Impact of Financial Crisis on the United States’ Banking Sector
The 2007-2008 crisis also referred to as the global financial crisis affected the banking sector across the world in many ways and the US banking sector was not spared. Over the short term period, the crisis affected the banking sector in several ways. Several banks incurred huge losses because of the increased default rate as people and businesses were unable to repay their loans. Mortgage defaults were very high making the banking sector to enact legislation to curb the spread of the crisis. The crisis caused the interbank lending sector to freeze with credit to consumers and businesses drying up. Such impact reduced the transactions within the banks causing massive losses of money and employment. The closing of some banks following the financial crisis was widely blamed on the lack of preparedness by the sector to enact regulation, especially on lending policies. The problems affecting the United States banking industry necessitated the enactment of regulations to cushion further sinking of the industry (United States, 2011). For the longer term, the financial crisis influenced the banking sector by spawning new regulatory action in the international arena through the Basel II, and in the United States through the Dodd-Frank Wall Street Reform and Consumer Protection Act.
Before the financial crisis occurred in 2008, regulations that were passed in the United States had pressured the banking industry to extend lending to consumers to buy homes. Many foreign banks in the country bought the collateralized U.S. debt as the subprime mortgage. This credit was sold to other investors across the world. The increasing numbers of the defaulting consumers in the United States on mortgage loans affected the sector significantly. Banks stopped lending to each other, and the situation became dire for other consumers as well as businesses to acquire credit. This situation also happened after the financial crisis since banks were not ready to start lending in large quantities at a go (United States, 2011). Banks were still recovering from the losses and the bad debts suffered due to high default cases. As a result, the banks were not in a position to advance loans to their creditors.
As a matter of intervention, Dodd-Frank Act was enacted and passed in the year 2010. This Act introduced stringent regulations in the United States banking sector. The Act required bank holding companies having assets worth more than $ 50 million to abide by strict standards of capital and liquidity. The Act set new restrictions on incentive compensation. This legislation also led to the creation of a Financial Stability Oversight Council, which included the Federal Reserve Bank as well as other agencies for coordinating the regulation of larger banks (Macdonald, 2012). Additionally, the Orderly Liquidation Fund was established to offer financial assistance towards the liquidation of the large financial institutions falling into trouble.
In addition, to highlighting the vulnerabilities of the individual banking institutions, the financial crisis exposed the systematic weaknesses that banks in the United States, which had seemed to be detrimental to the economy. Since then the system has undergone a marked change concerning the regulations due to the increased effort of the broader role of policy making in improving the financial stability. These changes, however, often come at a cost. For instance, there exists a tradeoff between the liquidity and capital requirement and the degree to which the banking sector meets the purpose of facilitating the economic activity (Macdonald, 2012). The severe burden that was placed on the banking industry also acted as an incentive for risk-taking activities as a way of transitioning the after crisis banking sector.
The 2008 financial crisis brought about a dramatic shock in the stability of the country’s economy. There were high and massive activities in policy making to reform the financial rules of the country. These rapid changes had a significant effect on the financial system of the country. For instance, the requirements that banks should have a sufficient loss-absorbing capital ensured that the financial institutions remain more resilient if a future crisis occurs. Such conditions may work well for the larger banks, which leaves the smaller banks in a struggling position because of the significant resources required (United States, 2011). In this regard, the small banks took time to recover and acquire increasing performance trend in the face of an economy where a few large banks control the banking sector.
On a positive side, the regulations that came after the financial crisis has transformed the financial system and its impact will be experienced for an extended period. The most tremendous of these impacts is the increasing growth of the capital markets and securitization interwoven with the traditional banking system. The impact of the legislation fell on other sectors and mostly the non-banking financial institutions. By extension, the changes in other areas were a result of the financial crisis and the transformations that happened and still happening in the banking sector (Batten & Szilagyi, 2011). Although the immediate effects were negative and harmful to the industry, the reforms that resulted from the crisis have assisted in creating a stronger banking sector in the country.
As a conclusion, the banking industry was among the most affected sectors, especially due to its roles in enhancing business operations. As a result of the crisis, some vast and small banks were facing turbulent times that were threatening their existence, and even some collapsed. As a result, the government has introduced new regulations aimed at restoring sanity and cushioning the industry from future crises. The reforms in the industry are still taking place, and they have played an imperative role in the resumption of stability in the industry.
References
Batten, J., & Szilagyi, P. G. (2011). The impact of the global financial crisis on emerging financial markets. Bingley, U.K: Emerald.
Macdonald, R. (2012). Genesis of the financial crisis. Hampshire: Palgrave Macmillan.
United States. (2011). The financial crisis inquiry report: Final report of the National Commission on the Causes of the Financial and Economic Crisis in the United States. Washington, DC: Financial Crisis Inquiry Commission.
