatest brunt, the effects of the global financial crisis were as well felt by countries in the developing world, least developed economies and emerging market economies were not spared either. This paper seeks to examine banking in emerging markets in the aftermath of the global financial crisis. It will highlight the implications of the crisis on the functionality of financial institutions specifically in banks in emerging markets. Foremost, this paper will provide a discussion on the structure and types of banks in emerging markets. Secondly, this paper will discuss the risks posed by the global financial crisis on banks. Moreover, it will highlight the role of the central bank in the management of the financial crisis and the outcomes that came about as a result of the role played by the central bank. Structures and Types of Banks In emerging markets banks can be grouped in various categories depending on the functions of the institution. Vazquez and Federico (2012, p. 3-4) explain that banks can be categorized into either local banks or international. The former being operational only within a country’s borders whereas the latter having its operations both in local and international markets. Nevertheless, the main feature that distinguishes banks from one another is the modality of ownership of the banks. Martin (2012) a specialist in Asian affairs groups banks in emerging markets into the following categories: 1) Government owned: These are banks that are managed by the state, the banks serve the purpose of providing financial services to citizens as well as the government, however Martin (2012, p. 2) stipulates that the history of China’s financial system forced the central government to start up state owned banks to create order in the financial system of the economy in the early 1900s. However, subsequent governments over the years have transformed these banks into equitized banks which are discussed in 2) below. 2) Equitized banks: These banks were previously state owned but disposed of by the state to the public through IPO sale of its shares to prospective shareholders who become the joint owners of the banks. Through the sale of shares of the bank, its ownership is transferred from the central government to the shareholders (Martin 2012, p. 3). 3) Local Banks: These banks were established within sub-regions of countries and serve interests of groups that formed them, they include local government, village, township and rural cooperative banks among other localised banks. Note that they are formed in the locality to cater for the interests of the groups that formed them (Martin 2012, p. 4). 4) Private Banks: These include joint-stock commercial banks and foreign banks. Operations of private banks especially foreign ones are not restricted to the locality and can transact business with their management exercising control of the financial institutions from abroad (Martin 2012, p. 5). 5) Underground banks: Also known as shadow banking incorporates illegal banking individuals taking deposits and providing loans to people who are unable or unwilling to use the legal banking system (Martin 2012, p. 5-6). This categorization of banks by Martin (2012) suggests a form of distinction of banks in emerging markets as well as the world at large with minor differences from one country to another. However, the functionality of banks is subject to rules and regulations set out by respective policy makers and agencies in their country as stipulated by law. The operation of financial institutes is therefore subject to operate within the dictates of the law and also the owner’s interest and as such, policy makers tailor their banks operations to their specific needs. Banks in the face of the Global Financial Crisis The global financial crisis may have originated in the United States but its effects are far reaching and have been felt all over the world. The period preceding the crisis was one in which banks all over the world carried on with their business as usual only to find themselves grappling with financial failure during the global financial crisis. Vazquez & Federica (2012) acknowledge that banks with weaker structural liquidity and higher leverage in the pre-crisis period were vulnerable and likely to fail in the period following the global financial crisis. The two are of the notion that domestically oriented banks i.e. those with exclusive operations within their home country were more susceptible to solvency risk due to excessive leverage. They also postulate that macroeconomic and monetary conditions are also shown to be related with the likelihood of bank failure. Nanto (2009, p. 12) a specialist in industry and trade of the congressional research service in the USA recognizes that the macroeconomic downturn confronting countries following the global financial crisis is the worst yet after the financial crisis of the 1930s. In the initial face of the global financial crisis, countries in emerging markets were faced with falling commodity prices, reduced exports and an increased flow of capital from their local economies into economies abroad. Hawksworht (2006, p. 7) explains that emerging economies such as China stood to gain from the financial crisis where an inflow of capital is expected to enter its market from the economies in developed world. This is attributed to the