A Theoretical Vista on Global Recession And Causes of Global Meltdown
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International Journal of Science Technology & Management ISSN 2321-774X
Volume 1 Issue 3, 2013
A Theoretical Vista on Global Recession And
Causes of Global Meltdown
[1] Dr. Sumitra, [2] Ms. Savita Beniwal
[1]Asstt. Professor, NMGC Hansi, (Haryana), [2] Research Scholar, Commerce, Sai Nath University, Ranchi
Abstract:
An extended period of international economic downturn. Generally, the International Monetary Fund (IMF)
considers a global recession as a period where gross domestic product (GDP) growth is at 3% or less. In addition to
that, the IMF looks at declines in real per-capita world GDP along with several global macroeconomic factors before
confirming a global recession. According to the U.S. National Bureau of Economic Research (the official arbiter of
U.S. recessions) the recession began in the United States in December 2007 and became international in September
2008 and is still ongoing. US mortgage-backed securities, which had risks that were hard to assess, were marketed
around the world. A more broad based credit boom fed a global speculative bubble in real estate and equities, which
served to reinforce the risky lending practices.
Keywords: Global Recession, Global Meltdown.
Introduction:
The recession in the US is the result of lower interest rate environment which attracts large number of home buyers
to take home loans. The banks in the US started reckless lending of the housing loans event to the customers who
have lower ability to repay these loans. The new Business models were developed by the financial industry in order
to expand the funds to increase the mortgage lending. Then the mortgage lenders sell these home loans made to the
borrowers to the investment banks. Investment banks in turn sell these mortgage based home loans to the investors
as mortgage backed securities. All the parties including banks started buying and holding these securities in order to
earn higher returns. But as the interest rate starts increasing, the borrowers failed to repay the loans and ultimately
the value of these securities starts falling. The more and more borrowers started to default and the investors started
to demand their money back. This has pushed the banks to sell these securities at lower sale prices (Myers and
Sendanyoye, 2009 ). As a result of this the banks suffered huge losses, bankruptcy, were forced to merge with other
institutions in order to survive, and consequently crisis turned into disaster. Housing slump in the US and the over
use of credit cards has led the US citizens to bankruptcy, resulting into slowing down of the consumer spending
which in turn has lowered the capacity of US to import goods from different countries and thus lowered the
industrial production. Not only this, the US investors started liquidating their investments from the financial
markets. Due to this, the stock market around the world has witnessed a terrific slow down. [10] The year 2008 had
marked the end of a growth cycle of international investment that started in 2004 and saw worldwide FDI down by
more than 20% in 2008 (UNCTAD, 2009). The Americans lost their jobs and their incomes had shrunk. The
recession has driven the unemployment rate to such a lower level that was not seen since 1993. All this has an
indirect impact on the global banking sector. This situation also affected the ability of US banks to transact with the
banks in different countries. The foreign banks in the US also get affected due to the US recession. The banking
sector around the world gets affected by this global recession directly. There were reduction in jobs and salaries in
the banking sector worldwide. Many of the banks also got bankrupt due to the effects of recession of the five large
US investment banks, Lehman Brothers went bankrupt; Bear Stearns and Merrill Lynch were acquired by other
banks. Out of these five banks, only Goldman Sachs and Morgan Stanley have survived because both of these have
changed their business models since the start of the crisis. But Indian banks due to their conservative approach have
not been much impacted. The banks in India remain resilient from the impact of world's recession because of strong
financial fundamental, strict vigil on risk appetite and firm monetary guidelines. The Indian banking sectors remain
54International Journal of Science Technology & Management ISSN 2321-774X
Volume 1 Issue 3, 2013
insulated from the factors leading to the financial crisis. The Banking sector no doubt has faced the pressures of
profitability due to higher funding costs, mark-to-market requirements on investment portfolios, and asset quality
pressures due to a slowing economy. During the period of recession the global exposure of Indian banks is relatively
very small, with international assets about 6 per cent of the total assets. In the year 2009 the banking system had Rs.
36 lakh crore of deposits and Rs. 26 lakh crore of advances (Vidyakala and Madhuvanthi, 2009).The Indian banking
sector has shown high economic growth and performance in the past, low default ratio, absence of complex financial
products, time to time intervention by RBI, proactive steps for maintaining the liquidity in the market have favored
the performance of Indian Banking in recent global financial turmoil. Barring the few incidents of decline in the
business performance indicators, the huge Indian financial sector having 82 lakh crores assets and 60 lakh crore
deposit base has grown at around 12 to 15 per cent per annum and has displayed stability for the last several years,
even when other markets in the entire world and in Asian region were facing a crisis. The bank expects that the loss
due to the subprime crisis would take away nearly 9% of the yearly turnover. The present study provides a vista on
global recession and its causes worldwide.[11] In particular, the paper has evaluated that whether there is positive,
negative or no impact recession on Indian economy. The next section reviews the relevant existing literature on the
core topic in worldwide.
