Impact of the Financial Crisis on Banking Sector The current financial crisis, which started in the Unites States, has dominated the headlines all around the world since summer 2007. The world has been experiencing one of the most severe crises such as the Great Depression from 1929. This started as a subprime crisis with problems in the subprime mortgage market in the USA in 2007 which spread throughout the world.

This subprime turmoil turned soon to a global financial crisis and turnaround to a worldwide recession (Calomiris, 2008). The effect of the financial crisis resulted in problems in the financial systems of many countries.The objective of this paper is to get an overview of the impacts of the current financial crisis on the banking sector in main regions of the world and also its impact on different industries. In this section some background information of the current financial crisis on banking sector will be discussed.

The subprime mortgage market has experienced a boom in the United States during the last few years because of the attractive mortgage loan terms. In addition, subprime mortgage borrowers were a new market for banks in the USA even though in the U. K. , larger mortgage loans were made available.Furthermore, homeowners borrowed more money against their homes to fund holidays, car purchases, home extensions and second homes etc.

Second homes might be holiday homes or homes bought to let with the intention of making more money as house prices rose. In addition, lenders such as Northern Rock even loaned more than the value of the property. This boom ended with the start of the current financial crises. In addition, there were a lot of hidden risks and failures in the mortgage market like the liquidity risk, credit risk, and interest rate risk which makes the banking sector vulnerable (Calomiris, 2008).

Figure 1: U. S. and European Bank and Insurance Company Market Capitalization, Writedowns, and Capital Infusions According to Figure 1, the impact of financial crisis on banking sector is very harsh. Since the beginning of the crisis, market capitalization of global banks has fallen by more than 50 percent from $3.

6 trillion to $1. 6 trillion. The following subsections provide an overview of needy banks in different regions: First, after the primary indication of liquidity crisis in August 2007, the U. S. anking sector got strong signals in which successively, banks have closed down. In March 2008 the US problems at investment bank Bear Sterns hit the headlines.

In addition, the Northern Rock was the first bank which seeks and receives a liquidity support from the Bank of England. Afterwards in January 2008, this bank became nationalized. Furthermore, the U. S.

government takes over Fannie Mae and Freddie Mac. In addition, there was a big shock when Lehman Brothers Holding filed for bankruptcy protection (Anonymous, 2008).In other major events include the acquisition of Merrill lynch by Bank of America Corporation and partial nationalization of Fortis holding and lot of undeclared large loses in financial markets worldwide over September and October 2008. There are 58 small regional banks which have failed since January 25th, 2008 (Fletcher, 2009). The situation of US banking sector can easily be analyzed by the following chart in which the non-borrowed reserves show sudden negative trend for the first time since these statistics have been kept (Chernlawski, 2008).

Figure 2: Non-Borrowed Reserves of Depository Institutions On the one hand, does it mean that US banking sector have not enough reserves even for its own stability and operations? On the other hand, the U. S. government says that the largest U. S: banks are strong enough to survive the recession, even if it gets worse.

Federal Reserve Chairman Ben Benmnke said that nearly all the banks that were evaluated have enough capital to absorb the higher losses envisioned under the hypothetical adverse scenario (Kurata, 2009).The same crisis situation also appeared in United Kingdom? s banking sector. The first target was the Northern Rock, medium sized British based bank (Anonymous, 2007) as mentioned above, this bank received a liquidity support facility from the Bank of England and later on it is nationalized. In other U.

K. based failed banks are HSBC Holding PCL, Royal Bank of Scotland, Barclays Plc, HBOS Plc, Loyds TSB Group Plc, Alliance & Leicester (Anonymous, 2008).In the first stage of crisis UK based banks also showed that they have adequate capital to absorb potential losses but after September 2008 major banks declared their losses one by one because there was a sudden increase in the number of borrowers defaulting on loans due to decreased in commercial and residential property prices. Moreover, banks asked for help from the government to stop the further losses on lending. The government has taken to improve banks capital positions. As a result, the government injected capital to some banks in the shape of bailout packages.

According to Bank? Credit Conditions Survey in April 2008 reported an intention to increase the availability of corporate and secured household credit over the following three months. Governments’ actions should provide some support to lending over the coming year. In return for access to the APS, Royal Bank of Scotland and Lloyds Banking group, each of these banks made a lending commitment. In addition, Northern Rock has been directed by the government to no longer reduce its mortgage book. In contrast, Barclays and HSBC have announced an intention to expand their net lending to businesses and households over the coming year.

In Europe the situation was not different from U. S. and U. K.

since the start of the global financial crisis because all major European countries are integrated with United States in business. In addition, the major Swiss bank UBS was involved in the U. S asset backed securities (subprime exposures) balance sheet. The consequences of U. S. were automatically diverted to European economies.

All European banks which were affected from the financial crisis on banking sector are mentioned as follows: The Unicredit SPA in Italy; ING Group N. V. , Rabobank, ABN AMRO Holding N. V. n the Netherlands; Credit Agricole S.