low cost of their products as compared to prices of the same commodities in the developed economies. Consequently, more of emerging economies products would be imported by the developed nations resulting in an outflow of finances from their economies into the developing ones. According to Vazquez and Federico (2012, p. 8-9), an indicator of the bank’s performance depends on its liquidity and leverage where the liquidity is measured by its Net Stable Funding ratio (NSFR) whereas its leverage is measured as the ratio between shareholder’s equity to assets. These are then used to indicate the performance of the bank with respect to the global financial crisis; the banks with weaker structural liquidity and higher leverage before the global financial crisis were more vulnerable to failure according to Vazquez and Federico (2012, p. 16), the local banks were more susceptible to failure as compared to the cross-border banks which held more financial stability. The two continue to explain that during the period of the global recession risk taking by banks was not commensurate with the financial vulnerability associated with the crisis that resulted in excessive hazards to the banks financial stability (Bender, Neilsen & Subramanian 2012; Keneourgios & Padhi 2012). Risks Posed on Banks by the Global Financial Crisis The global financial meltdown is one that has led to the restructuring of strategy when it comes to management of risks. Banks in the EMEs have over the recent past been on a recovery path from the effects of the global financial crisis. The United Nations (2009, p. 1) describe the global financial crisis as one that affected all regions with varied effects being felt from one region to the next and all regions suffering decline in growth. The United Nations presents several risks that affected banks in emerging market economies among other regions of the world that include: (i) Falling Equity Prices; this encompassed among other factors, massive outward capital flows and depression in exchange rates. (ii) Capital Flows decline; this incorporates foreign aid and foreign direct investments which declined in the subsequent periods of the global financial crisis. (iii) Steep decline in global prices; prices of commodities such as crude oil, food and metal have reduced pausing a challenge especially for developing countries producing raw materials as this translates to a decline in foreign trade earnings. (iv) Reduced global trade; the greatest brunt of the global financial crisis can be attributed to the inflexibility of world economies to engage in trade and thus export oriented nations which is a characteristic of most emerging economies suffer for lack of market for their produce (Bender, Neilsen & Subramanian 2012). (v) Rising Protectionism; through fiscal stimulus packages the world economies were at pains to cushion their economies from the effects of the global financial crisis and as such, take up trade limiting factors to counter the effects of the recession in a bid to evade contagion of the financial crisis effects from other parts of the world economies. (vi) Rising unemployment and increased poverty levels; Factory closures, retrenchments and layoffs have been the norm in most world economies following the global financial crisis further grappling the living conditions of people all over the world (Bender, Neilsen & Subramanian 2012). The role of the Central Bank in Managing the crisis The inflow of capital from banks in the developed nations into banks in the developing nations of emerging markets such as China and India pose a challenge for their central banks since the economies of developed nations are more centred on developing measures to counter the effects of the recession and would be more focused in clearing outstanding debts. Conversely, banks in the emerging market economies in subsequent periods of the financial meltdown stand to make tremendous gains from the inflow of capital from banks in the developed economies and the rest of the world through exports. Siregar, Vincent &Pontines (2011, p. 50) explain that the central banks in emerging market economies have it upon themselves, the task of maintaining financial stability beyond the monetary policy objective, that coordination and tighter regulations alone cannot be sufficient enough to achieve financial stability. Consequently, the potential rise of price factors such as exchange rate and asset prices had to be managed while taking into account the remaining vulnerabilities of the balance sheets of corporate and financial institutions, the overall investment climate and the demand in the economy (Siregar, Vincent &Pontines 2011 p. 55-56).Nanto (2009, p. 1) indicates that there are plans in progress by central bankers of countries of the world to take a lead role in coordinating and monitoring tougher financial regulations and serve along with the international monetary fund as an early warning for emerging financial risks. The solutions to the global financial crisis squarely depend on the efforts of the central bank and other banks in the EMEs in structuring a genuine solution such as developing an international financial and economic architecture that reflects the changing realities in the world and gives greater voice to banks in the emerging and developing economies. The participation of banks in