Financial liberalisation

Financial liberalisationFinancial Liberalisation refers to deregulation of domestic pecuniary commercialise and liberalisation of the capital account that implies removing the ceiling on affaire rates. When it is in a liberalised system the competition between the different l completioning institutions for the deposits will amplification interest group rates on deposits which will increase the deposits. The accessibility of point of reference will increase and this will cause an increase in practicement harvest. The stages of growth increases activity in the financial markets that go fors the introduction and the development of financial institutions. It is argued that financial institutions, by gathering and evaluating information from borrowers, allow the allocation of funds for investment plans to become more than efficient and therefore encourage growth and investment. relys jump out a role in the process of development. These confides gives the chance for individu als to stick out their savings in the form of deposits, so lowing the need to hold them in the form of illiquid uncreative tangible assets, as this increases liquidity in the economy. Banks could use the deposits to invest such as currency and capital etc. While an individuals need for liquidity body unpredictable, banks, by law of large numbers, face a predictable demand for deposit withdrawals, and this in turn allows banks to invest funds more efficiently. The rate of growth reacts positively to the interest rate but investment reacts negatively to the interest rate. Higher interest rate discourage low return investment, investors will be induced to undertake lavishly return investments, thereby bringing efficiency to investment, which in turn will improve the growth rate to a great extent than that which is possible under financial repression. Interest rate does non affect of saving indirectly but it is instead a role of income.The affinity linking the approachability of credit and investment growth raise be well-nigh interest rates which play a role more in particular, lenders and borrowers. The hypothesis is they can be sure about the brings being repaid. The problem is that borrowers can not guarantee their repayments. With this in mind uncertainty enters into the equation in to the loan repayment so lender take measures in case borrowers plans are unsuccessful and lenders try not to lose their loan capital. So in effect to cover this they use the credit standard in the loan calculation. For borrowers that mean they will bewilder to be able get the credit standard in order to receive a loan.If liberalisation happened and the reason was a rise in interest rate this will increase the deposit and increases in the availability of credit. But a rise in deposit will affect the loan rate by increasing but in relation with the surface of the loan cause increase in the repayment rate. So credit standard is set on size of the loan and when interest rate increases it does not cover the banks loan capital. So if banks would want to be covered by the credit standard they like to have zero credit adventure. To achieve this they would increase the credit standard to make sure that they zero credit take chances. This will mean that borrower would take a large amount or unable to tint the demand they will not be allowed the loan. This means an increase in the availability of credit will not guarantee access to the loan market.When interest rates increases, investors who want to get high returns will be attain less than they paid for and they will lose if they sell. Therefore they do not sell.Investors who invest large amount take advantage of high interest rate these investors have a high credit risk. So the greater flow of credit makes share prices to increase and they higher profits because of the price increase. Since profit from the acquisition and the sale of shares rises, loan capital will be further attracted to the stock m arket, so it increases the stock market activity. This introduces the possibility of attracting a substantial portion of the loan capital to move different parts of the economy in favour of financial assets. This evidently raises a concern about the efficiency gain by means of liberalisation. In this process them return on loans will no long-lasting be linked with the yield from shares rather it will be inter-locked with the return from the expected change in share prices when economic activities are falling. If bad news program spread that will decrease share prices. So investors will not make profit from the change in share prices. Therefore investors will aim it hard to keep their debt in order. This is where a serious problem arises, and that is, if the actual price falls short of the expected price and so borrowers wont be able to keep their word that they gave to banks. In this problem arises because the banks cannot maintain their credit standard requirements for these bo rrowers. In other words, banks have advanced loans which exceed the aggregate note value of the borrowers assets. Thus the core problem lies with banks needing to take high level of credit risk from large loans because of liberalisation.As said before any bad news that will cause banks a lot of problem and this will lead to a financial crisis. Because of this reason the crisis happens since most of loans had high levels of credit risk.The credit coquet is what economist use it means a shortage of funds for lending, which suppress the availability of loans. The credit cranch can happen for several reasons because of a grade rise in interest rates and the government has direct money controls and also funds decreasing in the capital markets.The latest credit jam happened because of a sudden increase in defaults on subprime owes. The realisation labour started in United States and stilltually spread across the world. The mortgage lenders sold haemorrhoid of mortgages to custo mers who have low income and who are first time buyers and have not got a good credit rating these customers are the called subprime borrowers. They thought that house market would boom and mortgages still reasonable but they were lax lending of mortgages to subprime borrowers. The reason they were lax is because mortgage brokers got paid to sell mortgages. These cause for more mortgages to be sold, even though it was expensive and high risk of default. Mortgages companies wanted to make more money on the subprime mortgages and they put the debt into a package and sold it to other companies. This is how it dark globally because of package sub-prime home loans into mortgage-backed securities known as CDOs (collateralised debt obligations). timesonlinea. 