Systemic Risk and SIFI and Global Economic Crisis Essay

Systemic Risk and SIFI and Global Economic Crisis - Essay Example However, between 1940s and 1980s, there were less bank runs in USA, mainly due to tight legal framework and due to the transformed atmosphere. However, the banking tighter regulation in U.S.A not proved to be satisfactory as more than 250 banks filed insolvency petitions between 1980s and 1990s. In 1990s, Asian countries witnessed an economic turmoil as a result many banks in those regions failed. The issue started with individual bank and slowly enveloped into the whole banking system of a nation and finally impacted the creditworthiness of such nation itself. Likewise, the subprime mortgage crisis occurred in the 2007 -2008 started with U.S financial institutions and U.S banks and finally impacted many financial institutions around the world. However, bank failures or bank runs are not occurring in all the nations. For instance, there is no bank failure at all in Ireland and in Switzerland. Rochet (2008) is of the view that interferences by politicians can play a significant role i n bank runs. Many frequent bank failures and bank runs urged the need to recognise and deter financial agonies in the future well before they commence. Hence, there is a necessity to establish a well-structured supervision system in the financial sector, and it should be given authority to identify â€Å"systemic risks.† Bini Smaghi (2009) is the first to emphasise the theoretical issues of systemic risk, and the agency established for the same is to be well versed in detection of risks, evaluation of risk, and finally giving warnings about risks. (Eijffinger 2009:44). This research will make an earnest effort to elucidate w what is meant by ‘systemic risk’ and discuss the relevance of ‘systemically important financial institutions’ for policymakers and the ways and means to avoid future bank and financial institution failures. â€Å"What is Systemic Risk?† Systemic risk is a peril that is widespread in a nation or the economy as a whole and cannot be avoid ed by coalescing the assets in well-diversified and large portfolios, and it is also called as non-diversifiable risk. Systemic risk starts off in various sizes, shapes and magnitude. In some countries, systemic risk has occurred due to foreign exchange risks and economic shocks and in some other nations, it has occurred due to internal or external war or due to political instability. In between 1992 to 2002, there were about eight regional / global economic crisis happened in Europe, Asia and U.S.A. In case of banks, the systemic risk area includes forex risk and interest rate risks. The low-quality credit assets will first collapse when the systemic risks deteriorate. A portfolio approach is the need of the hour to recognise such unique and susceptible sectors and credit asset allocations, which may witness a negative effect in various economic conditions. Hence, it is essential to structure the portfolio to be fine-tuned methodologically so that the rigorousness of varying macro- economic crisis is minimised. It is to be noted that systemic risk differs from industry to industry. (Joseph 2007:242). As per G10, a systemic risk is one where an incident will activate a deprivation of confidence or diminution of economic value and may result in vagueness that would compel the major segment of the financial system to destabilize due to negative impact on the real economy. Thus, a systemic risk will have four significant ingredients namely erosion of faith, a sudden spurt of vagueness, major segment of the financial system that might be impacted and poignant negative impact on the real economy.†(Eijffinger 2010 :44).†