'A STUDY OF GLOBAL FINANCIAL CRISIS'

ROLL NO: P 14

DIVISION: Finance A
 Introduction

The world economy was rocked by the catastrophic Global Financial Crisis (GFC) of 2007–
2008. India was among the nations affected, even though the United States served as its
epicentre. This assignment dives into the complex dimensions of the GFC within the Indian
context, offering a comprehensive examination of the causes of the crisis, the parties
involved, what went wrong, and potential preventative measures. It clarifies the key
takeaways for Indian authorities as well as how these takeaways might assist protect the
nation's financial sector from future catastrophes.

1. The reasons for the global financial crisis?

1. ANS: The growing global financial system's interconnectedness is what can be used to
pinpoint the GFC's roots in India. The bust of the American housing market bubble was the
main cause of the crisis. This was similar to the real estate and housing bubble in India, with
its soaring property prices and speculative financing practices. While excessive lending and
high leverage ratios in Indian banks were not directly related to subprime mortgages, they
bore frightening similarities to the U.S. banking practices that ultimately precipitated the
crisis.

2. The crisis surrounding subprime mortgages: It was the US housing market that initially
caused the catastrophe. During the housing boom, banks and other financial institutions
issued a lot of subprime mortgages, which are high-risk loans to borrowers with bad credit
records. Monetary-backed securities (MBS) and collateralized debt obligations (CDOs) are
sophisticated financial vehicles that were created by bundling these subprime mortgages.

3. Taking Too Many Risks: Driven by the desire for large returns, financial institutions
invested in MBS and CDOs without fully comprehending the underlying concerns, thereby
accepting undue risks. Financial innovation, such as the development of novel, intricate
financial instruments that were challenging to assess, further aggravated this risk-taking
tendency.

4. Insufficient Regulation:

- Excessive risk-taking was allowed to go unchecked because regulatory bodies and

government agencies did not sufficiently monitor and supervise the financial industry.

- The spread of these hazardous financial products was made possible by regulatory gaps and
a lack of transparency in the financial system.

5. The fourth weakness in the banking system was the large exposure that many banks had to
MBS and CDOs, which put a great deal of strain on the system when their prices started to
drop. While some large financial organizations needed significant government bailouts to
survive, others, like Lehman Brothers, crumbled.

6. International Interconnectedness: The financial system on a worldwide scale was

intricately linked. A systemic crisis was brought on by the collapse of one significant
financial institution, which triggered the downfall of others.
2. Entities involved in Indian?

ANS: Numerous entities were connected to the effects of the GFC in the Indian setting. Due
to their international activities and investments in high-risk assets, Indian banks and financial
institutions such State Bank of India, HDFC, and ICICI Bank had indirect exposure to the
Great Financial Crisis. The crisis also highlighted the complex interconnection of the world's
financial systems, which allows events in one region to have repercussions on markets and
institutions thousands of kilometres away. Additionally, the Reserve Bank of India (RBI) was
instrumental in controlling the crisis's knock-on effects on the country's financial sector.

1. Reserve Bank of India (RBI):

- The RBI, being the central bank of India, was instrumental in handling the aftermath of the
global financial crisis. - In order to avert a banking crisis and stabilize the Indian financial
system, it put monetary policies into place.

2. Banks for Commercial in India:

- The crisis impacted Indian banks because they held toxic assets connected to the Great
Financial Crisis, particularly those with exposure to foreign markets.

- On their investments in structured financial products, banks like ICICI Bank and SBI were
forced to take significant write-downs.

3. Partners in Trade and Industry:

The crisis caused a slowdown in the economies of many major economies, which in turn put
Indian exporters at risk of lower global demand. A side from the credit freeze, exchange rate
fluctuations also presented difficulties for importers.

4. Indian Stock Market:

- Reflecting trends in the global market, the Indian stock market saw notable volatility and
steep stock price declines. Throughout this time, investors suffered significant losses.

5. Indian Rupee (INR):

-During the crisis, the value of the Indian rupee declined dramatically in relation to other
major currencies. Foreign exchange reserves and trade were impacted by this depreciation.

3. What went wrong?

ANS: Following the Great Financial Crisis, a number of important factors became apparent
as having a significant role in the crisis within the Indian context. The first was the deficiency
in risk disclosure and openness. Like their international counterparts, financial institutions in
India have frequently come under fire for not being completely transparent about the amount
of risky assets they have invested in, which has caused market uncertainty.

The regulation of oversight was another important factor. Even though India's banking
system was more conservative than that of the United States, there were still weaknesses in
risk management, such as a lack of readiness for a worldwide financial crisis and inadequate
stress testing of financial institutions.

1. The subprime mortgage bubble burst:

Bursting the US subprime mortgage bubble was one of the main causes of the crisis. Many
high-risk subprime mortgages with bad credit histories had been given by banks to
homebuyers. Mortgage-backed securities (MBS) and collateralized debt obligations (CDOs)
linked to these subprime loans saw a dramatic drop in value when numerous borrowers
started to fall behind on their mortgage payments.

2. Complex Financial Instruments and Transparency Deficit:

- Financial institutions developed extremely complicated and opaque financial products,

like synthetic derivatives and CDOs, making it challenging to evaluate the underlying risks of
these products.