Literature Review:
A number of studies have conducted to study the background causes and impact of financial crisis. Whalen (2008),
reviewed the background and causes of the financial crisis and effect of the financial crisis. Labonte (2008) found
that the falling of housing prices, rise in commodity price and increase in prices of crude oil have a cumulative effect
which gave rise to the recession. The crisis hit the financial performance of US citizens, financial performance of
banks and also the financial sector jobs. The FDI world wide has slow down due to the financial subprime crisis.
The two major factor for the slowing down of the FDI's are the capability of firms to invest and the propensity to
invest, has been affected negatively by economic prospects, especially in developed countries that are hit by severe
recession. The FDI flows hit the industries like financial services, automotive industries building materials,
intermediate goods and some consumption goods (UNCTAD, 2009). [2] Marchionne (2009) illustrates the role of
banks in the subprime financial crisis, what actions they have taken in reducing leverage, and how security markets
have penalized bank equity. The weakness that are unique to the financial crisis 2007 are the transfer of assets from
the balance sheets of banks to the markets, the creation of complex and opaque assets, the failure of ratings agencies
to properly assess the risk of such assets, and the application of fair value accounting. Rakhe (2010) analyzed the
financial performance of foreign banks in comparison with other bank groups in India during 2002-03 to 2008-09.
The study indicates that access to low cost funds, diversification of income and other income to fully finance the
operating expenses are the important factors to the higher profitability of foreign banks vis-à-vis other bank groups
in India. Author expressed that efficiency of fund management, generation of other income are the most important
factor determining profitability in the banking system. However, as regards to the foreign banks, financial inter-
linkages and financial performance of parent banks are also equally important. [5] Sreeramulu (2007) study
compared the performance of modern banks (foreign and new private sector bank) with traditional banks (public and
old private sector banks) in terms of employee productivity and employee cost ratios. The study concludes that the
performance of modern banks was much superior to traditional banks during 1997 to 2008. [12] Shirai (2001)
assessed that prior to the reforms 1991, high entry regulation of private and foreign banks, the prevalence of reserve
requirements, interest rate controls, allocation of financial resources to priority sectors are the cause of financial
repression in the country. After 1991 reforms, the deregulations of deposit interest rates, deregulation of lending
rates, lower CRR and SLR, increased competition etc. have strengthened the Indian banking sector. The
privatization of banks at the right time has helped banks to show high performance and profitability. Roland (2004)
also evaluate the reforms that have occurred in the Indian banking sector by focusing on the changes in three
policies namely interest rate controls, statutory pre-emotions, and directed credit, Kumar (2007) evaluates the
55International Journal of Science Technology & Management ISSN 2321-774X
Volume 1 Issue 3, 2013
financial performance of private sector banks in India from the year 2004 to 2006. The study has evaluated the
banks on the basis of seven financial performance variables-Businesses per employee, return on assets, profit per
employee, capital adequacy, credit deposit ratio, operating profit and percentage of net Non performing asset to net
advance.[3] Trehan and Soni (2003) appraise the efficiency of the banking industry and separate those banks that
performed well from those and performed poorly. The results of the study shows that SBI and its associates are more
efficient than nationalized banks and the difference between the two groups are statistically significant. Vidyakala
and Madhuvanthi (2009) explains that the prudential norms adopted by the Indian banking system and the better
regulatory framework in the country have helped the banking system remain stronger even during the global
meltdown. The banking industry is indirectly affected due to the decrease in exports and drying up of overseas
financing. The Indian banks do not have big exposures to subprime market, thus the impact recession on the Indian
Banking sector is very small.
The existing literature revealed that the housing slump in 2007 results in the US Sub Prime crisis. And the
crisis gripped the whole world due to the trade relation of all the countries with the biggest economy i.e. United
States of America. The banking industry of all the developed as well as developing economics also gets impacted
due to the slowing down of the US economy. But the Indian bank are provided to be a promising bet due to its
conservative approach towards business and this sector does not get affected due to the global slowdown. So, by
reviewing all these literature, the study focused on the following objectives. The objective of the study is to
empirically find out the impact of recession on the Indian banking sector. [4]
Global Impact of Recession:
So far the global impact is concern; Expectations of growth rates for 2008 have fallen in most countries. In October
2007, world growth was predicted to be 4.8%. The IMF now predicts that it will be 3.7% only. Expectations for
2008 growth for advanced economies now stand at 1.4%, down 0.8 points from predictions made in October 2007.
