Lessons from 2008 global financial crisis: Ensuring financial stability

Our financial system was not directly affected by the global financial crisis in 2008 which shook the financial system of Europe and America.  
The financial system of Bangladesh is not isolated. The banking sector of the financial system is linked with all other banks in the world due to overseas banking transactions. So, the crisis arising from the banking sector or any scandal in the banking sector anywhere in the world may adversely affect the banking sector everywhere in the world due to interconnectedness. The performance of other sectors under the financial system like capital market, insurance, private equity and venture capital, micro finance, cooperatives etc. of any country in the world also indirectly affect other countries. The crisis in such sectors in a country may affect some economic activities like imports, exports, productivity, government revenue and expending, employment generation, inflation, gross domestic product (GDP) etc. of every country. But the crisis in the banking sector arising out of any banking scandal in a country may affect directly the banks of other countries instantly.
What did happen in 2008 during the global financial crisis? The main causes of the crisis in 2008 are: (i) the collapse of the US sub-prime mortgage market and the reversal of the housing boom, (ii) some financial products and instruments, especially derivatives and securitisation, have become so complex and twisted that trust in the whole system started to fail, and (iii) around the world stock markets fell, large financial institutions like Lehman Brothers, Washington Mutual Funds and three Iceland banks (Glitnir, Landsbanki and Kaupthing) etc. collapsed or were bought out, and governments in even the wealthiest nations had to come up with rescue packages to bail out their financial systems.
Why did it happen so?  
(i) Macroeconomic policies: Defective fiscal policies and monetary policies of advanced economies, especially in the USA, Japan and other countries within the euro area, fuelled the global credit boom leading to price bubbles in securities and housing sectors.  
(ii) Financial-sector supervision and regulation: It was a shadow (unregulated) financial system like money market, mutual funds, special purpose investment vehicles, hedge funds, private equity firms, etc. due to a lack of prudent compliance.
(iii) Managing risk creates more risk: Risk-managing securities like derivatives and securitisation created more risks and affected adversely the financial systems, and
(iv) Overleveraged global financial system particularly in the USA: Dramatic failure of corporate governance and risk management led to creation of financial engineering as indicated above, which overleveraged the market.
When confidence waned, funding dried up and structures collapsed. So, the crisis that incurred in 2008 did not arise from banks and financial institutions and that is why our banking system was not hampered instantly. But the risk is not over. If the crisis continues, the existing countries or others will find no prompt solution to the problem that will affect the international business as well. As such, the economic activities and the banking dealings with any foreign bank may run the risk of a crisis.
What is stated above is like setting fire to our home, as there is a chance that it will keep spreading, unless it can be controlled. Under the circumstances we should work in two ways. Firstly, we should keep an eye on the global crisis and prepare policy response to enhance and sustain our strength to absorb a shock, if any. Secondly, we should strengthen our financial system and bank with other banks in the world carefully. The financial crisis occurred in 2008 in the USA and other countries in Europe. If it occurred here in Bangladesh, the banks of those countries might have stopped dealings with our banks citing the risk factor. What we can learn from the crisis are:
(i) To control and regularise any easy consumer loan commensurate with the income and the cost of living. Due to availability of consumer loans including credit cards, the people tend to use such loans for consumption without any plan on payment or saving capacity. It has no value addition services and unduly it may create the price boom.
(ii) To ensure financial inclusion for value addition services for the sake of economic and social development.
(iii) To ensure the quality of assets through proper and due diligence while an investment is made, valuation of securities at a fair value and management of assets and liabilities of banks and financial institutions and to maintain the required Capital Adequacy Ratio (CAR).
(iv) To prohibit and not to allow securities like derivatives on subprime mortgage of houses having no substantial fair value of underlying assets or a company having no technical qualification by Bangladesh Securities and Exchange Commission (BSEC) to raise capital from the capital market.
(v) To make conservative fiscal and monetary policies.
(vi) To regulate any shadow banking system like private equity and venture capital strictly for ensuring a proper discipline so that the banking sector does not tend to invest in any private equity fund considering the less regulation.
(vii) To control a volatile market with a policy and its implementation, ensuring the role of mutual funds and bringing in more mutual funds to make the market vibrant and comparatively steady.
(viii) To ensure macro-prudential and micro-prudential policies upon review of circumstances.
(ix) To strengthen corporate governance practices both in the financial sector and in the listed and non-listed companies sucking money from any financial system.
(x) To ensure the central bank's onsite and offsite proactive supervision of day to day operation.
In assessing the financial stability in 2012, the World Economic Forum (WEF) ranked Bangladesh 37th out of 62 leading financial systems in the world. India was ranked 46th, Pakistan 50th and Sri Lanka was not in the list of the world's 62 financial systems. So, in the financial system stability ranking Bangladesh is in a good position. But the deterioration in quality portfolios and securities may threaten the banking sector and the capital market respectively. The Bangladesh Bank (BB) introduced stress testing for all banks and financial institutions to find out the shortage of Capital Adequacy Ratio (CAR) and take necessary actions or to relinquish the capital, if necessary. The Financial Stability Department of the BB works to ensure financial stability through overview of banking regulations along with micro prudential policies. The BB formulates and implements a cautious and restrained monetary policy and is advising appropriate macro-prudential policies like fiscal and foreign exchange policies to control the financial stability. The BSEC is now formulating regulations for private equity and venture capital. These regulations should be investment-friendly but protect the interest of stakeholders. Close supervision of the BB and prompt micro and macro policy responses are essential for sustainability of the financial system.
The writer is an Associate Member of ICAB and Head of Finance of Venture Investment Partners Bangladesh Ltd. (VIPB).
 roy_dipok@yahoo.com