Insurance and Reinsurance Finance Assignment

Insurance and Reinsurance Finance

Significance of study case
The study of financial crisis is very important as it helps in knowing about various risks. The
financial industry is the largest liquid market in the world that adds GDP of any country. The
banking industry in the USA supports the largest economy of the world with concentration on
private credit. The global financial collapse of 2007-2008 was considered as the worst financial
crisis since the Great Depression. It was a breakdown of trust and faith in the financial system
mainly caused by subprime lending and mortgaging. The government sponsored companies’
encouraged subprime loans to low-income buyers. Increased lending, low interest rates promoted
homeownership which resulted in creating the housing bubble (Randazzo and Young). The
primary cause of financial crisis was deregulation in the financial industry which can be
classified as follows.
Leverage
Excessive leveraging was at the center of all banking crisis. Leverage went beyond balance
sheets and the use of derivatives magnified the impact of downturn
Market risk
The banks incurred losses due to interest rate risk, equity risk, currency risk and commodity risk.
Potential losses were incurred due to fluctuation in interest rates, stock price, international
currency exchange rates and fluctuations in agriculture, industrial, metal, energy and gas
commodities (Amadeo).
Liquidity risk
Due to cash crunch, bank could not carry out day-to-day transactions. There was long lending
and short borrowing.
Operational risk

This risk is caused by failed internal processes, human errors, inadequacy in systems and losses
incurred due to improper processing of information, leaking or hacking information.
Systemic risk
The global risk of 2008 was a systemic risk which affected the whole financial industry
(Gangreddiwar).
The market instability dried up the circulation of money and slowed down the buying and selling
of assets resulting in collapse of Lehman Brothers. The housing bubble crashed, people lost faith
in banking system and borrowing skyrocketed resulting in declaring bankruptcy.
Conclusion
The global financial crisis demonstrated the breakdown of trust in the financial system. Around
the world financial institution like Lehman Brothers and others collapsed, some were bought out
and even the wealthiest nations had to bail out the financial institutions from bankruptcy. The
global financial meltdown affected the livelihoods of people, increased unemployment, and
traumatized the whole financial system of the world. The collapse of subprime mortgage market
created ripple effect around the globe. When people smelled something is fishy, they lost
confidence, lending slowed, assets plummeted so lenders wanted their money back but with no
secured retail funding, some financial institutions collapsed dramatically very quickly. This
problem was so large that new capital was injected in banks to run them but this was not enough
to restore the lost confidence.
In brief, the global financial crisis had foundation on bad theories, misunderstanding, bad
statistics, over confidence, and finally greed. Derivatives, hedge funds, credit default swaps and
related instruments were used to take more risk and make money quickly. In simple words, the

market became speculative in nature just like gambling. Each loss incurred resulted in more
betting and more risk taking to make up for the losses and this led to destruction of the banking
system. In a globalized system, credit crunch was so severe that it rippled through the entire
global economy creating global economic crisis (Shah).
References
Amadeo, Kimberly. "Here's How They Missed The Early Clues Of The Financial Crisis." The
Balance. 2018. Web. 2 May 2018.
Gangreddiwar, Aboli. "8 Risks in the Banking Industry Faced By Every Bank." MEDICI. 2015.
Web. 2 May 2018.
Randazzo, Anthony, and Carson Young. "What Caused the Meltdown: A Financial Crisis
FAQ." Reason Foundation. 2010. Web. 2 May 2018.
Shah, Anup. "Global Financial Crisis." The Global Village. Klett Sprachen, 2010. 23. Web. 2
May 2018.