Global Financial Crisis (GFC) is a nightmare to most of the people in the world. People realise the risk management problem after the GFC, people now learnt from it and try to solve the problem. They are trying to liberate form the problem of GFC by improving their risk management. This report will explain to the reader the mis-management before GFC and how the risk management has improved after GFC.
The sub-prime mortgage crisis was the initial causes of the GFC in 2007 to 2008.
Fundamental management and organizational failures has intensified the financial crisis. There are five types of risk management failures between the GFC. There are: inappropriate risk metrics, mismeasurement, ignored known and unknown risks, non-communication to management and operating problems. (Stulz, 2008) After the GFC, the bank improving on manages the financial risk; regulatory reforms and new Basel III emerge.
Traditionally, compare to the regulation the banks will higher their capital requirement themselves. After the GFC, bank realise this is important and efficient to prevent their risk. With the higher regulation launched by the local government and by the global, bank has a much tight risk management within them.
In addition, the risk manager must take a comprehensive view of all the possible risk for the short-term and long-term. Under the Basel III, the minimum capital requirements remain the same as 8 precent of RWA, and at least 6 precent on Tier 1 (up from 4 precent on Basel ll). Furthermore, the new regulation under Basel III that is minimum non-risk weighted ratio of common equity to exposures is 3 percent.
Global financial crisis (GFC) in 2007-2008
The global financial crisis occurred on middle of 2007 and into 2008, the stock market around the world have fallen, some large financial institutions, such as, Lehman Brothers, have collapsed or been bought out. The main effects were in the financial market of the USA and Europe.
A sub-prime mortgage is usually to leading to borrower whose loan applications did not meet the leading standards, for example, they are poor of credit history or not sufficient, or weak income and documentation. According to The Economist, by 2006, a fifth of all mortgage were sub-prime.
The US sub-prime mortgage crisis has led to increase the property prices and slowdown the US economy, and billions in losses by the banks. In recent year, the bank sold the repacked securitised mortgage to the bond market, so that they could quickly pool the loans and resell the loans through secondary market to avoid capital loss when the borrower defaults.
As shown in the below picture, the sub-prime model has no any banks checks, if the home buyer is defaults, the investor who buy the securitised home loan, they are not be able to get the money back from neither home buyer or bank. Figure1: complex lending; increasing risk (bbc.co.uk) If the borrower is default, then the collateral become a lender own as foreclosure, As shown in figure 2, if the housing price is decrease, then the bank sold the collateral in undervalue. The lender is losing the principle and interest of the mortgage.
Figure2: changes in house price during 2004-07 Source: office of Federal Housing Enterprise Oversight
Mismanagement of financial risk
The adequate of capital is required for the banks to operate and provides protection. Before the global financial crisis, the banks are holding lack of adequate capital as required. If the bank holding lack of capital, then they will not have sufficient funds available to pay debt or creditors.
The bank or financial institutions may overvaluation of the borrowers capability to repay the loan; the sub-prime loans have a higher risk of default, since the borrowers have weakened credit histories and low repayment capacity.
Credit risk is the risk that another party in a transaction will not