Global Financial Crises and Their Impact on Corporate Strategy

 

Global Financial Crises and Their Impact on Corporate Strategy

❖ Introduction

• Definition of financial crisis: A situation where financial assets lose a large part of their nominal value rapidly.
• Types: Banking crisis, currency crisis, debt crisis.

❖ Key Historical Financial Crises

1. The Great Depression (1929)

The Great Depression was the worst economic crisis in modern history, beginning in 1929 and lasting through the 1930s. It led to massive unemployment, bank failures, and a global economic collapse.

 

Major Causes of the Great Depression

• Stock Market Crash of 1929:
• In October 1929, the U.S. stock market collapsed after years of speculative trading.
• Millions of investors lost their savings, leading to a sharp decline in consumer and business confidence.
• Overproduction and Underconsumption:
• Industries and farms produced more goods than people could afford to buy.
• This caused prices to fall, profits to shrink, and companies to lay off workers.
• Bank Failures:
• Many banks had invested depositors’ money in the stock market.
• After the crash, thousands of banks collapsed, wiping out people’s savings and reducing money circulation.
• Decline in International Trade:
• The U.S. Smoot-Hawley Tariff Act (1930) imposed high taxes on imported goods.
• Other countries retaliated, causing global trade to fall dramatically.
• Unequal Distribution of Wealth:
• A large portion of national income was concentrated in the hands of a few.
• The majority of people had low purchasing power, weakening overall demand.
• Poor Monetary Policy:
• The Federal Reserve failed to provide enough money supply and credit after the crash.
• This worsened deflation and deepened the economic downturn.
• Speculation and Easy Credit:
• During the 1920s, people borrowed heavily to invest in the stock market.
• When stock prices fell, they couldn’t repay loans, causing widespread defaults.

Summary:

• The Great Depression was caused by a combination of economic imbalances, financial mismanagement, and loss of confidence, beginning with the 1929 stock market crash and spreading across the world.
• Triggered by stock market crash in the US
• Global trade and employment collapse
• Lesson: Need for market regulation and central bank roles

1. Asian Financial Crisis (1997)
• Started in Thailand, spread across Asia
• Weak corporate governance, high foreign debt

The Asian Financial Crisis began in July 1997 in Thailand and quickly spread to other Asian economies including Indonesia, South Korea, Malaysia, and the Philippines. It led to sharp currency devaluations, stock market crashes, and severe recessions across the region.

Major Causes of the Asian Financial Crisis (1997):

1. Excessive Short-Term Foreign Borrowing:
• Many Asian countries borrowed heavily in foreign currencies (mainly U.S. dollars).
• When their local currencies weakened, it became difficult to repay these debts.
2. Fixed or Pegged Exchange Rates:
• Several countries kept their currencies pegged to the U.S. dollar.
• When the U.S. dollar strengthened, their exports became expensive and less competitive, leading to trade deficits.
3. Weak Financial and Banking Systems:
• Banks gave out high-risk loans without proper checks.
• Poor regulation and lack of transparency made financial systems vulnerable.
4. Real Estate and Stock Market Bubbles:
• Easy credit led to over-investment in real estate and stocks.
• When these bubbles burst, asset prices fell sharply, triggering panic.
5. Speculative Attacks on Currencies:
• Investors lost confidence in regional economies and started selling Asian currencies.
• This led to massive currency devaluations (especially Thai baht, Indonesian rupiah, and Korean won).
6. Current Account Deficits:
• Many countries imported more than they exported, leading to large balance-of-payments deficits.
• This made them dependent on foreign capital inflows, which dried up during the crisis.
7. Investor Panic and Contagion Effect:
• Loss of confidence spread quickly from one country to another.
• International investors withdrew funds from the entire region, worsening the crisis.

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Summary:

The Asian Financial Crisis was caused by over-borrowing, weak financial systems, fixed exchange rates, and loss of investor confidence, resulting in a chain reaction of currency collapses and economic downturns across Asia.

