Highlights on Governance ... Economic Crises and Emergence of Governance Banking Expert . Ahmed Youssef Al-Bader

From time to time, we experience huge economic and financial crises at the international level that would have catastrophic impact on all countries around the globe whether developing or developed countries. The economic and financial crises would cause several sever damages and negative effects on several levels. First: Companies and Financial Institutions, which are exposed to bankruptcy and mergers and acquisitions resulting from such crises. Second: Securities and Stock Exchange Markets, which record huge losses as the investors suspend their trading due to low prices of shares, bonds, stocks and other various financial and investment derivative instruments. Third: Currencies, which often are subject to changes in their value, due to their direct relationship with various financial and economic sectors and the different transactions of the companies. Finally, fourth: The State, which are represented in deflation, inflation and budget deficit.

Introduction to Economic Crises and Types

Based on the foregoing, it is necessary at the outset to clarify the concept of the economic and the financial crisis, and the main differences between both of them. Given the various concepts and definitions regarding the nature and concept of these crises, we will address the basic concepts for each of them. Accordingly, Economic Crisis is defined as “A situation in which the economy of a country or a region experiences a sudden downturn or imbalances”. This crisis takes three main forms, namely: First: Periodic Crisis: it is characterized by "the regularity in the occurrence and general". It is considered iterative as it affects the production, trading, consumption, accumulation, and general as it spreads across different sectors within the borders of a country and may spread to a greater level to the surrounding region. The second form is Intermediate Crisis and it is characterized by being "Limited" as it results from partial imbalances in the iterative process and affects some sectors, and often remains within the borders of the relevant country, i.e. it is not characterized with spread or expanded like the periodic crisis. The third form of economic crises is “Structuralism” and it is characterized by “reciprocity”. This crisis appears as a result of fluctuations between the mutual elements of the capital, including production and consumption. This crisis often appears in major sectors, including, but not limited to, food, energy, etc. Although this crisis is characterized by sustainability and continuity for long periods, it is not considered one of the crises that run through the different parts of economy, as the case with the periodic crisis.

Introduction to Economic Crises and Types

The financial crisis is defined as “a sudden and sharp decline of the value of the financial and in-kind assets that the financial institutions possess”. It is also defined as “sudden and sharp imbalances suffered by the economic environment, resulting in the cessation of the main activities and functions of the financial institutions, and collapse of some financial institution which negatively affect the activities of the other sectors”.

The crisis includes four main forms:

  1. Banks Crisis: This crisis results from the sudden and successive withdrawals of deposits available with banks by depositors. Accordingly, the bank fails to satisfy these transactions due to the investments it makes and the retention of a percentage thereof as they are the depository of such cash deposits for its various purposes.

  2. Debt and Credit Crisis: This crisis results from the accumulation of bad debts with banks and financing entities due to the customers’ inability to repayment in addition to the abundance of deposits while refusing to grant credit funds to customers for two main reasons. The first reason is to provide the space to settle the bad loans and the second reason is the belief that the customers are not able to pay.

  3. Currency Crisis "Exchange Rates": This crisis results from the rapid changes towards the decline in the value of the currency, which makes it ineffective in fulfilling its role as an intermediary for exchange. This decline results from large speculations in currency to achieve profit from the differences in its exchange rates.

  4. Financial Markets and Exchanges Crisis: This crisis attributes to the rapid speculative made by the investors and thus highly increasing the value of the concerned asset than its fair value in order to achieve profits from the value of this increase and not from the actual value of the asset. Given to this speculative, the investors sell their assets and thus the value of the asset is gradually decreased until decline and collapse.

Main Factors for Emergence of Financial and Economic Crises

The causes of these crises are several factors that contribute to their emergence, including financial and non-financial factors. The most prominent is that entities such as companies and financial institutions in their size and content as public, family and other forms of companies which accompanied with the emergence of modern administrative systems that focus on relations and reciprocal roles between internal and external parties to manage these various companies and institutions, and its different types. This is in addition to the emergence and development of economic and commercial globalization and the opening of the financial markets and the intertwined economies of the world’s countries. Accordingly, it resulted in the acceleration of the pace of competition between the financial institutions to make the largest share of profits and control those markets. In addition, the technological revolution and the innovated technology exploited and used by the companies and financial institutions in their activities and businesses to obtain the largest share of the profits, as well as the various financial tools, such as bonds and others upon which these companies and financial institutions relied heavily in their financing and investment operations played a substantial role in such various types of risks and increase of their dangers.

Emergence of Governance

The term governance emerged for the first time on the economic and financial levels at the end of the 1970s, when the Public Pensions Fund in the United States of America has issued its report on the corporate governance and its importance. This report included a definition of governance and a set of guiding principles for its application within the American companies. The report of the Pubic Pensions Fund was issued in conjunction with the report entitled (Role and Composition of the Board of Directors of Large Public Subscription Companies issued by the Directors of Major American Companies). The major American companies attempted to draft a legislation that limits the acquisition and merger movements between the American companies. This report further shed the light on the duties of companies’ directors and the rules that must be satisfied for the proper management of the companies, as well as the importance of rotation between the members of the companies’ board of directors. This report also addressed the huge losses incurred by the United States of America as a result of the international financial crisis during the period (1975 – 1977 AD) known as the “US Dollar” crisis that arose due to the ongoing disturbances and flections in the exchange rates of the US dollars to the foreign currencies. However, governance, during this period, did not receive the required attention and these reports did not attract the lights on its importance, as the report issued by the Pensions Fund has been subject to severe criticism, and thus the Fund has repealed hereof. However, the report remained as general instructions and controls on the practices related to the governance.

In the early 1990s, the United Kingdom followed the footsteps of the United States of America concerning its desire to highlight the importance of governance in companies and financial institutions, and its role in reducing the economic and financial crises. Government of the United Kingdom authorized Sir George Cadbury to develop the foundations for the rules of private governance in the United Kingdom in 1992, and he defined governance as "financial and non-financial control systems by which companies are directed and controlled”. The United Kingdom has taken this step following the end of the financial market crisis that has swept the developed countries of the world, starting from New York Stock Exchange to Britain and Japan during the period (1987-1989). This crisis attributed to several reasons, including the decline in the price of the US dollar in the aforementioned 1970s crisis, changes in debit/interest rate made by the European countries, and imbalances between savings and payments that happened in conjunction with the huge separations of ownership in British companies. It is worth noting that the efforts made by the United Kingdom to establish the concept of governance have been succeeded when compared to the efforts made by the United States of America, but it did not succeed in achieving the desired result towards intensifying interest in governance.

The economic and financial crises all over the world during the period (1997 – 2008), starting from the "Asian Tigers" crisis and ending with the "Subprime Mortgage" crisis, forced the manager of the central banks and international organizations specialized financial and economic business to take governance into consideration and devote the necessary effort towards its development. All countries have paid great attention to governance due to the unprecedented risks and damages it posed, which constituted blatant threats to the governments of the countries and its various entities. Moreover, one of the main reasons for the emergence of these crises include the weak management practices and the absence of appropriate control within the companies and financial institutions.

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