A. , Societe Generale, Natixis, BNP Paribas and Groupe Caisse d’Epargne in France; Fortis and Dexia S. A. in Belgium; UBS AG and Credit Suisse Group in Switzerland; IKB Deutsche Industriebank AG, Deutsche Bank AG, Bayerishe Landesbank, Landesbank Baden-Wurttembert, WestLB AG, Dresdner Bank AG, HSH Nordbank AG, DZ Bank AG, Landesbank Scahsen, Commerzbank AG, and Hypo Real Estate Holding AG (Erlend, 2009). Figure 3: Developed Europe: Bank Losses According to Figure 3 (Q2 2008), all major European countries are cruelly affected from the current financial crisis.Especially, U.

K. with a total loss of $61. 3 billion, Germany with a total loss of $56 billion, Switzerland with 54. 3 billion, France with $25.

1 billion, the Netherlands with a total loss of $12. 1 billion, Belgium with $10. 8 billion, and Italy with a total loss of $2. 4 billion. In Germany, for instance, the government-supported Landesbanken are the location of some of the most severe losses (Calomiris, 2008). The current global financial crisis did not much affect the Asian Economies.

That is because in Asia there is a smaller presence of foreign anks. This is an evident from the fact that the share of banking assets held by foreign banks in these economies generally lies between 0 and 10 percent (Rakesh, 2008). Even though China which is an emerging market and almost every big company are doing business there, but for some reason the Chinese banking industry is not deeply integrated with the global financial market, and therefore the current financial crisis did not much have an impact on the Asian economies. It has had limited direct exposure to the subprime crisis (Liu, 2008).

In the UAE? financial sector, including national and international players, they have been profitable now and in the past. They are capable to absorb the losses if they have any, because of their huge reserves. UAE banks are relatively less dependent on external financial markets (Anonymous, n. d.

). The banking crisis has also consequences in almost all sector of the economy. Especially the production sectors, this implies, for example an increase of unemployment or cut down the working hours, consumer spending decreases, tight credit conditions and lower financial wealth.These lead to decline business and dwellings investment. In addition there is a decrease in demand of traded manufactured goods especially in the car industry. One of the factors underlying the crash in world trade flows is that, during the current downturn, the trade-intensive elements of demand have been most affected.

For instance, demand for capital good, motor vehicles and other consumer durables have fallen across many countries, like in Europe, United States and Japan (Anonymous, 2009). According to Figure 4 the world trade in goods and the world industrial production has weakened significantly.In addition, travel industry has also suffered from the financial crisis. Furthermore, the result of the high price of crude oil increased the cost for transportation such as airplanes, trains, cruise, and bus. The British travel industry had to suffer from the financial turmoil when tour operator Travelscope and carrier MAXjet Airways collapsed at the end of 2007 (Nikolis, n.

d. ). Figure 4: World industrial production and world trade in goods The U. S.

Federal Reserve reported industrial production plunged 2. percent in September, the steepest decline since 1974. Another report by the Philadelphia Federal Reserve on factory activity in the mid-Atlantic eastern region indicates also an extremely weak condition. The index plunged 41 points to minus 37. 5, the worst level since 1990 (Anonymous, 2008). The world is facing one of the most severe financial crises, a crisis of confidence, of capital, of credit, and of consumer and business demand.

Almost every country around the world is developing plans of stability to come out from this crisis.Without financial stability banks are unable to provide credit for new ideas in business, no opportunities for new jobs, no possibility for new housing credit and so on. According to IMF (2009), there are three priorities to stabilize the financial sector. First, ensure that the banking system has access to liquidity. Second, identify and deal with impaired assets.

Third, recapitalize weak institutions that are viable and resolve from nonviable banks (IMF Global Financial Stability Report April 2009).To summarize, we can assert that the financial crisis has a huge impact on banking sector. For some years now, the banking sector and industries are currently experiencing a major shock, caused by problems in the subprime mortgage market, which spread to securitization products and credit markets more generally. Banks are being asked to boost the amount of risk that they absorb and so they increased lending to the subprime market at rapid rates. The resulting effects on the housing market are having easier access to mortgages which increased demand and prices.When interest rates started to rise to combat inflation, defaults in the subprime market rose.

In addition, as the defaults grew, the liabilities of banks to the debt which had been built up increased. The losses that the banks have suffered limit their capacity to absorb these risky assets. Therefore, banking crisis occurs which led to a sharp reduction in interbank lending as credit dried up. The result is a tight credit along with the collapse of the housing market fed through to the real economy and unemployment began to rise and economic activity to slow.Furthermore, market capitalization of global banks has fallen by more than 50 percent and so banks successively have closed down or need financial help not only in the U.

S. but also in Europe, Asia and nearly all over the world because all major countries are integrated with United States in business. The consequences which occur in the United States were automatically diverted to the world economy. Therefore, most economies of the world experienced recession by 2008 and every country is drawing plans of stability to come out from this crisis.