Expectations for emerging and developing country growth in 2008 now stand at 6.6%, also down 0.8 points from a
year ago. Projections of world growth for 2009 slumped from 4.4% to 2.2%. Every G7 country aside from Canada is
expected to contract next year and the United States and United Kingdom are already in recession. Every BRIC
country (Brazil, Russia, India, and China) has seen growth expectations fall by between 1 and 3 percentage points.
[13]
Causes of Global Meltdown:
Every day the main headline of all newspapers is about our falling share markets, decreasing industrial growth and
the overall negative mood of the economy. So what has caused this major economic upheaval in the world? What is
the cause of falling share markets the world over and bankruptcy of major banks? The financial meltdown had its
origin in the US mortgage market of the early and mid-2000s. At the time, the economy was booming, the US
government was intent on making home ownership affordable to more people, financial institutions were awash with
liquidity, and real estate values were rising endlessly. Competition among mortgage lenders led to innovation –
teaser rate adjustable mortgages and other non traditional mortgage lenders led to innovation such as no and low
documentations loans that opened up the real estate market to borrowers who previously would not have qualified
for credit, i.e. subprime borrowers. All as well, provided those interest rates did not rise and housing prices
continued to escalate. In 2004 however, the Federal Reserve began to raise interest rates, in 2006, housing prices
started to taper off after rising nearly 50% between 2000 and 2006. [1] As the market declined, borrowers who had
expected to refinance their mortgages when their loans re-priced to higher interest rates coupled with higher monthly
payments found they were not able to do so. Consequently, these borrowers were unable to meet payment
requirements, leading to defaults that escalated as real estate values continued to decline. Concurrent with the
56International Journal of Science Technology & Management ISSN 2321-774X
Volume 1 Issue 3, 2013
growth in mortgage lending, significant financial innovation was occurring in the financial markets. Pools of
mortgage loans, including those extended to subprime borrowers, were aggregated into portfolios of structured
products based on the cash flows of the underlying assets- in other words these loans were securitized. These
securities were marketed to both institutional and retail investors. To enhance the marketability of these instruments,
CDS were issued, and the growth in the CDS market paralleled the growth in the underlying mortgage market.
While some of these financial instruments ended up in hedge fund portfolios, due to the significant volume of this
market and the underlying assets as well as considerable investor appetite, these instruments became widely
distributed throughout the global financial system to buyers ranging from government sponsored enterprises and
financial institutions to mutual funds/pensions funds and retail investors. Given the sponsorship of instruments and
retention of key risk components by a number of the large financial firms, concerns over the safety, soundness and
credit worthiness of a number of key market participants (including Lehman Brothers, AIG, Merrill Lynch) began to
impact the market negatively as the crisis began to unfold. Since many of the instruments involved are complex and
lack transparent market pricing, they not only are hard to price, but illiquid, further exacerbating the funding and
capital issues of a number of financial organizations. [9] A similar picture than emerged in other developed countries
as the combination of competition, innovation, readily accessible credit, and the ballooning of securitization and
resulting leverage created a massive systematic susceptibility to falls in global residential property values and
mortgage defaults, in addition to huge losses incurred on exposures to the US subprime market. News of massive
losses by institutions most exposed to such risks evolved and escalated, eventually creating a crisis of confidence
among lending banks in the money markets and increasing difficulty among banks that were most affected to raise
or refinance the short- and medium term borrowing they needed to fund their long-term assets. That lack of
confidence quickly turned into a “credit crunch” in which some banks could not fund existing loans and most banks
were unwilling to extend new credit either at all or at least on any terms resembling those on which they had
previously extended credit.
Impact of Recession on India:
Though no one likes or wants a recession But In the age of globalization, no country can remains isolated from the
fluctuations of world economy. Heavy losses suffered by major International Banks is going to affect all countries of
the world as these financial institutes have their investment interest in almost all countries. So, what is the reality for
countries like India? It would be naïve to imagine that a recession in the United States would have no impact on
India. The United States accounts for one-fourth of the world GDP and any significant slowdown is bound to have
reverberations elsewhere. On the other hand interdependencies between the US economy and emerging economies
like India and China has reduced considerably over the last two decades. Much has happened between then and now.
