In this highly interconnected world, any global financial concern is expected to affect the livelihood and economic situation of almost all individuals. The recent global financial crisis that was experienced by all nations around the world was one great example of how the fall of the mightiest and strongest financial institutions could largely affect all the other aspects of the financial systems around the world (Shah, A. 2009).
Even the wealthiest nations around the world like the United States of America did not escape from the hideous effects of the global economic crisis as the world stock markets have downturned and the known huge financial institutions have fallen down. According to Shah, A. (2009), the global financial crisis was mainly brought about by quite a number of failures in the banking system and the use of certain financial instruments.
Klinz, W. (2008), on a paper he wrote entitled "The International Financial Crisis: Its Causes and What to do about it?", the sub-prime crisis was one of the major causes of the global financial crisis which first hit the United States and then easily spread across other financial markets. The sub-prime crisis is defined as a real-estate financial crisis which was triggered by a sudden increase in foreclosure activities and mortgage delinquencies due to the fact that attractive loan incentives encouraged thousands of people to avail of mortgage loans which they could not afford to pay (Bernanke, B. 2009).
Guina, R. (2008) argues that another main cause of the global financial crisis was greed. Securitization was one of the most popular financial instruments adopted by many financial institutions which resulted into great profit. But when banks and other known financial institutions started wanting to gain more profit to the point of abusing securitization or the selling of assets to avoid risky loans, financial issues started to break in.
The Lehman Brothers for instance, one of the largest investment banks in the United States, entered into the mortgage loans business by buying mortgages and making more securities out of it which they can sell to people. However, this attempt to gain more profit failed as interest rates increased and the ability of borrowers to repay became more difficult. As a result, a whopping USD$60 billion bankruptcy case was filed by the Lehman Brothers due to bad real estate loans (Reingold, J. 2009).
Similar to the case of the Lehman Brothers, many banks also went beyond their areas of expertise by entering into the mortgage loan business in order create more securities. These banks engaged into the field of "buying" and afterwards "selling" and "trading" riskier loans in order to off-load these risky loans and pass them on to others. This eventually backfired to these financial institutions which caused their immediate downfall (Guina, R., 2008).
The ultimate result of all this was money-flow paralysis wherein there was such a huge decrease in money supply and overall economic activity due to the eventual withdrawal and confidence of the people in these financial institutions. To immediately restore the situation back to how it was prior to the crisis, banks that ran out of capital reserves started turning to the government for monetary capital. As a result, the economy suffered as these recovering banks pulled out money from the government which could have been otherwise spent to sustain more economic activities (Shah, A. 2009).
Moreover, since making loans is the lifeblood of the financial and banking institutions and their current loans are not being paid due to the inability of the people to pay for their credits, then the banks suffer greatly from these unpaid loans. This is because unpaid loans means negative cash flow and negative cash flow means the inability of the banks to offer new loans to other businesses and individuals which sustains the banking business (Guina, R., 2008).
Aims of the Study
This study on the "The Impact of Global Financial Crisis on Loan Banking in relation to Ethics and Corporate Social Responsibility" aims to scrutinize the extent of impact of the global financial crisis on loan banking with particular reference to ethics and corporate social responsibility.
In essence, this study will provide an in-depth examination of the causes and effects of the global financial crisis particularly on loan banking. This study will directly answer the question, "How was the loan banking industry impacted by the global financial crisis?" and secondly, "How was the loan banking industry impacted by the global financial crisis in the perspective of ethics and corporate social responsibility?".
In order to answer these two main questions and ultimately address the major aim of the study, this paper will discuss the causes and effects of the global financial crisis in general. This paper will discuss the causative factors which triggered the on-going financial crisis today as well as its effect on the economy and financial markets all over the world and then put a special emphasis on the crisis' effect on the loan banking sector.
This paper will also discuss the financial system scenario in the past prior to the outburst of the global financial crisis. It will also present a clear picture of the financial and economic sector during the financial crisis and finally present its predictions on the financial market after the crisis.