 

3. Global Financial Crisis (2007-2008)

Global Financial Crisis of 2007–2008 was the most severe economic crisis since the Great Depression. It originated in the United States due to the collapse of the housing market and widespread defaults on subprime mortgages. Financial institutions had bundled these risky mortgages into complex financial products, such as mortgage-backed securities (MBS) and collateralized debt obligations (CDOs), which rapidly lost value when borrowers began to default. Major investment banks like Lehman Brothers collapsed, while others such as AIG and Bear Stearns required massive government bailouts. The crisis led to a global credit freeze, steep declines in stock markets, widespread job losses, and economic recessions around the world. Governments and central banks responded with emergency measures, including interest rate cuts, stimulus packages, and bailouts to restore financial stability. In the aftermath, significant regulatory reforms were introduced, such as the Dodd-Frank Act in the U.S., to improve oversight and prevent future crises.

The Global Financial Crisis (GFC) of 2007–2008 was the most severe economic downturn since the Great Depression. It began in the United States housing market and quickly spread worldwide, leading to the collapse of major financial institutions, stock market crashes, and global recession.

Major Causes of the Global Financial Crisis:

1.     Housing Bubble and Subprime Mortgages:

o   Banks issued subprime loans (high-risk home loans) to borrowers with poor credit histories.

o   Housing prices rose rapidly (a “bubble”), and when they started to fall, borrowers defaulted on their mortgages.

2.     Excessive Risk-Taking by Banks and Financial Institutions:

o   Banks used complex financial instruments like mortgage-backed securities (MBS) and collateralized debt obligations (CDOs) to repackage risky loans and sell them to investors.

o   These products were highly leveraged and poorly understood, increasing systemic risk.

3.     Failure of Financial Regulation:

o   Regulators failed to monitor banks’ excessive risk-taking and inadequate capital reserves.

o   The “shadow banking system” (investment banks, hedge funds, etc.) operated with little oversight.

4.     Securitization and Globalization of Risk:

o   Financial institutions worldwide bought U.S. mortgage-backed assets.

o   When U.S. housing prices collapsed, losses spread globally, affecting banks in Europe and Asia.

5.     Overconfidence in Credit Ratings:

o   Rating agencies (e.g., Moody’s, S&P) gave high ratings (AAA) to risky mortgage securities.

o   Investors trusted these ratings, unaware of the underlying risks.

6.     High Leverage Ratios:

o   Financial institutions borrowed heavily to increase profits.

o   When asset prices fell, they couldn’t cover their debts, leading to insolvency.

7.     Collapse of Major Financial Institutions:

o   Iconic firms like Lehman Brothers went bankrupt, while others (e.g., AIG, Bear Stearns) required massive government bailouts.

o   This led to panic and loss of confidence in the global banking system.

8.     Global Interconnectedness:

o   Financial markets were tightly linked, so the crisis quickly spread from the U.S. to Europe and the rest of the world.

Summary:

The Global Financial Crisis was caused by risky lending practices, financial deregulation, excessive leverage, and the collapse of the U.S. housing bubble, resulting in a worldwide economic meltdown.

• Subprime mortgage collapse in the USA
• Collapse of Lehman Brothers
• Bailouts of major banks and automakers
• Shift toward tighter banking regulations (Basel III)

 

❖ Impacts on Corporate Strategy

• Risk Management Focus: Greater focus on financial risk mitigation
• Capital Restructuring: Companies reduce debt levels
• Cost-Cutting Measures: Downsizing, divesting non-core assets
• Diversification: Spreading investments across regions/sectors
• Cash Flow Planning: Strong focus on liquidity

 

Financial Technology (FinTech) and Digital Transformation

❖ Definition of FinTech

• The integration of technology into offerings by financial services to improve their use and delivery.

❖ Key FinTech Innovations

• Mobile Payments: Easypaisa, JazzCash, PayPal, Apple Pay
• Robo-Advisors: AI-powered financial advice (e.g., Betterment)
• Blockchain & Cryptocurrency: Bitcoin, Ethereum, use in decentralized finance (DeFi)
• InsurTech: Online platforms for insurance
• Crowdfunding & P2P Lending: GoFundMe, LendingClub

❖ Impact of FinTech

• Speed & Efficiency: Real-time transactions
• Financial Inclusion: Reaching the unbanked
• Cybersecurity Challenges: Data privacy risks
• Disruption of Traditional Banks: Rise of neobanks
• Cost Reduction: Automation reduces operational costs

❖ Examples

• HBL Konnect (Pakistan): Expanding access to financial services
• Revolut / NayaPay: Digital-only banks changing banking norms

❖ Discussion

• Are FinTechs replacing traditional banking or complementing it?

