The Global Financial Crisis

Courses Info

Level: AS Levels, A Level, GCSE – Exam Boards: Edexcel, AQA, OCR, WJEC, IB, Eduqas – Economics Revision Notes

This refers to the decline in World GDP in 2008-2009
Before the Global Financial Crisis, asset prices were high and there was a boom in economic demand
There were risky bank loans, borrowers had poor credit histories and many households defaulted on their mortgages
Consequently, banks had lost huge funds and required assistance from the government
Banks may struggle to provide depositors with money on demand if there are insufficient funds in a vault or they lose money on investments
Interest rates were at 5% in 2008
Government borrowing increased as they received less government revenue (tax)

In an attempt to increase consumer spending, the government implemented the Fiscal Policy and reduced VAT from 17.5% to 15%
Interest Rates were also cut to 0.5%
Banks employed a program of Quantitative Easing
At first, £75bn was injected into the economy, however the current amount of injections i the economy is £375bn

Borrowers had poor credit histories due to risky bank loans and high asset prices
In the US, many home owners defaulted on their mortgages shortly in 2007
Consequently, banks had lost huge funds and required assistance from the government
Banks were not aware of how risky the loans were and hence there was asymmetric information
There are now tougher requirements that need to be met to get a loan or mortgage from a bank as banks have become risk averse

A moral hazard is when there is a risk that the borrower performs an action making them less likely to repay a loan, however this action may not be ethical or desirable in the eyes of the lender
This is likely to occur when there is some form of insurance
If banks know they have support from the government or the Bank of England, they may choose to take more risks
Due to the degree of risk taking, the Financial Crisis has been deemed as a Moral Hazard
Negative Externalities exist in Financial Markets in the form of systematic risks

Market Bubble – these occur when the price of an asset is expected to rise significantly, causing an excess demand
Since demand outweighs supply for the asset, the price rises beyond the market value
When the price falls back to its original market value, the bubble then ‘bursts’
Investors try to sell their assets and there is a loss of confidence, leading to economic decline

Governments use regulations and guidelines to regulate banks as it helps to ensure the behaviour or banks is clear to other firms / banks / individuals who do business with banks

Banks are regulated by:

Financial Conduct Authority – regulates banks to ensure they are honest to consumers and aim to protect consumer interests. They also promote competition
Prudential Regulation Authority – promotes safety and stability of banks / investment firms / other financial institutions. Protects policyholders
Financial Policy Committee – ensures a stable financial system and regulates risk in banking

Quick Fire Quiz – Knowledge Check

1. Explain what happened during the Global Financial Crisis in 2008 (6 marks)

2. Explain some of the policies the government implemented to help the economy during / after the Global Financial Crisis (4 marks)

3. Identify and explain three contributing factors to the Global Financial Crisis (12 marks)

4. Identify and explain the three main regulators of banks (6 marks)

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