Furthermore, this paper will discuss the extent of impact of the global financial crisis on the loan banking sector in relation to ethics and corporate social responsibility. This paper will evaluate the ethical implications of the global financial crisis vis-à-vis the loan banking sector and afterwards delve on the corporate social responsibility issues which arose out of this worldwide financial issue.
A. The Loan Banking Sector in the Past Prior to the GFC in relation to Ethics and CSR
Prior to the global financial crisis, the financial market was relatively stable. Credit served as the lifeblood of the financial institutions and the market economies. Savings and funds were continuously generated by the banks which they in turn use for making and providing loans and investments to both businesses and household individuals. The bonds and stock markets were also functioning quite well performing the same function of making the financial system work (Bernanke, B. 2009).
A decade ago prior to the flare-up of the economic crisis, the industrial countries including the United States were generating tremendous amounts of savings coming from domestic and foreign sources. These foreign savings came from the fast-emerging Asian market which chose to put their money on investment opportunities in the already-established industrial countries like America. In fact, in 2006, the net-flow of domestic and foreign savings in the United States amounted to USD$ 825 billion which if only were invested the right way, could most likely have solved the financial crisis today (Bernanke, B. 2009).
Because of this huge surplus in the funds available for the financial markets, financial institutions insistently engaged in competing for borrowers. This resulted into an outburst of cheap credit which became available to both businesses and households. According to Guina, R., (2008), cheap credit even resulted into the increase in confidence of the people to engage in loans, specifically mortgage loans, which will enable them to make investments and buy real-estate properties like houses which they can eventually sell and earn profit from.
Cox, W. (2008) states that prior to the crisis, lending and acquiring loans became so convenient that its demand increased more than expected allowing people to buy and acquire high-priced assets which they really could not afford in reality. As a result of this convenience and wide-open mortgage lending available even to the common people, the housing bubble rapidly increased alongside the continuous expansion or boom of the loan banking industry particularly in mortgage lending.
Unfortunately, the lending and acquisition of loans process was done recklessly. Smith, S. (2010) argues that the lenders or the loan banking institutions did not oblige the borrower to make a credit down payment nor did they examine and consider the borrower's financial capacity to pay the monthly dues of the loan and its interest rates. These careless acts by the loan banking institutions were even backed up by their strong beliefs that the prices of the real estate assets would continually go up which would allow borrowers to build more equity in their "house investments" and eventually allow them to refinance continuously.
Moreover, Guina, R. (2008) adds that mortgage brokers became very common, with the aim of selling houses to anyone who wanted to buy a house out of impulse, since they knew they will be getting a fee out of the completed loan transaction. Clearly, there was an abuse in the use of financial instruments such as loans prior to the global financial crisis.
The recklessness and negligence of mortgage lenders was therefore one of the root causes of the subprime crisis which ultimately led to the global financial crisis. Clearly, this act was unethical because these mortgage lenders were driven by greed or the desire for more profit and more money which ultimately backfired them and caused much greater problems even to other nations.
Moreover, the financial market regulatory board failed to perform its corporate social responsibility of checking the balance on the use of loan banking as a financial instrument to gain and maintain financial stability. If only the regulators did impose strict regulations on lending and engaging in loan transactions, the crisis would not have been created and the abuse in loan banking would not have occurred.
B. The Present State of the Loan Banking Sector due to the GFC in relation to Ethics and CSR
According to the World Bank (2010), two years after the outburst of the global economic crisis, the financial market is showing signs of stabilization. Although relatively weak, the financial market is slowly recovering from its negative growth position as an increase in global output is expected to register at 2.7 per cent by the end of the year compared to the previous year of only 2.2 per cent.
In the summary released by the World Bank (2010), the Asian economies were shown to still be adversely affected by the financial crisis. Certain countries in Central Asia and Europe, Africa, Latin America and the Middle East suffered intensely from the global financial crisis due to the collapse in stock market, global trade and the overall financial disruption triggered by the crisis.
The impact of globalization has made the world smaller and the nations interconnected that when financial crisis hits, the interconnection among the nations could pose as a great disadvantage. Today, given that the loan banking sector is still continuously suffering from the intensity of the financial crisis which hit both the developed and even the emerging economies, there is no doubt that the whole banking system is still in a precarious state.
