Expansion of the modern global economy caused changes in the source of financial system’s instability. Theoretical considerations evolve due to more and more factors that determine market conditions. Depending on the circumstances of a country or region and macroeconomic policy – primary and secondary fac-tors form differently. The study includes the analyze the greatest crises in the last three decades – Asian crises, crises of Latin America and the global financial cri-sis. Indicated these determinants, which were originally (primary) and could be a warning before the crisis and those that have a secondary character – appearing with the escalation of instability.
According to the Krugman model, one of the fundamental cause of finan-cial instability are changes in the functioning of the economic system (factors in-fluence on economy). It means deregulation and intensification of market disci-pline, including tightening in monetary policy. In Indonesia in the 1990s, it was an abolition of controls the size of loans and interest rates by the central bank. In the United States in 1999 there was legislated the Gramm-Leach-Bliley Act, which abolished prohibition combining bank’s investment activities with de-posit-credit practice since 1933 (after the Great Depression). It increased the scale of banks’ activities and the ability to generate higher risk.
7 P. Krugman: A model of balance of payments crises. „Journal of Money, Credit and Banking”
1979, No. 11, pp. 311-325.
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During financial instability, there is an effect of reducing the reserve ratio of foreign countries in relation to investment and consequently, the outflow of for-eign capital. This implies a loss of investors’ confidence, threatens the stability of national currency and the problems of debt service denominated in foreign currencies. Finally, it results in reducing the volume of exports, generating a cur-rent account deficit. In the Asian crises in the 1990s, there was a rapid risk in-crease as a consequence of the earlier intense capital inflows, accompanying economic development. However, the increase of capital was not offset by the relevant regulations and mitigation mechanisms.
Instability in the banking sector, leading to a banking crisis, is a particular form of financial instability. Instability usually begins with the liberalization of the banking sector – the reduction of capital requirements, decrease the required reserve rate, loosening opening new branches and subsidiaries of foreign banks regulations. Increasing competition in the banking sector fosters lower banks’
requirements posed to potential borrowers. It results in reduction requirements of client’s creditworthiness. Banks pay more attention to a current value of collat-eral, or to increase the volume of loans, in order to maximize interest income.
However, if there is a decline of the market conditions and asset prices, collat-eral reduces rapid its value. The main cause of banking sector’s instability is therefore too excessive debt, incurred as a result of credit expansion. This in-creases the size of bank’s assets, which in the short term has a positive impact on the generated its profit. But, in periods of economic recovery, capital is usually invested in venture capital investments. During a recession it turns out to be an ineffective. Overinvestment and sub-optimal resources allocation result in an in-crease in asset prices, particularly real estate and declines on capital markets (crisis in Malaysia, the global financial crisis). Banking institutions take exces-sive risks, using short-term funding source for long-term lending. In Asia, it re-sulted in a seven-fold increase in the size of banks’ assets and a twelve-fold in financial institutions in the years 1990-1996, while only doubling the size of real GDP. The weakness of a financial system functioning is determined by worse banks’ and non-bank financial institutions’ asset quality. According to the data for Asian countries before the crisis in the 90s the share of overdue loans to total loans for banks was at least 15% and twice more for financial institutions8. There were not right criteria for loans’ diversification, which raised the sector risk, re-lated to the increasing share of loans to finance real estate market (Thailand, US). Rapid growth in property prices, due to easy access to credit, takes the form of a speculative bubble, which ‘break’ causes significant deterioration of finan-cial institutions. At the same time, deregulation and liberalization of the banking
8 C.J. Lindgren, T.J.T. Baliño, Ch. Enoch, A.M. Gulde, M. Quintyn, L. Teo: Financial sector crisis and restructuring lessons from Asia. „IMF Occasional Paper” 1999, No. 188, p. 94.
Aleksandra Szunke 170
sector are associated with loosening of prudential regulations. Ineffective super-vision over the financial institutions, during the weakness of the financial sys-tem, makes it more susceptible to the occurrence of the crisis. In Ecuador, in the period preceding the collapse, the banking supervisory inspections relied solely on an examination of compliance with its regulations, but did not taking into ac-count current market conditions. Another cause of instability is also the specula-tive attacks on currency, causing its depreciation (attacks on Thai Batha in July and December 1996, Malaysia, Hong Kong and Singapore currency in 1997, the Argentine currency devaluation).
These primary factors characteristic for the situation before financial insta-bility may occur alone, without involving crisis. Then, they are only a part of the normal functioning of the market economy. However, their mutual dependencies and linkages and the scale of their impact can cause another factors (through domino effect), developing in the period of instability.
