The world economy has been hit by a severe financial crisis, resulting in the worst global economic downturn for over 60 years. Triggered by difficulties in the housing market that exposed the way that banks and other lenders had been underestimating real risks for too long, the crisis quickly spread throughout global financial markets destabilising banking systems around the world. As a result, the impact has spread beyond the financial system, hitting economic growth, prosperity and jobs throughout the world.
This document for H M Treasury sets out the Government’s analysis of the causes of this financial crisis, the action already taken to restore financial stability and the regulatory reforms necessary to strengthen the financial system for the future, so that consumers, businesses of all sectors and the economy as a whole continue to have access to the stable credit, essential for future growth, investment and innovation. It argues that the crisis has been caused by the failure of the banking sector across the world, to understand the true risks created by the innovation and rapid growth of interconnected, globalized markets for financial services in recent years. The firms that have failed in the typically allowed their businesses to become overextended through: excessive leverage and risk taking; over-reliance on wholesale funding; overdependence on particularly risky product streams, such as buy-to-let mortgages or derivatives; or poor management decisions in respect of acquisitions.
As a result, Government intervention has been necessary to: protect depositors in banks and building societies; enable banks to continue to lend to the economy during the recession; and to restore financial stability. In the Budget 2009, the Treasury estimated that the cost of Government action could eventually be as high as £50bn. But the costs of Government inaction would have been far higher, as a modern economy cannot function without a stable banking system. The way firms manage risk, the quality and quantity of capital they hold, and the way regulators monitor firms need to change. Further regulations on how banks operate globally are also necessary in order to prevent global financial crises from recurring in the future.
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