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Financial crisis
- 1. Fathima Naseeha (AAT(PF), BM(Hons) Accounting, KIU)
- 2. Contents What isFinancial Crisis Types of financial crisis Theories of financial crises Causes and consequence of financial crisis Case Studies related to Financial Crisis Golden key Case Lehman brothers case Financial Crisis and the Sri Lankan Economy Measures to control Financial crisis in Sri Lanka Conclusion
- 3. Financial crisis • Financialcrisis is any of a broad variety of situation in which some financial assets suddenly loss a large part of their nominal value. Financial crisis situation in which the supply of money is outpaced by the demand for money. • This means the liquidity is quickly evaporated because available money is withdrawn from banks or financial institutions. Forcing banks either to sell other investments to make up for the shortfall or collapse. • In a Financial crisis, asset price see a steep decline value, business and consumers are unable to pay their debts and financial institutes experience liquidity shortages.
- 4. Types of financialcrisis Banking crisis A situation where a commercial bank suffers a sudden rush of withdrawals by depositors is called a bank run. In such situations, banks cannot immediately fulfill the entire demand for money by the general public, because the bank may have invested its money in a variety of assets, gains of which may be realized during a long period of time. This may lead to a bank panic or banking crisis. Currency crisis An international financial crisis may occur when a country is suddenly forced to devalue its currency because of a speculative attack. This may be referred to as a currency crisis or a balance of payments crisis Stock market crashes A stock market crash is a sudden dramatic decline of stock prices across a significant cross section of a stock market, resulting in a significant loss of wealth
- 5. Sovereign defaults Whena country fails to pay back its sovereign debt( repayment of countries government debt), it is referred to as a sovereign default. A balance of payment crisis along with a sovereign default can lead to a sudden stop in capital inflows or a sudden increase in capital flight Bursting of the financial bubble A bubble is a rapid escalation of assets prices followed by a contraction, often created by a surge in asset price that is fundamentally unwarranted by the assets and driven by exuberant market behavior. When no more investors are willing to buy at the elevated price, a massive sell-off occurs, causing the bubble to deflate.
- 6. Theories of financialcrises Irving Fisher & Milton Freidman Neoclassical Dichotomy John Maynard Keynes Model of monetary production economy Hyman Minsky An Explicit Model of Financial Crisis
- 7. Irving Fisher &Milton Freidman - Neoclassical Dichotomy monetary sphere in the short- and medium-term can become a disturbing factor for the real sphere. Irving Fisher and Milton Friedman, the icons of monetarist thinking in the 20th century, made this point very strongly. In extreme cases developments in the monetary sphere can lead to financial crises with far reaching repercussions for the real sphere.
- 8. John Maynard Keynes-Model of monetary production economy money plays a key role and penetrates all spheres of the economy. Instabilities and financial crises all develop within the framework of a monetary production economy. Hyman Minsky -An Explicit Model of Financial Crisis
- 9. Causes and consequenceof financial crisis • Strategic complementarities in financial market • Leverage • Asset Liability Mismatch • Uncertainty and herd behavior
- 10. Case Studies relatedto Financial Crisis • Case Study of Golden Key Golden Key Credit Card Company fully owned subsidiary of Ceylinco Group which had more than 300 subsidiaries. It is incorporated in June 03, 1977. Pioneered the Credit Card industry in Sri Lanka in the Early 1980s. Responsible for setting – up the initial Merchant Network utilized by all credit card companies.