- When the underlying assets (subprime mortgages) went bad, investors, including large
financial institutions, frequently lost a lot of money because they didn't fully comprehend the
risks involved with these products.

3. Taking Unreasonably Big Risks:

- Financial organizations that took on excessive risk in an effort to maximize profits. They
didn't fully understand the risks involved because they thought they could profit from
intricate financial instruments.

-The availability of inexpensive credit and the conviction that home prices would never drop
significantly increased people's willingness to take on excessive risk.

4. Reduction in Trust:

The global financial system rapidly lost public trust as the crisis deepened. Due to uncertainty
regarding their counterparties' exposure to toxic assets, banks became reluctant to lend to one
another. Due to the credit freeze brought on by this lack of trust, it became more difficult for
people and companies to obtain financing, which made the economic crisis worse.

5. Inadequate supervision and regulation:

Governmental organizations and regulatory bodies did not sufficiently oversee and regulate
the financial sector. Regulation-related gaps made it possible for excessive risk-taking and a
lack of transparency to continue.

- The instruments necessary for regulatory bodies to keep an eye on and control the risks
connected to intricate financial products were lacking.
4. What could have been avoided?

ANS: With the benefit of hindsight, a number of actions could have been taken to lessen or
prevent the effects of the GFC on India. The regulatory authorities in India had the
opportunity to impose stricter guidelines on risk assessment and disclosure, necessitating
greater transparency from banks regarding their exposure to international financial
instruments. Systemic risk would have been reduced by stricter banking industry regulations
that prioritized the monitoring and control of complex financial products.

To further mitigate the crisis's effects on India, the RBI should have been more proactive in
spotting new threats and weaknesses in the global financial system and acting before they
became serious. A stronger focus on investor education and financial literacy may have better
equipped Indian investors to comprehend the dangers of intricate financial products.

1. Observing Prudent Lending Practices: If banks had followed more responsible lending
guidelines, the Great Financial Crisis might have been avoided. If they wanted to avoid
lending too much on subprime mortgages, they ought to have thoroughly evaluated the credit
of the borrowers.

2. Transparency and Risk Assessment:

- By performing more precise and thorough risk assessments of complex financial products
like mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), financial
institutions could have prevented the crisis.

Investors would have been less likely to invest in assets they didn't understand if these
products had been transparent, enabling them to understand their underlying risks.

3. Tougher Regulatory Monitoring:

- The crisis might have been avoided or at least lessened with better regulatory oversight.
Authorities were required to make certain that financial institutions were properly managing
risks and had sufficient capital.

- Adopting more stringent regulations on the use of leverage and the development of
financial derivatives may have prevented excessive risk-taking.

4. Sturdy Risk Management:

- It would have been essential to have better risk management procedures in place within
financial institutions. They ought to have evaluated the possible repercussions of a housing
market slump and implemented the necessary risk-reduction strategies.

5. Reduced Moral Hazard:

– Eliminating moral hazard would have been crucial. The message from governments and
regulators should have been to let poorly run financial institutions fail in order to deter
excessive risk-taking.
5. Further, specify what lesson the regulatirs in Indian should learn from the crisis?

ANS: For Indian regulators, the Great Financial Crisis is a crucial lesson. It emphasizes the
necessity of thorough regulatory reform that takes into consideration the intricacies of
contemporary financial markets. Crucial takeaways for Indian regulators encompass:

Improved Transparency: Authorities should require financial institutions to declare their

exposure to risky assets in a thorough and transparent manner.

Stress testing: To evaluate financial institutions' crisis resilience, banks and other financial
institutions must undergo regular stress testing. The RBI needs to keep hammering home how
crucial stress testing is for finding potential weak points.

Mechanisms of Early Warning: The aftermath of international financial crises can be lessened
by creating an early warning system to detect systemic risks and quickly implementing
intervention measures.

Capital Flow Management: Putting in place practical capital flow management strategies.

1. Improve Risk Management:

- Indian regulators ought to stress the significance of sound risk management procedures in
financial institutions. This includes conducting frequent stress tests and carefully evaluating
any possible weak points in the system.

2. Increase Regulatory Monitoring:

- Regulatory agencies such as the Securities and Exchange Board of India (SEBI) and
Reserve Bank of India (RBI) ought to improve their regulatory and supervisory capacities.

- Tighter control should be put in place, along with thorough oversight of financial
institutions and products, particularly those that have exposure to foreign markets.

3. Prudential Norms Implementation: - Prudent norms, which mandate that banks maintain
sufficient capital buffers, liquidity, and risk management frameworks, ought to be put into
place and enforced by Indian regulators.

A robust and well-capitalized banking system is crucial, as the lessons learned from the
Great Financial Crisis underscore.

4. Make Transparency a Priority: - It is essential to promote transparency in financial

products and transactions. It is imperative for regulators to guarantee that investors are
provided with comprehensible and unambiguous information regarding the hazards linked to
financial products.

5. Reduce Moral Hazard: - Regulators should refrain from endorsing the failure of poorly
run financial institutions as a means of generating moral hazard. This may deter taking
unwarranted risks.