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Market Failure - Essay Example

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The present subprime mortgage crisis that hit the credit markets and banking systems is due to the increase in loan defaulters, thus making the banks to bankrupt. Industrial Development Finance Institutions (IDFIs) are expected to stimulate industrial investment in both private and public sectors in developed and developing countries. It is their role not only to inject capital, but also to blend capital with entrepreneurial skills to support industrial advancement in an underdeveloped economy. A great variety of IDFIs has been established in the developed and developing countries since 1945, many following independence in the late 1950s and 1960s of former British and French colonies, to provide both medium- and long term loans to industrial and agricultural projects. There is hardly any developing country where there is not at least one development bank. Regardless of their variations in the set and functional roles, a large number of development banks in Asia, Africa and Latin America are now jaundiced by persistent debt defaults. In fact, there are few IDFIs in developing countries like India and China, which have not been adversely affected by persistent debt defaults.
It has been found that debt default occurs due to borrower's inability or unwillingness to repay debt. It may be that there are borrowers who are willing, but not able to repay debt. Again, there are borrowers who are able, but not willing to repay debt - debt default arises in both cases. However, this chapter concentrates on the borrowers' ability to repay industrial debt, rather than willingness to repay industrial debt. The ability to repay industrial debt is influenced by a number of factors relating to industrial financing. In particular, what industrial project is financed; how it is financed; how its management from the set up stage to loan liquidation stage is helped by an IDFI is very important. As regards what type of industrial project is to be financed, the development bank must, of necessity, restrict itself to financing only those development projects that are bankable.
The choice of a project lies within the developmental role of a bank. As a development institution, a commercial or an IDFI should deal with those projects with the highest ranking on the development-impact scale and as a banking institution, it should finance those projects with the highest ranking on the interest-rate scale. It means that a bankable project should satisfy both developmental and financial criteria, unlike a commercial bank that stress the financial role rather than the developmental role.
It appears from the above that debt default may arise if the development bank finances non-bankable projects that are not capable of generating enough income within a reasonable time to cover the costs of operation, repay the principal debt, meet costs of borrowing and earn enough profit to motivate its promoters to remain in operations.
The role of a development bank, particularly a public industrial development bank, is not solely confined to the supply of medium- and long-term loans and/or equity. Unlike ...Show more

Summary

The year 2008 was marked by volatility in the world stock market due to subprime mortgage crisis. Market fluctuations in the US markets exerted a profound influence on world markets. There were times when no satisfactory explanation could be found for the fluctuation in prices…
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Market Failure essay example
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