24 Feb. 2010. They sold it to hedge funds and investment banks because they thought they would get high returns on it. They well-tried to spread the risk but made the situation worst.The rating agencies gave subprime mortgages a low risk rating but they are actually high risk rating and this got transferred to the lenders. In the balance sheets the risk would not be shown.Many of these mortgages had an introductory period of 1-2 years of very low interest rates. At the end of this period, interest rates increased. mortgagesguideuka, 24 Feb. 2010. So this cause mortgages repayment to become expensive after the introductory period because interest rate increased from inflation. withal Homeowners also faced lower disposable income because of rising health care costs, rising petrol prices and rising food prices. mortgagesguideukb, 24 Feb. 2010. Homeowners found it difficult to hold their houses because it was getting repossess. Many Homeowners were not able to repay the mortgage payments and so this caused an increase in default on their loans. Because of the defaults it was one of the main reasons of the end of admit boom in the US. With housing prices falling this caused further problems with mortgages. For e xample, pot with 100% mortgages now faced negative equity. It also meant that the loans were no longer secured. If people did default, the bank couldnt guarantee to recoup the initial loan. mortgagesguideukc, 24 Feb. 2010.Many US mortgages companies went bust because of the increase in defaults but mortgage lender were not only to suffer as banks lost money in mortgage debt because of the package they got from US mortgage companies. Now Banks had to write off big losses and made them indisposed to lend, mostly in the subprime sector.This was a domino effect and the affect the rest of the world for borrowing money and raising funds. For example, biotech companies rely on high risk investment and are now struggling to get complete funds. mortgagesguideukd, 24 Feb. 2010. Since the borrowing was restricted this also affected the economy with a recession very likely especially in US. But In UK mortgage lender were more controlled in lending than the US. .In the UK many problems occurr ed with Northern Rock who invested in subprime mortgages. Northern rock had a high % of risky loans, but, also had the highest % of loans financed through reselling in the capital markets. When the subprime crisis hit, Northern Rock could no longer raise enough funds in the usual capital market. It was left with a shortfall and eventually had to make the humiliating step to asking the Bank of England for emergency funds. Because the Bank asked for emergency funds, this caused its customers to worry and start to withdraw savings (even though savings werent directly affected). mortgagesguideuke, 24 Feb. 2010. Also another banks HBOS having the same situation. This shows that word and mouth can cause total panic in short amount of time.The events in the US caused the same problems in the UK with mortgages being expensive and the market drying up and with high risk mortgages taken away. This cause house prices to fall and homeowner facing negative equity so they default on loan, which m akes bank lose more money. For example Bradford Bingley was nationalised because it couldnt raise enough finance. The BB had specialised in buy to let loans, which are particularly susceptible to falling house prices. mortgagesguideukf, 24 Feb. 2010.This credit crunch may last for a while because house price in the US as well as UK is still going down which makes mortgage loans under valued. Also interest rates are soaring especially when the homeowner finish their inductor periods. If a recession happens in US it could make more bad loans. It will be hard to get more confidence in the financial markets. In conclusion credit crunch could have been avoided if banks had a tighter restriction on access to loans, especially in the US and making sure no bad news circulates as this make people panic and making the situation worst. As for financial liberalisation it is important to introduce an interest rate ceiling on deposit rates to reduce excessive competition among lending institutio ns for depositors, which may minimize the possibility of financial crisis. BibliographyBooksLecture notesBasu.S. Financial Liberalisation and Intervention A New Analysis of Credit RationingPeter Howells and Keith Bain. (2008) The Economics of Money, Banking and finance A European text Fourth edition, Essex, Pearson limitedWeb PageE. Murat Ucer. Notes on Financial Liberalization, online Available from http//www.econ.chula.ac.th/about/member/sothitorn/liberalization_1.pdf Accessed 24 Feb 2010David Budworth, The credit crunch explained, online Available fromhttp//www.timesonline.co.uk/tol/money/reader_guides/article4530072.ece Accessed 24 Feb 2010Credit crunch explained, online Available http//www.mortgageguideuk.co.uk/blog/debt/credit-crunch-explained/ Accessed 24 Feb 2010John Abbey, The credit crunch explained, online Available http//www.johnabbey.co.uk/wsb4919660101/creditcrunch.html Accessed 24 Feb 2010