Financial Crisis

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Systematic Risk

Systematic risk also known as counterparty or default risk played a very critical role in the financial crisis of 2007 to 2008.This is the risk that counterparty will default on its obligations. It usually occurs due to improper information. The financial crisis was mainly affected by the counterparty risk. According to Taylor (2009), he argues that major increase in the counterparty risk caused the financial crisis. Many customers failed to meet their obligations and thereby increased the level of counterparty risk. Policies which were put into place became less stringent. This mainly contributed to default by customers and therefore the financial crisis.

Part B

Basel III

The 2007-2008 financial crises analyzed the importance of putting measures in ensuring the financial institutions are regulated efficiently. This includes ensuring enough liquidity in order to withstand adverse circumstances. The issue of funding which was witnessed during the financial crisis period impacted on regulating and using effective risk management process in ensuring banks to mitigate the crisis. Banks need to manage their market and liquidity risk to avoid such economical occurences.The global crisis enabled the Basel Committee on Banking Supervision to strengthen its efforts on capital principles and liquidity risk. The report enabled banks to be vigil and prudent in managing their liquidity. Therefore the Basel III increased the level of risk management and measurement to encourage banks to be more risk cautious. The Basel III formulated the below measures for global harmonization in the banking sector.

Qualitative measurements of risk

The Committee had to put in place two qualitative metric measures to manage the level of risks (Basel, 2010).The measures are the Net Stable Funding ratio and the Liquidity Coverage Ratio. The Liquidity Coverage Ratio calculates total value of the quality liquid assets over a 30 day cash outflow. In simple terms, in order for the banks to meet their obligations on drawings on liabilities over the next 30 days, LCR, requires the banks to hold the value of high quality asset which is more than net cash given out. High quality assets include central banks reserves, cash and highest rated debts obligations (Basel, 2010).Another qualitative measure which was put in place is the Net Stable Funding ratio. This ensures that long-term financial assets are to be covered with stable financing. Stable financing includes preference shares, capital and liabilities which mature more than one year. It therefore shows that these two qualitative measures are very crucial in ensuring that risk is managed by the banking institutions to avoid the probable financial crisis. It will therefore require the risk analyst to analyze and report periodically to the management the calculated ratios.

Liquidity and risk levels

According to Went (2010), he stated that there are two types of liquidity, market liquidity and funding liquidity. It also did an analysis on how this two liquidity impacted heavily on the financial crisis. Many banks had relatively high capital during the financing crisis but they faced the turmoil as they did not manage their liquidity accurately. The above liquidities are mutually reinforcing and are analyzed as below:

Funding liquidity

This is the ability of a firm to meet its short term financing ability. The bank’s liquidity position matters when it is able to fund its short-term obligations on a short notice as well as have readily available current liquid assets (Gomes and Khan, 2011).

Market liquidity

This is the ability of an agent to execute market deals without causing market disruptions such as price changes. This can be considered along various market dimensions such as resilience, depth and breath. Therefore managing this two liquidity levels would mitigate chances of facing financial crisis by the banks.

Risk level and capital requirements

During the financial crisis period, financial markets were mainly affected by the financial products like the derivatives and off-balance sheet assets. Therefore the Basel III made reforms to the capital requirements, by raising the minimum capital required in transacting for complex assets (Went, 2010).It also introduced some of the risk management measures such as moving over-the-counter contracts to centralized counterparty in order to mitigate systematic risk which may occur.

Increase in Capital ratios

The Basle Committee introduced new standards of classifying assets under a percentage of risk weighted assets. This was meant to increase resilience in the financial sector during tough economic times. It also formulated policies such as having forward looking approach in case of loss situations, having buffers to prevent loss and preventing excess growth in assets.

Supervisory Review Process

The reforms undertaken, included raising the standards of regulation and reviewing the process in case of financial crisis. This was due to the fact that Basel II had loopholes which oversaw the happenings of 2007-2008 financial crises. Review process was therefore provided to occur continually to make sure any loophole in the process is fully covered.

High Quality Assets

The committee also proposed on defining a high quality asset as a regulation method. Therefore asset quality is very important as well as the ease of selling the asset. Therefore assets should be very distinct in order to classify and regroup it when calculating risk adjustments level.

Part C

Balance sheet changes for Four Australian Banks

Nine years since the great depression, banks in Australia have regained after the after effect of the financial crisis. The banks were the most affected with most of them being fined or paying debts. According to the regulation, banks have been told to recover. The banks are supposed to improve and the balance should show stability from the previous performance. Banks are therefore encouraged to improve in their capital requirements and add value to their assets consequently. The transition period took time but eventually the banks showed improved performance from the below analysis. The big banks in Australia according to asset value were analyzed. This