Whenever we face a financial crisis, the main question on everyone’s mind is to determine what or who is the cause of this situation. Security? Deregulation? Greed? One can say that it is not just one aspect that leads to such a crisis but a combination of many factors.
Some of the reasons might be evident while others are not visible to the naked eye.
It is difficult to determine the root cause without knowing all the intricacies of a situation. Mentioned below is a list of possible clauses, which can collectively be a major cause of financial crisis.
Excessive leverage is a key factor behind a financial crisis. Leverage travels far beyond the balance sheets. Leverage is inserted in off-balance instruments like derivates, structured securities, etc. As a matter of fact there is no clear and transparent accounting for leverage.
This means it becomes difficult to restrict and manage the skill of legislators. One effective solution is to evaluate and accept consequences which probably are less harmful than the previous financial crisis. You can also implement higher capital needs for the same.
Instead industry should be permitted to adopt a transparent pattern which is much more efficient and effective.
Liquidity equates to lending long and borrowing short. There was a severe need to restrict this mismatch in liquidity. There are institutions which mis-lead investors about their true liquidity and reap benefits from this. It is difficult to understand such accounting gimmicks.
#3-Clash of interest
You will hardly find any profession with such a large number of conflicts of interest. For instance, the asset management industry is also amazed with the ‘old school’ approach of bankers. This has compelled the financial industry to switch to a business approach which is customer friendly. It is crucial for bankers to understand the demands of their customers and thereupon offer services.
#4-Taxes and subsidies
The tax policy of a country has a significant effect on cash flow of capital. There are certain tax codes which are required to be refurbished for better financial effect. For instance, implementation of financial transaction tax results helps you to put off short-term speculation while also providing long term investment benefits.
Our society is rather in need of more progressive capital gain tax which boosts real long term investment speculation. It is essential to make sure that the subsidy is recycled back into the economy instead of it being used as speculation.
It is wise to eliminate subsidy on debt according to the financial situation. For example, you can encourage more debts when you have excess money in the market.
You must be acquainted with the fact that the financial system has out grown traditional parameters and is interlinked to an extent, such that it affects almost all citizens. When it comes to the common man governance plays an integral role in determining the extent to which they are affected.
#6-Too huge to fail
The current market condition tells us that the industry comprises of firms of a complex nature.
A theoretical approach assesses different scales of economies which diverts you from the main issue. The truth is that efficiency improves at different scales but it still lacks optimal effectiveness.
Every industry needs equilibrium of efficiency and resiliency to survive and one needs to understand this fact. Diversity, decentralisation and maintenance are secret ingredients in order to improve resiliency.
The truth is that even when financial institutions commit fraud they are too big to penalise and are often subject of Government grants in their recovery.
The best example can be the recent PPI scandal, which surprised most of the UK citizens as plenty of high street banks were involved in the scandal. Even today, you can claim PPI yourself or consult a reliable company to guide you in the process, if you were mis-sold a policy previously.
#8-Poor economic assumption
If only economists would have been able to foresee the consequences, citizens could have been protected from the repercussions. One cannot neglect the fact that market situations are unpredictable but with elite expertise one can probably anticipate changes in the market.
The desire to achieve thousand million pounds in a short run can be quite harmful in the long run. It has been rightly said that, ‘easier it comes, faster it goes.’ The desire to achieve a goal is a positive thought but there is a thin line between desire and greed. When your desire surpasses a specific level it turns into greed.
For instance, bankers were paid exorbitant prices to secure toxic mortgages which later on had an adverse impact on the reputation of the bank’s image. Playing with legal and financial aspects is identical to playing with fire as you might get burnt in the process.