From a conventional viewpoint, the major cause of the current financial crisis was the reckless lending by European banks and governments. This left countries like Greece, Ireland, Portugal, Italy, and Spain with huge debts. Although the people in these countries are blamed as being reckless borrowers, the European banks were also reckless lenders because they gave out money without putting into consideration the financial statuses of the people and governments.
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It is believed that most of the lending institutions and banks knew that the borrowers were lying but wanted to make profits out of the European boom. The paper analyses how the issue could have caused the current financial crisis and if it was foreseen. It also analyses whether it could have been ameliorated and what can be done now to improve the situation.
The reckless lending practices by banks and governments in Europe led to the opaque and complex financial instruments of risk transfer (Daianu & Lungu 2008, p.80). This is supported by the fact that the reckless lending of the huge amount of finances in the subprime markets led to financial shocks in the European markets (Nugroho & Miles 2009, p.2).
Because of the low levels of transparency involved in the financial transactions especially in the assets market on credit instruments, the rate at which the financial markets would fall was accelerated. This caused a breakdown in the relationship that existed between the lender and the borrower. The lenders issued out money without considering the credit risk of the borrowers and the assets markets prices. This was necessitated by the boom in the housing sector that was high.
The banking sector and the governments lacked regulatory and supervisory oversight that would ensure transparency was encouraged especially from the borrowers’ side. Because of the laxity in the banks and lending institutions, faulty accounting models and risk managements models , and the incentive structures, risk was underpriced (Ely 2009, 99-100).
The incentives encouraged borrowers’ take risks and collude with credit rating agencies, insurance companies, appraisers, real estate developers and financial institutions which later lead to the underpriced risks costs. The situation was foreseen but according to Ely (2009, p.94-95) the crisis was encouraged by self interest from the lenders and the borrowers. It could have been averted but based on the reckless lending and lack of transparency the crisis was bound to happen.
Based on the current situation of the market financial crisis that has widespread across in the Euro zone, the situation could be improved with time. So far, institutions like IMF and the European Union have come together to rescue the most affected nations like Greece. The situation can be averted through the introduction of new changes especially in the supervisory and regulatory systems (Daianu & Lungu 2008, p.90).
However, the change should be carried in phases to avoid further credit crunch. The private and the public institutions need to cooperate to avoid any laxity and encourage transparency especially in the financial assets markets. So as to reduce the liquidity risks in the financial lending institutions, the EU and governments should enact compliance and conformity systems (Daianu & Lungu 2008, p.92).
This would be initiated through the Basel II framework which has not been fully operative during the time of the financial crisis. This would make the systems more compliant and reduce the chances of spreading risks.
Therefore, based on the analysis, the reckless lending by the financial institutions was the major cause of the markets financial crisis in the Euro zone. It was attributed by laxity, lack of transparency, poor compliance and conformity systems, and self interest to make interest. Currently, it can be improved setting systems that are transparent and conform to the Basel II requirements.
Daianu, D. & Lungu, L. 2008. Why is this financial crisis occurring? How to respond to it? Alliance for Liberals and Democrats for Europe, pp.71-105.
Ely, B. 2009. Bad rules produce bad outcomes: Underlying public-policy causes of the U.S. financial crisis. Cato Journal, Vol. 29, No. 1, pp. 93-144
Nugroho, Y. & I Miles, I. 2009. Mini study 06 – microfinance & innovation. Global Review of Innovation Intelligence and Policy Studies, pp-1-48