- 11. Golden Key collapsedin 2008, after revealing fraud worth Rs. 26 billion. Accepting funds from the public at high interest rates from 12 percent to 30 percent was the key reason for the collapse of the Golden Key Credit Card Company
- 12. Loss ofinvestor confidence and liquidity constraints Loss the performance of the finance sector Measures taken to safeguard Seylan Bank Change in the Ceylinco Saving Bank Increase the importance of corporate governance Things of impact by Golden Key case
- 13. Reasons for thecollapse of Golden Key case Mismanagement of Funds Assets were much lower than the liabilities Internal frauds by top management Maturity mismatch of asset & liabilities Accepted deposits from customers- short term liabilities High cost funds 20-30% on deposits Lack of risk management policy High liquidity risk Lack of monitoring and regulatory mechanism Lack of good corporate governance No independent audit Manipulation of financial statement
- 14. Lehman brothers case Introductionof Lehman brother • Lehman brother founded by German immigrant henry Lehman in Montgomery,albama in 1844.in 1859 henry Lehman and his brother Emanuel and Mayer founded Lehman brother. • Lehman brother is a global financial service firm whole bankruptcy in 2008 was largely caused by and accelerate the subprime mortgage crisis. • It provided investment banking,trading,investment management, private banking,brokerage,private equity and associated services.
- 15. On September15,2008 Lehman brother is filed for bankruptcy. With $639billion in assets and $619 billion in debt. Lehman's bankruptcy filing was the largest on history.as its assets far surpassed those of previous bankrupt giants such as WorldCom and Enron. Lehman was the fourth largest US. Investment bank at the time of its collap with 25000employees worldwide. Lehman’s demise also made it the largest victim of the US. Subprime mortgage included financial crisis that swept through global financial markets in 2008.
- 16. Reasons for thecollapse of Lehman brother • Asset – backed securities and collateral debt obligations. • Lehman brother underwrote mortgage – backed securities more than any other firm accumulating an 485 billion portfolio or four tims its shareholders equity. • Leverage level up to 20 – 35 percent of their equity capital in order to invest on securitized product using debt capital. • Excessive risk taking. • Passing the investment risks through unregulated credit default swap where they didn't have any adequate capital behind them
- 17. Financial Crisis andthe Sri Lankan economy A declining growth rate Increase in government debt Increase in external debt Unemployment rate Import Export change Rupee under pressure for depreciation Government Debt in Sri Lanka averaged 5523822.15 LKR Million from 1990 until 2019, reaching an all-time high of 12271315 LKR Million in the first quarter of 2019 External Debt in Sri Lanka averaged 45512.04 USD Million from 2012 until 2019, reaching an all-time high of 54221.66 USD Million in the first quarter of 2019 Unemployment Rate in Sri Lanka increased to 4.70 percent in the first quarter of 2019 from 4.60 percent in the fourth quarter of 2018. Youth unemployment rate also increased to 21.90 % in the fourth quarter of 2018 from 19.60 % in the third quarter of 2018. It was 15.40% in 2015 previous Government had kept the value of the rupee artificially at high levels by supplying dollars to the market from the country’s inadequate foreign exchange reserves. When the reserve levels which had been built by borrowing and not by earning had fallen to a critically low level, the country could no longer continue to feed the market’s voracious demand for dollars. Exports, a means of earning reserves, had been declining both in dollar terms and as a share of the total GDP.
- 18. Measures to controlFinancial crisis in Sri Lanka. • Prevent increasing and unsustainable deficits • Interest rate should be slightly increase in order to maintain inflation at law levels • Precautionary investment policy, especially for large projects, when such projects are financed by the state budget. • Better and careful monitoring over the internal financial system even if the system seems healthy and not affected by contagion. • Banking supervision methods such as the strict guidelines for maintains of non – performing loans (NPL) were also helpful to maintain levels of loans as well as to reduce the risk arising from delivery of credit. • Issuance of directions to commercial banks by the CBSL for releasing of foreign currencies for travel and other purposes depending on the purpose was another measure to protect foreign currencies of the country. The requirement of producing documentary evidence was helpful to regulate the movements of foreign exchange transactions.
- 19. Conclusion • financial criseshave taught many lessons to the regulators, governments, financial institutions and to the general public at large. In spite of many lessons learnt from the historical financial crises, financial crises have occurred repeatedly. We have discussed about financial crisis, types of financial crisis, theories of financial crisis and literature Reviews about financial crisis and effects of financial crisis in Sri Lanka. The financial crisis characterizes the nature of a global systemic crisis in the 21st century. It has demonstrated that increasing linkages, technical innovation and management changes have increased both the robustness and fragility of the global financial network.