and practices expanded cross-border banking, increased interdependencies between banks in different countries, intensified vulnerabilities and fuelled contagion risk. Many global banks had shifted their financing strategies, relying more heavily on market funding, and the associated liquidity disruption and shortfalls further amplified financial system fragility. Further several new and complex financial products were introduced into the markets. In many cases, the originators of these products did not fully understand the inherent risks due to the products’ complexity, or because the regulatory framework necessary to create the incentive for proper risk management were absent. In sum, all this amounted to a heady mix with disastrous consequences. The developed economies went through a massive credit expansionary phase that created an extreme imbalance between lenders and borrowers. With the economies slowing and the debt-burden mounting, borrowers are having a hard time returning the money. George G. Kaufman and Kenneth E. Scott define ‘systemic risk’ as “the risk or probability of breakdowns in an entire system, as opposed to breakdowns in individual parts or components, and is evidenced by co-movements (correlation) among most or all the parts”. Systemic risk, which drives most crises, refers to the possibility that a highly non-linear event, such as, the failure of an individual firm, will seriously impair other firms or markets and even negatively impact the broader economy with high social costs on those completely irresponsible for causing the crisis. This debilitating process could trigger a vicious cycle of eroded confidence in financial markets and regulators, stringent regulation, the expansion of the state, and move towards protectionism. But what is worse is that the financial and economic crisis is morphing into a sovereign debt crisis in advanced countries. The International Monetary Fund suggests that as much as 75% of the “fiscal stimulus” in the advanced countries comprises non-discretionary countercyclical measures. From 2008 onwards, several episodes of financial instability and volatility in market dynamics devastated the world economy. These financial risk related issues increasingly highlighted the fragility of banking and finance and stress the inter-linkages of financial markets. The vulnerability of banking sector of developing countries is starkly reflected in
macroeconomic fluctuations, excessive exposure to sensitive sector and political interference in their operations. Jerry Bowyer in a recent article (Systemic Risk Is About CharacterMar 19, 2012) has succinctly summed up “Risk is not eventdriven; risk is character-driven. Events are not the cause; events are the effect of national character”. THE EURO CRISIS Initial worries about the solvency of Greece from late 2009 stemmed from high deficits, fake budget figures and low growth. But the problem of a sovereign debt crisis, which stemmed from rising government debt levels and a downgrading of government debt of certain European states, rapidly spread from Greece to Italy, Ireland, Portugal and Spain.
Post 2009, the problem of sovereign debt increases accentuated across the European Union (EU). But these problems acquired terrifying dimensions for Portugal, Italy, Ireland, Greece and Spain (PIIGS). PIIGS are characterized by high structural deficits, odious debts, low prospects for high and sustained growth and low productivity improvements. What worsened matters was globalized finance; lax credit standards during the 2002-08 period that fostered highly risky lending and borrowing practices; global trade imbalances; grim reality of the realty and pronounced deceleration in economic growth. Apparently prudent fiscal policies could be derailed by undetected imbalances and systemic risk. Fiscal policy choices related to government revenues and expenses; and bailout approaches to troubled banking
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