Just recently, in an article written by Floyd Norris of the New York Times, stated that recent reports indicated that USD$1 out of USD$8 of mortgage loans is in a high risk of not being paid. The reports which were released by the FDIC or the Federal Deposit Insurance Corporation also indicated that the number of banks which are in deep trouble are fast-increasing. This therefore implies that the bank failure rate is also set to increase (Norris, F. 2010).
Moreover, recent reports also proved that the most problematic of all types of loans are the mortgage or real estate loans as more troubled borrowers are being counted in. The FDIC however also sent reports that the total outstanding loans are also falling down. By the end of 2009, it went down to USD$7.3 trillion from USD$8 trillion recorded amount in 2008 (Norris, F. 2010).
According to Norris, F. (2010), the figure may have declined due to the bank's refusal to lend to the troubled borrowers this time. Apparently, the decline in the amount of outstanding loans demonstrates that the banks have already learned their lesson of applying a careful evaluation on the capacity of a potential borrower to repay his loans or credit. It also implies that the regulatory board is now implementing stricter measures when it comes to lending or processing loan transactions.
Nevertheless, the decline may have also been caused by a huge reduction on borrowing or loan transactions due to the business owners and households' lack of confidence to repay the credit. Since they themselves experienced the impact of the credit crisis, it seems that a huge percentage of them have learned their lesson of not borrowing more than their capacity to pay. It could also be that others merely refuse to borrow money or acquire loans when they know that a crisis is on-going and the economy is weak (Norris, F. 2010).
From an ethical standpoint, this might be the right thing to do by the people as they are already considering and weighing carefully the consequences of their actions, that is, whether to acquire a loan or not. Given this, they are most likely to be borrowing money not out of impulse but out of necessity. The fact that it took a lot of time for these people to decide on whether to acquire a loan or not means that they are already being responsible for their loans and will therefore not consider borrowing money more than what they can afford to repay (Norris, F. 2010).
However from the financial market's point of view, the lack of confidence of the people in borrowing money means a perilous financial situation. In fact, this was the cause of the eventual outburst of the global financial crisis. Since loans and credit were the lifeblood of the financial institutions and were one of the greatest sources of their profits, any constraint or interruption in the flow of it may already result to a great damage on the financial market (Guina, R., 2008).
The flow of credit could have been prevented from being dried up if in the first place, the financial institutions knew their corporate social responsibility of educating both the businessmen and the household owners on how to use their credits or loans wisely and effectively. Since the financial institutions are in the business of lending or simply, loan banking, they must be active enough to protect their business. The key is educating the people on how to acquire good loans and better investments to keep the money flowing and be able to sustain the financial market. Credit by itself is not a bad thing. It only becomes bad depending on how it is used or spent (Guina, R., 2008).
C. The Future State of the Loan Banking Sector after the GFC in relation to Ethics and CSR
According to Claessens, S. Kose, M., & Terrones, M. (2008), global financial crises triggered by real estate crisis and credit crunches usually take a long and hard time prior to its full recovery. It may last for more than two and a half years depending on the extent of the damage it has caused in the financial market. The on-going recession, claimed to be the worst since the 1930s Great Depression, is assumed to be most likely felt within the next three years from today. This is because recessions triggered by credit crunches and subprime mortgage crisis result to tremendous amounts of losses which are more than three times greater than any other type of recession.
The three authors also predicted that this type of recession currently being experienced by the whole world is most likely to register huge declines in both investments and consumption leading to huge losses in output and sharp decline in the unemployment rate which would be felt even until three years from now. Certainly, it will take much longer time for the whole financial market to recover given that more and more troubled borrowers are being identified and more and more banks are identified to be standing on a very precarious situation (Claessens, S. Kose, M., & Terrones, M., 2008).
It is also predicted that more banks will cut back on lending in the next three years since these banks have suffered more than enough losses already to recover immediately and continue lending. These banks' lack of capital will eventually cause its most natural death if not bailed out by the government or a major financial institution (Ritholtz, B., 2009).
