Vol 7 (2010) - Issue 1

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The Global Financial Crisis: Implications for Finance and Financial Regulation

1. Introduction

During 2008, for the first time since the 1930s, the world economy experienced a systemic financial crisis: on 18 September, the international financial system was on the precipice of collapse and global credit markets essentially ceased to function for the following four weeks. While the ultimate economic impact of the global financial crisis is still unfolding, following a series of dramatic events including the failure of major financial institutions and significant government interventions in the financial system around the world, it is now unlikely that either the global or any major domestic financial system will collapse, causing the onset of an economic depression of the sort unseen since the 1930s. The causes of the global financial crisis are now generally understood, however, and major initiatives are underway around the world to reform financial regulation, with far reaching consequences for the future of global finance.

2. Underlying causes

As is often the case with financial crises, many of the underlying factors leading to the global crisis of 2007- 2008 arose from responses to previous crises. In this case, certain underlying factors date as far back as the design of the US financial regulatory system in the Great Depression of the 1930s. However, the most important elements developed primarily from reactions in the 1980s and 1990s to the 1980s developing country debt crisis and the 1990s Asian financial crisis.

One of the underlying causes of the global crisis was a divergence between domestic regulatory structures and the realities of global finance. This was most acutely the case in the United States but also in the European Union and the United Kingdom among others. In the context of the United States, one must look back to the previous major systemic financial crisis and resultant economic collapse: the 1920s and the Great Depression of the 1930s. In addition to its economic interventions, the Roosevelt administration also initiated the wholesale redesign of the US financial system through legislation and regulation. With certain changes, this regulatory system continues to exist. However, the financial and economic environment in which it operates has changed completely, not least as a result of globalisation, technology and complexity. As can be seen, the complexity of this system was certain to produce overlaps and gaps: these were to be brought dramatically to light in 2008.

In 1983, the global financial system experienced its next major episode of systemic risk, but one that did not lead to a systemic crisis in international financial system: the Developing Country Debt Crisis. This crisis essentially destroyed the capital base of the world’s largest international banks and led developed country governments (led by the United States and the United Kingdom) to develop a new internationally agreed minimum capital standard, the Basel Capital Accord of 1988.