emerging economies in setting up of policies that would streamline the relationship between trade and industry of the global financial system to forge a stable monetary structure of the world market that is resistant to the effects of a financial crisis such as the global financial crisis (United Nations 2009, p. 10-11). According to Hawksworth (2006, p. 38), the central banks in emerging economies have the mandate of ensuring that a recurrence of the financial crisis such as the global financial crisis is prevented by all means necessary. Hawksworth continues to suggest a few options to explore with regards to steps that the central banks and other banks in these economies should take. These steps include; (a) That they should not seek to subsidise industries in their own countries that cannot compete with rival firms in the emerging economy markets and third world economies. This move is greatly seen to protect the economies from sudden loss of jobs and reduced demand for products that would translate into costly consequences later on. (b) That developed world economies should not be seen to pick winners through industrial policy but rather create an environment for potential winners to emerge. (c) That they should not relapse into protectionism but make efforts in reducing tariffs and improving market access in a reciprocal basis with emerging economies (Hawksworth, 2006. P 38) Current macroeconomic and social challenges posed by the global financial crisis require better understanding of appropriate policy responses in relation to the best remedy for attaining financial stability. An understanding of the international rules and systems relating to finances and trade among the emerging economies is also beneficial. This must be backed by a move to counteract the effects of crisis contagion from banks in the developed world realised from the global financial meltdown and prevent it from spreading into the banks of emerging market economies. In the same respect banks in emerging markets need to manage the implications of the current economic slowdown after a period of strong progressive growth through social protection schemes. Banks in EMEs should as well consider policies pertaining to financial flow in terms of aid and direct foreign investments which depend on the choice of whether high risk economies should be facilitated with financial aid and if so, which channel would be most appropriate (Eichengreen 2010; Velde 2008). Conclusion Financial implications brought about by the global financial crisis indiscriminately influenced the functionality of banks in both developed and emerging economies at varying degrees. Nevertheless, the effects were felt by all sectors of the world’s financial market, not even the developing countries were spared. Steps taken by the central bank to counter the effects of the global financial crisis in emerging markets have progressively steered the economy in emerging markets. As a result, the economy in emerging market is heading towards recovery with major players reaping the better part of the crisis that saw an increase in international trading. It is however worth noting that policies should be tailored jointly by all stake holders in the world financial market especially banks in the emerging economies so as to create an environment that is friendly to all financial markets. This must be done in attempts to maintain stability of the monetary system, steer economic growth and protect banks in volatile emerging markets from collapse. Future occurrence of financial crises can therefore be effectively managed if issues discussed are deliberated on to tailor the best move in countering the effects of such an eventuality (Eichengreen 2010; Velde 2008). References Bender, J., Neilsen, F. & Subramanian, M., 2012, ‘Emerging markets during the crisis’, Journal of Alternative Investments, vol 13, issue 2, pp. 104-126. Eichengreen, B., 2010, ‘Lessons of the crisis for emerging markets’, International Economics and Economic Policy, vol 7, issue 1, pp. 49-62. Hawksworth, 2006, ‘The world in 2050: How big will the major emerging market economies get and how can the OECD compete?’ Price Waterhouse Coopers, viewed September 15 2012 Keneourgios, D. & Padhi, P.2012, ‘Emerging markets and financial crises: Regional , global or isolated shocks?’ Journal of multinational financial management , vol 22, issue 1-2, pp. 24-38. Martin, F, 2012, ‘China’s Banking System: Issues for Congress’, Congressional Research Services for Congress, viewed September 15 2012 Nanto, K. 2009, ‘The Global Financial Crisis: Analysis and Policy Implications’, Congressional Research Services for Congress, viewed September 15 2012 Siregar, R., Vincent, L. &Pontines, V., 2011, ‘Post Global Financial Crisis: Issues and Challenges for Central Banks of Emerging Markets’, SEACEN, Staff paper No. 8, viewed September 15 2012 United Nations, 2009, The Global Economic and Financial Crisis: Regional Impacts, Responses and Solutions, viewed September 15 2012 Vasquez, F. & Federico, P. 2012, ‘Bank Funding Structures and Risk: Evidence from the Global Financial Crisis’ International Monetary Fund Working Paper, WP/12/29, Viewed September 15th, 2012 Velde, W., 2008, ‘The Global Financial Crisis and Developing Countries’, Background Note, Overseas Development Institute, viewed September 15 2012, Read More