Strengthening the causes of financial instability induces the general eco-nomic instability, which appear to be secondary imbalances determinants. They are no longer the direct cause of the crisis, but only a kind of corollary of the previous. When banking sector starts to have problems of rapidly increasing share of bad debts, deterioration in loan portfolio’s quality due to a decrease in asset prices, banks begin to struggle with a lack of liquidity. Market observes de-clines in property prices and the substantial collapse of capital markets (in the Philippines resulted in a sharp decline in the primary stock index of the level of 2900 points in July 1997 to less than 1450 points at the end of this year). In that case, monetary authorities think they have to rescue banks in difficult financial situation in order to prevent complete breakdown of the sector. They increase capital in threatened banks, until exhaustion of the assets that give them security.
At an early stage of instability, it encourages banks to increase lending volume at high risk (moral hazard), deepening even more breakdown. Conviction of the banks’ bad condition causes a loss of confidence in banking sector, reducing consumption and investment, and withdrawal of previously invested capital in deposits. Deepening structural and fundamental weaknesses and irregular eco-nomic and monetary policies lead to sustained long-term ecoeco-nomic imbalance.
Finally, there is a credit crunch, caused the banks’ liquidity problems and a loss of the borrowers’ ability to payment their obligations. Moreover, the out-break of a banking crisis, often entails a currency crisis (twin crisis) and depreciat-ing national currency (Asian crisis). Ratdepreciat-ing agencies lower the ratdepreciat-ings of financial institutions and countries, resulting in loss of confidence in economies and their currencies, and finally a further outflow of capital. The deepening breakdown could lead to insolvency and the collapse of the major financial institutions (ex-ample: Bank of Commerce in Bangkok, Orient Commercial in the Philippines, Lehman Brothers in the U.S.). Some, in turn, is capitalized, or fully nationalized
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(three major banks in Iceland). Strong correlations in the global economy, cause the contagion effects of the crisis to other countries in the region (the Asian crises, crises of Latin America), or to global economy (crisis in XXI century).
References
Alawode A.A., Al Sadek M.: What is financial stability? „Financial Stability Paper Series” 2008, No. 1.
Bordo M., Eichengreen B., Klingebiel D., Martinez-Peria M.: Is the crisis problem growing more severe? „Economic Policy” 2001, Vol. 16, No. 32.
Caprio G., Klingebiel D.: Episodes of systemic and bordeline financial crises. World Bank, Washington 2003.
Crockett A.: Why is financial stability a goal of public policy? Federal Reserve Bank of Kansas City, „Economic Review” 1997, No. 4.
Davis E.: A typology of financial instability. Oesterreichische Nationalbank (Central Bank of Austria), Financial Stability Report 2001, No. 2.
Krugman P.: A model of balance of payments crises. „Journal of Money, Credit and Banking” 1979, No. 11.
Lindgren C.J., Baliño T.J.T., Enoch Ch., Gulde A.M., Quintyn M., Teo L.: Financial sector crisis and restructuring lessons from Asia. „IMF Occasional Paper” 1999, No. 188.
Mishkin F.S.: Global financial instability: Framework, events, issues. „Journal of Eco-nomic Perspectives” 1999, Vol. 13, No. 4.
DETERMINANTY ESKALACJI NIESTABILNOŚCI FINANSOWEJ GOSPODARKI GLOBALNEJ
Streszczenie
Zaburzenia cyklu koniunkturalnego, eskalacja napięć na międzynarodowych ryn-kach finansowych oraz rosnąca liczba zjawisk kryzysowych spowodowała zwrócenie uwagi ekonomistów na zagadnienie niestabilności finansowej w gospodarce globalnej.
Dotychczas bowiem skupiano się wyłącznie na pojęciu stabilności finansowej oraz spo-sobach jej utrzymania. Wraz z rozwojem systemu finansowego zauważa się systema-tycznie rosnącą liczbę czynników, będących albo pierwotnymi przyczynami niestabilno-ści, albo też czynnikami wtórnymi – towarzyszącymi warunkom destabilizacji, których występowanie warunkowane jest zaistnieniem wcześniejszych. Celem opracowania jest identyfikacja pierwotnych i wtórnych determinant eskalacji niestabilności współczesnej gospodarki światowej. Ekspozycja przebiegać będzie w płaszczyźnie kryzysów azjatyc-kich, kryzysów Ameryki Łacińskiej oraz globalnego kryzysu finansowego.