The Indian economy has shown a robust and consistent growth trajectory and the projection for 2008 is 9%. Indian
exports to the United States account for just over 3% of GDP. India has a healthy trade surplus with the United
States. Thus, the effect may not be as drastic as would have been the case in the 1980s. [8]
Conclusions And Recommendations:
Indian Economy
As per the RBI report, The Indian Economy continued to record strong growth during 2007-08. With adverse effect
of global recessions on Indian industry and service sector, the Real GDP growth rate of India, has declined from
9.6% in 2006-07 to 9% in 2007-08. But the overall growth of real GDP rate of the India economy during 2007-08
was noteworthy in the global context. Indian Banking industry remains resilient from the affects of the global
recession. There is a trust among the people in the country about the strength of the banking system. There are no
pitfalls in the reforms that took place in 1991 to improve the banking sector. The banks should retain their
57International Journal of Science Technology & Management ISSN 2321-774X
Volume 1 Issue 3, 2013
conservative approach towards business because its conservatism has made the Indian Banks a reliable bet for its
customers. The Banks had best used the technology and have used the manpower in an effective manner. The study
of the study shows that the bank is sufficiently equipped to absorb losses occurred due to global recession. The
Indian banks have high liquidity which shows that the banks have effective cash management system. [7][14] The
Indian Banks are professionally managed and have made them to grow faster and stronger. The study has shown that
the banks have high productivity efficient management performance and high liquidity talented employees. So to
maintain the growth of India banking industry, the paper recommends that banks should start exploiting the new
technologies to enable their employee to have more clientage in order to increase the business and profitability. To
remain competitive in this kind of environment, banks should try to retain the talented workforce with contributes
most to the profitability goals of the banks. The management should further try to control the over the expenses and
disbursement cost in order to increase the profits. The banks should focus on the risk management while expanding
its business internationally. The banks should offer the products to the customers according to their taste. The banks
should create a friendly customer environment to satisfy their customers and to retain them. Banks should have an
ability to repeat and sustain such efforts in future, which would be critical in maintaining their profitability. [6]
References :
1. Straw Will, “The Global Meltdown – A Background Brief”, Centre for American Progress, December 12,
2008.
2. Sanyal Siddhartha, “GDP Slowdown Realities”, Edelweiss Research Report, Novemeber, 10, 2008.
3. Weller Ludwig, “OECT Report: German Jobless to top 5 million in 2010”, International Committee of the
Fourth International (ICFI), April, 2009.
4. Post Liberalization Period, Presented at The 2008 World Congress on National Accounts and Economic
Performance Measures for Nations, May 13 -17, 2008, Washington DC.
5. Levine, R., Loayza, N., Beck, T. (1999), Financial Intermediation and Growth: Causility and Causes, The
World Bank, Washington, D. C. (World Bank Policy Research Working Paper 2059).
6. Mukherjee, A., Nath P. and Pal M. (2003), Resource, Service Quality and Performance Triad: A
Framework for measuring Efficiency of Banking Services, Journal of the Operational Research Society.
7. Manabendranath Pal (2003), Identification of linkage between strategic group and performance of Indian
commercial banks: A combined approach using DEA and Co-plot, The International Journal of Digital
Accounting Research, Vol. 1, No. 2, pp. 125- 152, ISSN: 1577-8517.
8. Puneet Verma and Nitin kumar (2007), A study of credit deposit ratio in selected states in western India”,
The ICFAI Journal of Bank Management Vol: 6; No. 4, pp. 31-39.
9. Rajan, Raghuram G. and Luigi Zingales (2001), The Firm as a Dedicated Hierarchy: A Theory of the
Origins and Growth of Firms, Quarterly Journal of Economics, Vol. 116, August, 805-851.
10. Rakhe P. B. (2010), „Profitability of Foreign Banks vis-à-vis Other Bank Groups in India – A Panel Data
Analysis‟, Reserve Bank of India Occasional Papers, Vol. 31, No.2, Monsoon.
11. Shanmugan K. R. and Das A. (2004), Efficiency of Indian commercial banks during the reform period,
Applied Financial Economics, Volume 14, Issue 9, 2004: 681-686.
12. Sharad Kumar and M. Sreeramulu (2007), Employees‟ Productivity and Cost – A Comparative Study of
Banks in India during 1997 to 2008, RBI Winter 2007 Issue of its Occasional Papers.
13. Statistical table related to banks in India, RBI publication, various volumes.
14. Uppal R.K. (2009), Indian Banking-Scaling New Heights in Emerging New Competition, Pakistan Journal
of Social Sciences (PJSS) Vol. 29, No. 2 (December 2009), pp. 175-188.
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