Book Report: Bank Finance Management

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Bank Finance Management

The global economic crisis, that has its roots in the global financial crisis of 2007 and 2008 started off from the collapse of giant financial institutions such as Bears Stearns, Lehman Brothers and Citi Bank. In the pre 2007 era, the global economy and in particular the American economy saw a sharp boom in the credit and housing sector. In greed to attract clientele and business, financial institutions relied on weaker calculations of Value at Risk figures, which not only resulted in underestimation of risks but also resulted in poor monitoring of balance sheet growths.

There have been several direct and indirect problems pertaining to risk management practices that the financial institutions ignored and in turn saw found themselves near to insolvency. These included liquidity problems, problems pertaining to capital reserve requirements and further the pressure intensified by the Basel Accord provisions in a crisis situation.

Negative financial intermediation, lack of liquid assets, money multiplier effect, plunging prices of straight bonds and poor credit ratings have all contributed to what led to one of the greatest economic crisis in the history. In 2008, the President of USA devised a Working Group on Financial Regulation. The working group pointed out problems such as poor calculation methods of Valuation of Risk, liquidity pressures and exponential and unmonitored balance sheet growth as major contributing factors. The report also pointed out that lack of comprehensive and essential data required for adequate risk measurement was also an important issue that needs to be addressed.

Introduction

The government of United States of America has proposed a further cut in federal government spending. The government of United States of America states that the proposed cut is part of a short-term spending plan for the forthcoming fiscal term. Ever since the economic crunch has struck the country's economy, and business giants started to fall out of business, the government of United States of America increased its government spending to a substantial level. This was necessary given the rate with which unemployment levels were shooting up and GDP of the country was rapidly declining. While the increased government spending resulted in giving support to a lot of declining firms, it ended up increasing pressures on its current accounts. As a result, the existing Democratic government had to face severe criticism from the Republican opposition, who thought that the only solution to the declining economic growth is that the government should cut down on its spending. The science of economics suggests that scarce resources need to be efficiently utilized in order to achieve optimum outputs. Contrary to that, the opposition believes that the government spending are unproductive and continuing these spending would create an economic pressure on more productive economic activities. Government, amidst the ever increasing defence budgets, also had to allocate huge amount of money for bailout packages for huge giants, that until recently were major contributors of the U.S. economy. Some major collapsing corporate giants included Lehman Brothers, Citi Bank and AIG Insurance Inc.

The world has seen great economic evolutions over a period of time. Today, the contemporary world in general adheres to the mixed market economy system that works in amalgamation of private sector and the public sector. While micro economic decision making in all mixed economies lie with the private sector the degree to which public sector influences the economic decision making of the private sector may defer from country to economy. The macroeconomic goals that any government would want to achieve in order to stabilize its economy are common among all economies regardless of the kind of economic policies a country follows. These macroeconomic goals are discussed as follows.

Controlling inflation rates which involve prices stability.

Lowering the unemployment rate and achieving full employment.

Increasing national output and achieving economic growth.

Maintain a positive Balance of Payment

Redistribution of income and wealth which involve minimizing gaps between economical classes.

While all these aims are interrelated to each other in one way or the other the strongest basis of relationship is formed by Inflation and employment. While generally, they tend to have an inverse relationship. This means that when Inflation increase, employment decreases and vice versa. This makes it trickier for the governments to devising their economic policies as aiming at achieving price stability might end up resulting in increasing unemployment, which again goes against government objectives. The only situation where a direct relationship exists between the two economic goals, which is inflation and employment, is when the economy is going through 'stagflation'. Stagflation refers to a situation where inflation is extremely high and economic growth does not exist which results in an increasing unemployment rate at the same time. The recent economic crunch of 2007-2008 has pushed the United States of America and subsequently the global economy into a stagflationary situation. The responsibility of this massive economic crisis, one of the worst in the millennium, are allegedly the financial institution, and in particular the banking sector.

The economic trends between 2005 and 2010 have been a roller coaster ride for both the economists and the people in general. This made it necessary for economists and analysts to debate and argue about different types of financial concepts and their effects on the economy. The beginning of the U.S. recession in2007 has led to a phenomenal increase in the debating societies and associations of professionals which discuss topics such as financial intermediation, liquidity, interest rates, financial assets and money multiplier concepts. The importance of discussing these issues comes from the fact that they are directly or indirectly, in one way or the other, related to interest rates, which serves as a major role in an economy's growth or recession. The variation in interest rates paves way to changes in other economic indicators such as inflation, employment rates and balance of payments. Keeping in view the recent global economic recession, the role of financial intermediaries has also gained importance, as these are the agents which determine the interest rates, which consequently effects all other economic indicators. The subject of economics on micro and macro level highlights the importance of financial concepts. Discussion of these financial concepts is also important because understanding and application of such concepts differ from person to person as these concepts are complex in nature. The significance of these concepts is immense as these were the financial intermediaries which played the role in the bailouts of banks in major economies of the world and the downturn of stock markets around the world. The collapse of the real estate market was in one way or the other related to the same financial role models.

As stated earlier, the banking sector and other financial institutions had to carry the burden and were held responsible for the crisis. The primary reason of the crisis remained a sharp boom in the real estate and credit industry. Financial institutions underestimated risks and allowed extensive loans at huge mortgages. The end result was many financial institutions; especially those that underestimated risks and had little provisions for doubtful debts were frozen with almost negligible liquidity. This resulted in one of greatest economic downfall in the history.

Financial Intermediation and its contribution to Economic Growth

The term Financial Intermediation can be perfectly defined as "managing funds between surplus and deficit agents." However, the definition tends to be incomplete without understanding of the source through which such financial intermediation is performed. The financial intermediation is performed by a financial intermediary. The best example of such a financial intermediary is " Bank of America." The role of such financial intermediary is to maintain a balance between surplus and deficit. In other words it channels funds between agents of surplus and deficit. For example, if Bank of America obtains deposits from one of its customers and uses such deposits to advance loans to its other customers, then the bank is performing financial intermediation.

The concept of financial intermediation is of great significance as it plays a major role in the economic growth of any country. The financial intermediaries have a major role to play in economic growth as they determine the interest rates and other economic indicators which directly affects the rate of economic growth in an economy. Economists have differing opinions regarding the impacts and implications of financial intermediation on economic growth (Badun, n.d.). Economists have worked on many economic models, and each of these models discusses different channels through which finance influences growth. The theory of Montiel (2003) explains the link between financial intermediation and economic growth. The theory discusses three factors through which economic growth occurs through financial intermediation. The theory discusses how financial intermediaries can perform financial intermediation in order to trigger economic growth. The financial intermediation contributes to economic growth by creating opportunities for the accumulation of physical and human capital. The accumulation of physical capital is done by a financial intermediary. Such physical capital is diverted towards the most productive activities. The allocation of physical capital to such productive activities leads to the employment of human… [END OF PREVIEW]

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