There was a sudden rush for bank credit from the various sectors of the economy and there were perceptions of credit crunch. Moreover, in view of incomplete pass-through to domestic petroleum prices in the first half of 2008-09 (before the sharp correction in international crude oil prices), there was a large demand from petroleum companies for bank credit. For almost similar reasons, other companies also had a large resort to bank credit. Reflecting these factors, growth in non-food bank credit accelerated to around 30 per cent by October 2008. Nonetheless, there was a perception that there was credit crunch during this period, which could be attributed to a large decline in non- bank sources of funding.
The influence of interest rates on the speculative component of asset prices is unclear from both a theoretical and empirical perspective, Kohn, (2008). In the context of the current global financial crisis, with deleterious impact on growth and employment and significant fiscal costs, the issue of relationship between monetary policy and asset prices needs to be revisited. It can be argued that the output losses of a pre-emptive monetary action might have been lower than the costs that have materialized from a non-responsive monetary policy. At least, a tighter monetary policy could have thrown sand in the wheels and could have reduced the amplitude of asset price movements. As asset prices bubbles are typically associated with strong growth in bank credit to certain sectors such as real estate and stock markets, pre-emptive monetary actions could be reinforced by raising risk weights and provisioning norms for sectors witnessing very high credit growth. For both monetary and regulatory actions to be taken in tandem, it is important that both functions rest with the central banks. In this context, the recent trend of bifurcation of monetary policy responsibility from regulatory responsibility appears to be unhelpful (Mohan, 2006b)). On balance, it appears that pre-emptive and calibrated monetary and regulatory measures would be better than an inertial monetary policy response. Such an approach can help in mitigating the amplitude of the bubble in both the upswing and the downswing of the cycle and contribute to both macroeconomic and financial stability. This view seems to be gaining ground. As the IMF in its recent assessment notes: “Central banks should adopt a broader macro-prudential view, taking into account in their decisions asset price movements, credit booms, leverage, and the build up of systemic risk. The timing and nature of pre-emptive policy responses to large imbalances and large capital flows need to be re-examinedâ€, IMF, (2009b).
It thus appears that the sharp swings in monetary policy, especially periods of prolonged accommodation, in the advanced economies are the underlying causes of the ongoing global financial crisis. While until recently, the “Great Moderation†since the early 1990s – reduction in inflation and reduction in growth volatility – had been attributed, in part, to the rule-based monetary policy, it now appears that that volatility in monetary policy can also have the side-effect of creating too much volatility in financial markets and financial prices, which can then potentially feed into the real economy with dangerous consequences, as indicated by the ongoing global financial crisis.
A legion of both policymakers and scholars are at work analyzing the causes of the crisis and finding both immediate and longer term solutions (For example, the de Larosiere Report (2009), the Turner Review (2009), the Geneva Report (2009), the Group of Thirty Report (2008).
What I will attempt to do is to provide my interpretation of the unfolding of the present global financial crisis; how it is affecting us; why the Nigeria financial sector has been able to weather the crisis relatively well; the analysis of our policy response; and, finally, some implications of its longer lasting effects.
Also as emphasized by Greenwald, B and Stiglitz,(1988), Bemanke, and Gertler(1995), a sharp decline in the stock market, as in a stock market crash can increase adversely selection and moral hazard problems in financial market because it leads to a large decline in the market value of firms net worth. (Note that this decline in assets values could occur either because of expectations of lower future income streams from these assets or because of a rise in market interest rates which lower the present discounted value of future income streams).
In addition, the decline in corporate net worth as a result of stock market decline increase moral hazard incentives for borrowing firms to make risky investments because these firms now has less to lose if their investment go sour. Because borrowers have increased incentives to engage in moral hazards and because lenders are now less protected against the consequences of adverse selection, the stock market decline leads to decrease in lending and a decline economic activity.
Bernanke and Gertler (1995) pointed it out in their paper titled “Debt market also play a role in promoting financial crisisâ€. Existing survey of credit view, an important transmission mechanism of monetary policy a rise in interest rates and therefore in households and firms interest payment decrease firms cash flows, which causes deterioration in their balance sheets. As a result, adverse selection and moral hazard problem becomes more severe for potential lenders to these firms and households, leading to a decline in lending and economic activity. There is an additional reason why sharp increases in interest rates can be an important factor leading to financial crises.
According to Greenspan (2008), negative shots to bank can take several forms. We have already seen how increases in interest rates, stock market crashes and anticipated decline in inflation (for developed countries), or an unanticipated depreciation or devaluation (for developing countries with debt denominated in foreign currencies), can cause a deterioration in non-financial firm’s balance sheets than make it less likely that they can pay their loans back. Thus, these factors can help precipitate sharp increases in loan losses which increase the probability of bank insolvency.
Stiglitz (2008) in ‘The Guardian’ on America financial systems failed in its two crucial responsibilities managing rise and allocating capital. The industry as a whole has not been doing what it should be doing, and it must now face change in its regulating structures.
