Essay, Thesis

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1Introduction
1.1Importance of the issue

Global Financial Crisis of 2007-2008 has been the worst since the Great Depression in the 1930s.The financial crisis has had a profound effect, much more than that anticipated by many. The national borders have been breached and the ramifications are still being felt far from the epicentre. Although the global economy is recovering, the confidence in the markets is still weak as market participants are looking for a direction which is by no means straight forward.

Mr. Jean Claude Trichet (President of the European Central Bank) opines that “financial crises share some commonalities. In particular, crises are associated with the emergence of euphoria and complacency in financial markets, typically supported by rapid credit growth and a growing belief that new concepts like financial innovation or technological advances have rendered old limits on economic performance obsolete.” [1]

At the same time Trichet acknowledges the fact that each crisis is also unique. Every crisis has its own characteristics which make it different from the previous ones. In order to avoid the next crisis it is essential to understand the causes and mechanisms behind the current crisis. Every crisis takes its own course in the financial system and affects specific sectors more than others.

As is the common perception, government regulations follow the crisis. Regulatory bodies analyse the events specific to the crisis and try to bring down formal regulations which would avoid a similar crisis in the future. After witnessing trillions of dollars of losses, high unemployment rates and company bankruptcies, national governments are pressurised and are expected to take immediate and concrete actions that restore the market confidence. But often, regulatory bodies come out with regulations which are not the optimal solution. These regulations can be more than required or sometimes, in political pressure emphasise on matters that are not the actual causes of the debacle.

The aim of this thesis is to understand the financial crisis, its causes and the regulatory policies that have come up to avoid a next financial crisis. There has been lot of discussion on the miscreants that spawned the crisis. This thesis also tries to identify the ‘Achilles Heel’ of the financial crisis of 2007-2008.

In order to have more checks on the identified devils of the financial crisis, new regulations have been proposed or introduced in almost all the countries. This thesis tries to understand the new regulations that have come up in the US and the European Union. Also, it tries to identify the similarities and differences in the approaches of regulatory bodies in the two regions. Assessment and impact of these regulations is also discussed. Every regulatory body invites public comments to consult the new regulations. These comments help us to identify the sentiments and views of different market participants. Analysis of these comments is also presented.

1.2Methodology

This thesis uses a lot of information available from various books on financial crisis, conferences and panel discussions, blogs and newspaper articles, websites of central banks and various regulatory bodies.

To start with, the definition of the crisis helps us to have a literal understanding of the term ‘financial crisis.’

In order to understand the causes of the crisis we need to understand the past events that moulded the current crisis. They include the financial landscape existing before the crisis, working of the global financial system and the shadow banking system. The thesis looks at the evolution of the financial system in the past two decades and links it to the development of the current financial crisis. Literature review of the financial systems of various countries along with understanding of general economic cycles was done.

The concept of ‘shadow banking system’ and ‘mortgage equity withdrawal’ has been explained...
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