Financial Crises and Regulations

Although it is a controversial issue what the concept of crisis refers to, there is a consensus on that there exists four types of financial or economic crises in general:
• money crisis
• banking crisis
• external debt crisis
• systemic financial crisis

A speculative attack on the value of a currency is called a currency crisis, if it leads to a depreciation of the foreign exchange reserves or a significant rise
in interest rates in order to prevent the depreciation of the currency.

A banking crisis arises when the actual or potential bank failures prevent banks from fulfilling their obligations, or when the government is forced to intervene to prevent this failure.

An external debt crisis occurs if an entity cannot pay the foreign debts, whether it is a government or private sector.

On the other hand, systemic financial crises are defined as financial distortions that have significant effects on the real economy by preventing the efficient functioning of financial markets.

Financial crises are usually caused by the following factors (Mishkin and Eakins, 2012):
• Mismanagement of financial liberalization
• Asset Price bubbles or booms, meaning market prices of assets realized above
economic values
• High uncertainty, usually following economic downturns or stock market crashes
• Current account deficits
• Budget deficits
• Excessive borrowing of government
• Excessive borrowing of businesses
• Vulnerability or fragility of banking industry

The effects of financial crises, in general, may include:
• Economic downturn
• Deterioration of cash flows
• Decline of lending
• Deterioration in the balance sheets of financial institutions
• Deterioration in the balance sheets of businesses
• Currency crises
• Rises in debt burdens
• Bank failures
• Company failures
• Increased volatility in financial markets
• Rises in inflation and interest rates
• Rises in unemployment

Dutch Golden Age
The name given in the Dutch history between the years 1585-1702. In this period, the Netherlands became one of the world’s leading countries of science,
commerce and art.

18. Century is called the era of stock market balloons. The first two famous stock market balloons are:
• the South Sea Company (UK), which was based in the UK, and
• the Mississippi Company (Project), which was based in France.

The Great Depression is the name given to the economic depression that started in 1929 and continued throughout the 1930s.

Declines in stock prices led to significant macroeconomic problems such as:
• diminishing credits,
• closure of workplaces,
• firing of workers,
• bankruptcy of banks,
• declining money supply,
• other economically detrimental events.

There were various solutions to the global debt crisis: Baker’s plan, Brady’s plan, legal and political regulations and debt-equity changes.

Ponzi finance is a type of financial fraud based on the principle of continuous fund raising from newcomers to the system.

Financial crises are associated with four deadly D (economic downturns, revenues down, debt, downgrade).

In October 1929, a great economic crisis started in the US and affected all the world. During this era the financial industry did not exist in Turkey yet. Turkish economy was mainly based on the agricultural sector. Yet, at the advent of the 1929 great depression, the agricultural sector had collapsed due to taxes, primitiveness and the damage caused by the war. During the crisis, due to the intense imports of minorities and lowering prices of agricultural products, Turkey had a relatively high level of foreign trade deficit and the value of the Turkish lira decreased rapidly.Additionally, the first installment payment of the debt inherited from the Ottoman Empire became due. As a result of these undesirable developments, an economic crisis broke out in the country.

The main reasons for the 1994 and 1998 crises were (BDDK, 2010).:
• existence of the unsustainable debt burden in an economic atmosphere, where there was high and volatile inflation and unstable growth performance
• structural problems, especially financial markets, which could not be resolved
permanently

The 21 February 2001 crisis, which was also a foreign currency crisis, was mainly caused by high increases in the current account deficit.

Regulatory frameworks in regarding financial institutions utilize:
• Disclosure requirements (disclosure of financial statements and relevant information)
• Deposit insurance
• Capital requirements
• Supervision
• Assessment of risk management
• Restrictions on competition

The main objectives of imposing financial regulations are as follows (Llewellyn, 1999):
• to sustain systemic stability,
• to maintain the safety and soundness of financial institutions,
• to protect the consumers.

The Committee’s first meeting took place in February 1975, and meetings were held regularly three or four times a year since.

The Basel Committee consists of senior representatives of bank supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, Netherlands, Sweden, Switzerland, United Kingdom and the United States.

Tier 1: A term used to describe the capital adequacy of a bank. Tier I capital is core capital; this includes equity capital and disclosed reserves.

Tier 2: A term used to describe the capital adequacy of a bank. Tier II capital is
secondary bank capital that includes items such as undisclosed reserves, general loss reserves, subordinated debt of five years.

The main objective behind the introduction of the Basel II Accord was to narrow the gap between regulatory capital requirements and the economic capital produced by the banks’ own internal models.

The proclaimed features of Basel II and its differences from Basel I are the following (Moosa, 2015).:
• BaselIIincludes a “moresophisticated”measurement framework for evaluating capital adequacy;
• Basel II is not only about capital adequacy, but also about improving risk management in the finance industry by providing the correct incentives for better corporate governance and fostering transparency;
• In Basel II, an explicit weight is assigned to operational risk;
• Basel II is more risk-sensitive than Basel 1;
• Basel II allows a greater use of internal models for risk assessment and the calculation of regulatory capital.

Unlike Basel I, which had one pillar (minimum capital requirements or capital adequacy), Basel II has three pillars:
• Minimum regulatory capital requirements;
• The supervisory review process;
• Market discipline through disclosure.