Given all these important information, there is really no doubt that the kind of recession or global financial crisis that the world is experiencing today is very costly due to the huge amount of losses caused by negligence and abuse of certain financial instruments that otherwise would have benefited the financial market if only used the proper way.
The important lessons therefore that can be taken out from this global financial crisis that the world is currently experiencing is the corporate social responsibility of the financial institutions to educate people with regard to their money, loans and investments. The types of recession triggered by real estate crisis and credit crunches are the worst types of recession as they result to huge amounts of losses and that although the effect may only be felt gradually, the impact is quite deep and the agony is quite long as well (Claessens, S. Kose, M., & Terrones, M., 2008).
Ethical standards must also be set by the financial market in order to manage and prevent abuses of the financial instruments i.e., loan banking and securitization by any of the global financial institutions. The financial institutions must also set specific punishment on anyone who abuses these financial instruments and use them for selfish gains. In this highly interconnected world, the consequence of one single action by one institution affects all the others in all nations. Hence, financial market regulators and policy makers must work hand in hand in order to guard and protect the global financial system and be able to sustain and maintain its stability (Claessens, S. Kose, M., & Terrones, M., 2008).
Conclusion
The extent of impact of the global financial crisis on loan banking is tremendous. Credit is technically necessary in order for the financial institutions to survive and thrive but ironically, credit may also appear to be its worst enemy when used and abused.
The recent on-going global financial crisis was caused by several factors. One is the subprime mortgage crisis which caused the collapse of mighty and established investment banking institutions like the Lehman Brothers, Bear Sterns, Merrill Lynch, Morgan Stanley and Goldman Sachs. Even AIG which was one of the world's largest insurer companies in the world fell down because of the crisis (Smith, S., 2010).
Thousands of bad loans due to the recklessness in lending of mortgage brokers and other financial institutions were the ultimate reason why the collapse became very inevitable for thousands of small banks and even might and established investment companies which entered the mortgage lending business. Securitization and loan banking were completely abused by both the ordinary people and the financial institutions that it back fired practically everyone, even those nations and companies which did not abuse it (Guina, R., 2008).
In conclusion, greed which led to the abuse of the financial instruments that otherwise could have benefited the financial markets was the ultimate cause of the major economic downfall suffered by the many financial institutions around the world. The lack of active financial regulators and policy makers who were supposed to act as watch dogs, guarding and ensuring the safe and secure flow of loan banking transactions also contributed much to the decline of the market economies (Guina, R., 2008).
Furthermore, the lack of corporate social responsibility and the ability to see the ethical and economical impact of the abuse in selling and re-selling assets and making reckless loan transactions also became a very big factor which led to the sudden and unexpected collapse of the financial market leading a great financial crisis which was claimed to be the worst ever since the Great Depression during the 1930s (Guina, R., 2008).
Recommendations
Now that the impact of the financial crisis has greatly paralyzed the loan banking sector which was the lifeblood of the market economies, there is an important need to restore and gain back the market confidence in order to keep the money smoothly flowing and prevent the further damage of the crisis.
For thousands of small banks and investment companies who were severely losing capital due to extremely bad loans which disrupted their money and capital flow, the author of this paper recommends that they must stop lending for the mean time but allot a relatively longer time for their financial recovery by accomplishing bail outs from major financial institutions.
Second, the financial regulators and policy-makers must create fair and legal financial policies which protects and prevents the improper use or abuse of the financial instruments like loan banking and securitization in order to ultimately prevent the crisis from becoming worse.
Third the financial policies must be hinged from the corporate social responsibility of financial institutions to educate the people with the proper use of their money and investments and must never be used solely for the purposes of gaining profit out of the unethical practices.
Fourth, the financial instruments i.e., loan banking and securitization must be restored to its original function being a great source of profit for the different financial institutions prior to the global financial crisis. For instance, the regulators must disseminate the right procedures for listing, rating and trading of the various types of securities and inform the market of its associated levels of risks. The financial policies must serve the benefit of both the lending institutions and the borrowers and proper policies must be created in order to prevent the crisis from happening again.