Sustainable Finance and ESG Investments

❖ What is Sustainable Finance?

• Financial services integrating environmental, social, and governance (ESG) criteria into decision making.

❖ ESG Defined

• E – Environmental: Climate change, carbon emissions
• S – Social: Labor standards, human rights, diversity
• G – Governance: Transparency, board structure, ethics

❖ Why ESG Matters?

• Increasing investor awareness
• Regulatory requirements (e.g., EU Taxonomy)
• Long-term profitability and lower risk exposure

❖ ESG Investment Tools

• Green Bonds:

Definition:
Green Bonds are fixed-income securities issued to finance environmentally friendly projects — such as renewable energy, clean transportation, waste management, or climate adaptation. The key feature is that the raised funds are exclusively used for projects with positive environmental impacts.

 

Key Features:

1. Purpose-Driven: Funds must be used for specific green or sustainable projects.
2. Transparency: Issuers often report how the funds are allocated and what environmental benefits result.
3. Same Structure as Regular Bonds: Investors receive periodic interest payments and repayment of principal at maturity.
4. Certification: Many Green Bonds are verified under frameworks like the Green Bond Principles (GBP) or certified by organizations such as the Climate Bonds Initiative (CBI).

 

Types of Green Bonds:

1. Use of Proceeds Bonds: Funds used for specific green projects.
2. Green Revenue Bonds: Repayment comes from revenues of the green projects.
3. Green Project Bonds: Investors directly invest in specific green projects.
4. Green Securitized Bonds: Backed by assets that generate environmental benefits (e.g., solar energy receivables).

• Sustainable ETFs (Exchange-Traded Funds):
• Definition:
  Sustainable ETFs are investment funds that focus on companies or assets meeting certain environmental, social, and governance (ESG) criteria. These ETFs aim to provide investors with financial returns while promoting sustainability and ethical business practices.

 

• Key Features:
• ESG Screening:
  Investments are selected based on how well companies perform in areas like environmental protection, social responsibility, and corporate governance.
• Diversification:
  Like other ETFs, sustainable ETFs provide exposure to a broad range of companies or sectors, reducing individual company risk.
• Transparency:
  Holdings are publicly available, allowing investors to see exactly where their money is invested.
• Low Cost:
  Many sustainable ETFs have relatively low management fees compared to actively managed mutual funds.

 

• Types of Sustainable ETFs:
• Environmental ETFs: Focus on renewable energy, clean water, or pollution control.
• Social ETFs: Invest in companies with strong labor practices, diversity, or community engagement.
• Governance ETFs: Target firms with ethical leadership, transparent management, and fair shareholder treatment.
• Broad ESG ETFs: Combine all three (E, S, and G) factors.

Impact Funds:

Definition:
Impact Funds are investment funds designed to generate measurable positive social and environmental impact alongside a financial return. Unlike traditional funds that focus solely on profit, impact funds seek to solve real-world problems—such as poverty, education, healthcare, renewable energy, and climate change—while still providing returns to investors.

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Key Features:

1. Dual Objective:
• Financial return
• Measurable positive impact on society or the environment
2. Measurable Impact:
   Impact is tracked using indicators such as SDGs (Sustainable Development Goals) or other recognized metrics.
3. Broad Scope:
   Includes investments in both developed and developing markets, targeting sectors like health, education, clean energy, microfinance, and sustainable agriculture.
4. Long-Term Vision:
   Focuses on sustainable outcomes rather than short-term profits.

 

 

Types of Impact Funds:

1. Social Impact Funds: Target improvements in social outcomes (e.g., healthcare, education, housing).
2. Environmental Impact Funds: Focus on clean energy, water conservation, or biodiversity.
3. Blended Impact Funds: Combine both social and environmental goals.

 

❖ Global Trends

• BlackRock: World's largest asset manager shifted to ESG
• Pakistan’s Green Bond initiative

❖ Benefits of ESG Investing

• Positive brand image
• Reduced legal and reputational risk
• Long-term value creation

❖ Criticism of ESG

• Greenwashing: Misleading ESG claims
• Lack of standard metrics for ESG performance

 

📝 Suggested Readings:

• "The Big Short" by Michael Lewis (for 2008 crisis)
• OECD Reports on FinTech
• BlackRock’s ESG Investment Strategy
• Financial Times & World Economic Forum blogs