The world of finance: Revisiting by honouring the basics

Dr B K Mukhopadhyay

(The author is a Professor of

Management and Economics, formerly at IIBM (RBI) Guwahati. He can be contacted at m.bibhas@gmail.com)

Will it be proper to think that the danger period is over? It is beyond any shade of doubt that the financial system is one of the most important inventions of the modern society – the primary task being to move scarce lendable funds from those who save to those who borrow to buy goods and services and to make investments in new equipment and facilities so that the overall economy can grow, backed by stability and at the same time increase the standard of living.

Clearly speaking, the financial system determines both the cost of credit and how much credit will be available to pay for the thousands of different goods and services. As such, the happening in this system has a powerful impact in the health of the overall economy – regional or global.

Who can say that the recession will not be visiting in the coming days? The signs of recession and slowing down of the pace of economic growth / activity are very much alive, inclusive of the biggies (even Germany, among others, are already showing a declining trend)!!

Obvious enough, the last recession has taught us a good lesson. The financial world has to be more cautious than ever before in as much as the fluctuations cannot be wiped out. Naturally, any laxity could invite further problems.

That is to say the time is especially ripe to have more updated internal risk-management process. Newer risks have surfaced over time and the capital markets (where the banks are still the major players) cannot simply be expected to behave as per one’s expectations. That is why constant watch over the trends should continue to be there.

Risk management: Heat is on

Intensive risk management efforts are to continue - newer threats sooner detected the better. Immediate systemic failure of the banking system / risks may be said to have receded, but the threats loom large in as much as there remains many unknown factors still to be countered. How effectively and how fast the upcoming plans would be implemented still remains unclear. For example, the future of hedge funds – a major collapse of $ can trigger a systematic shock. Side by side, big liabilities in the credit-default swap market are no less capable of triggering the financial accident.

Is it not true for the investment banks? The importance of such banks do not call for fresh mentioning - an investment bank is an intermediary that performs a variety of financial services that include underwriting; acting as an intermediary between an issuer of securities and the investing public; facilitating mergers and other corporate organizations as well as act as a broker for institutional clients. In fact, the unique role of an investment bank resumes with pre-underwriting, counselling and continues after the distribution of securities in the form of advice.

Policy makers, no doubt, have also been watching the recent development very intensively so that economy’s growth momentum should not be lost. After too much foot-dragging, from uncertain occurrences as well as ominous signals it appears that at last we have arrived at a coherent and credible approach to at least prevent the recurrence of collapse of the major banks of Europe and the US. No doubt, given the ongoing facts and circumstances, the steps taken so far are most practical and direct solution, apart from ideological dimensions.

Rain rain go away, come again another day!

Factors that cause financial crisis still hover around. Recession is over, but the effects cannot be said to have vanished! In fact, any financial crisis can be caused by, among others, increase in interest rates; increase of uncertainty; asset market effects on balance sheets; problems in the banking-financial sector and of course the government’s fiscal imbalances. These lead to adverse selection and moral hazard problems worsening, which, in turn, pave the way for declining economic activity, bank panics, unanticipated decline in price level (recession looms large), foreign exchange crisis.

Actually it is confidence that emerges as the greatest casualty of the market crisis. To what extent snap shot measures would ultimately act as the saviour / shore up business confidence is to be watched. At times the uncertainty factor became so strong that the leading financial institutions hesitated to credit smaller banks, which, in turn, failed to re-credit business or simply did not want to risk it. Private customers did suffer as well.

Unless the global banking system, which happens to be the monetary circulation system for the non-financial sector of an economy, resumes higher credit business, the current economic situation and thereafter the recession possibilities stricken by the confidence crisis could well emerge as a reality.

Whatever is, the damage from further meltdown, if revisits, will be more tough – not only for the financial world, but for households and companies – the degree being different at best. Naturally, it is high time that the international cooperation should come up with larger vigour as global cooperation on this score is urgently awaited backed by experience sharing. If the world again faces recession (too much of inflation control may lead to), it will be a very hard nut to crack!

Though the fact remains that credit crisis and the high interest rate regime told upon investment as the same simply started drying up, yet considering the ongoing facts and circumstances the entire process is to be run very cautiously in as much as increased spending means more importing of capital equipments, which, in turn, leads to slim current account surpluses and reduce global imbalances.

Appropriate

supervision is a must

Balancing between spending and tax initiatives is to be maintained on the one hand, while on the other, the focus is reasonably expected to be on to help the visible underperforming economies simultaneously treating investments that would also benefit Europe and US in the long run.

The IMF is absolutely right in advising strong policy actions to mend the financial sector and macro-economic measures (monetary plus fiscal measures) so as to stimulate effective demand and by now almost all economies have been pursuing these policies without being able to put a brake on the downturn. ‘A unified approach’ to financial problems and ‘strengthening the fiscal framework’ requires a good bit of attention by all of the economies – big or small. If the government policies fail to dispel uncertainty, reduced demand for consumer and capital goods would continue to prevail as a result of postponing expenditures by the household and business wing!

In today’s complex financial world business requires a myriad of services to maintain competitive advantage. Expertise must be developed in a number of services so as to meet financial goals, ensuring good financial health services should not remain confined to tax planning, elder care planning, financial and estate analysis, social security benefits analysis, accounting and book-keeping services, interim CFO support and comprehensive wealth management.

The ongoing situation / happenings, thus, are to be watched intricately and as such countering the same calls for global cooperation at an unprecedented pace.

Prevention of large-scale bank collapses is a must. Whatever it is, nothing can be taken as final shot!