The global financial crisis was the worst economic disaster that shook the world after The Great Depression. Years after the Financial Crisis 2008 took place and the Lehman Brothers, a global financial firm, collapsed, we still don’t understand it in its entirety. Banks began to doubt each other, trillions of dollars evaporated and a global trust deficit emerged. It was not until the government jumped in late 2008 that the financial markets finally settled. So much has changed in the banking sector and corporates since then as everyone railed in the aftermath of the 2008 crisis, vowing to ensure that a collapse of such magnitude never happened again.
The 2008 crisis was greatly exacerbated by irresponsible behaviour and excessive risk-taking by the banking sector. Consequently, central banks, regulators and policymakers were compelled to take extraordinary measures to strengthen the banks against future shocks. Regulations were passed that required them to keep more capital against the risks they took and restrictions were imposed in a bid to discourage such aggressive lending in the future. The ‘Dodd-Frank Wall Street Reform’ and ‘Consumer Protection Act’ was enacted in the U.S. which led to the formation of financial regulators that monitor the financial stability of firms that are “too big to fail” and prevent predatory mortgage lending. This Act hands regulator the power to subject a firm to intense scrutiny and seeks to improve consumer confidence, increase transparency and end objectionable banking operations.
Years after the Financial Crisis of 2008, a ring-fencing policy that separates a company’s financial assets from the other assets was pursued. As a result, banks ring-fence a part of their fund holdings related to retail banking branches. This was done to ensure that if the bank fails, its retail customers’ money would be safe. Investment banks underwent more stress testing by regulators and had to develop plans facilitating recovery from a crisis. The insurance industry was reworking its model and was routinely monitored to identify gaps that could pose a risk to the financial system. In European countries, various regulatory bodies such as the European Banking Authority (EBA) and the European Securities and Marketing Authority (ESMA) were established.
After the Financial Crisis of 2008, banks have become more resilient as they are better capitalised and less exposed to global financial contagion. Several banks have gone far and beyond as they have separate investment banking divisions from retail ones to protect the interests of depositors. Volatile short-term lending has been cut sharply and they have reduced the scope and scale of their trading activity, thereby lessening exposure to risk. In Eurozone countries, banks retreated from international activities, thus becoming more local and less global; less money flowing across borders, in toto, leading to a reduction in risks related to such a crisis.
The Financial crisis of 2008 also brought to light the dangerous corporate culture that had existed in banking for many years. As a result, corporates are subject to stricter vetting and regulations have been imposed on potential appointments at executive level across the industry to ensure those leading the sector understand the responsibilities of their position. Business houses now endeavour to have a more stable funding base with enough liquid assets to survive a crisis of such magnitude. Small businesses had to bear the brunt of the financial crisis and came to a virtual standstill. Their ability to borrow money was hit hard which eventually led to the emergence of other options of alternative lending such as merchant cash advances, microloans, crowdfunding etc. Credit unions have ramped up and the loan programs for small businesses have also expanded. This has ensured access to funds needed to refuel the business and prosper again.
While the 2008 crisis certainly changed the global economy, it has also altered the behaviour of consumers, particularly U.S. consumers. This financial crisis brought them under great psychological pressure. Many consumers became rational and price sensitive. They cut their spending on conspicuous goods and postponed the purchase of large goods. On one hand, this crisis changed their perceptions regarding the value of the goods they received whereas on the other, alter their willingness to pay and all this fundamentally reoriented what they chose to buy. Ultimately, consumers discovered that the quality of lower-priced brands was higher than expected and they no longer saw value in the additional brand benefits. Besides, people who suffered in the crisis of 2008 focused more on corporate behaviour and had a preference for companies and brands that were more kind, empathetic and socially responsible. These changes in consumer attitude years after the Financial Crisis of 2008 are not a fancy notion but a reaction to economic hard times.
The crisis profoundly impacted the stock markets. In the aftermath of the crisis, there were fewer IPOs and the publicly traded stocks dwindled. This led to the rise of ETFs (Exchange Traded Funds) as they well fitted the post-crisis investment psychology particularly well because of less risk involved. The landscape has certainly changed in the labour market as well. Active labour market policies are formulated to minimise lay-offs and employment contracts are subsidised by the state to ensure security to unemployed. The technology industry also gained prominence after the crisis. Banks exclusively focussed on the need to acquire new technology to increase efficiency by automating manual tasks, improving the quality of data analytics, tracking debts and using artificial intelligence to better anticipate customer needs.
Is the financial system really safer than it was before? Years after the Financial Crisis of 2008, the banking sector has witnessed notable structural shifts. Prime focus on recovery and resolution put banks into a healthier condition. The economy was back on track as governments pumped trillions of dollars. The demand for safe assets increased as investors became more aware of the risk.
In 2017, the housing market, the ground zero of the crisis, stopped its downward slide and markets largely recovered as the prices of houses rose. But in some countries like India, the banking sector became overregulated which resulted in low profitability. Loans were inadvertently given to high-income groups elsewhere which resulted in more investments in large fancy houses. People with low incomes and low credit scores were left behind. Years after the Financial Crisis of 2008, the trend of larger firms is still intact. The credit firms such as Moody’s and Fitch that came under scrutiny for assigning favourable ratings to risky debt still dominate the market. There is a lot that has not been done and continues even today. Derivative markets need to be made safer, large banks should split-up and market-based finance must replace the so-called shadow banking.
Although people are sane enough to not fall for such traps again they can surely fall for many others. Therefore, what becomes more important is how fast we clean up when a bubble bursts. Nevertheless, these changed practices and regulations do not provide sturdy solutions to deal with a financial crisis but this economic wisdom can at least help us in fighting a crisis or an even worse impending recession due to the ongoing coronavirus pandemic.
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Currently pursuing Economics (Hons.) from SRCC, Simran is an avid reader and is always on a lookout for some ‘real’ knowledge. She is a proud member of BTS Army and has an innate obsession for Sundays. She often finds herself stuck in the rat race and struggles to have a consensus between her heart and mind.