Friday, March 20, 2009

Central Banks to the rescue! – Practice or theory? –European perspective

In a classic classroom theory on banking industry, when commercial banks experience difficulties, they can always refer to the central bank for assistance. This is why the central bank is often called on as the lender of the “last resort”

It is therefore conceivable, that the current world economic crisis present an ideal platform for the central banks to fulfill their theoretical banking obligations. However, many commentators, economists and analysts are against such bail outs.. and perhaps for a good reason.

Taking both sides into account, how can we make sense of the “Pulson’s Plan” with a 700 billion dollar injection into the US banking system in order to rescue various institutions from their financial woes.?

The basic problem for the current banking system is the fact that they have lost the trust of their clients. Clients distrust banks and other financial institutions in fear of discovering more “skeletons in their closets” (bad credits) or other financial instruments based on (among others) real estate debt.

The whole process which led to this financial crisis was based on financial institution ‘A’, giving real estate loan/credit to family B, taking real estate as collateral and security for their loan. The financial institutions were less interested in financial ability of B to service such credit facilities. When B (and millions of others) suddenly became unable to repay the credit, the effect was one of a chain reaction, which pulled in larger and larger victims.

The fore-mentioned “Pulson’s Plan” and injection of the $700+ billion dollars into US financial system actually causes more chaos, which is stirred up by the very same recipients of the funds which have initially been responsible for the current state of affairs. The ‘plan’, did not cater for assistance for the basic level credit recipient, who is the primary spark of this global chaos.

The financial crisis is well and truly here. Europe was not immune either. The news is full of European banks that are in financial trouble and are being rescued by individual governments or their affiliated central banks. E.g. Hypo, Fortis, etc.

A new question is borne: Is the European Union able to combat this latest financial crisis as a union, or will all of the individual countries, deal with their own problems? Well, Europe isn’t able to act as a single body; therefore it is more susceptible to be effected by various problems of a global nature. At the same time, it is the very lack of European single-mindedness which underpins the power of the European Union. The example of such is Fortis Bank, where three of the European countries (Belgium, Holland and Luxemburg) injected over 11 Billion Euro for its rescue.

Its becoming apparent, that the role of the central bank, will not therefore be the role of the lender of the “last resort” as it is in the case in EU, it will continue to be a loose union between several countries with common monetary policy, leaving national issues to be dealt with on a national level as it is the case with policies of migration, financial crashes, global warming/green issues as well as international trade and politics.

by: Andrew Ochudzawa