Government borrowing during a crisis period and the contribution of credit risk to the Global Financial Crisis

Government borrowing takes place when a country is experiencing crisis. Government borrowing refers to the total amount of money that the government borrows by issuing securities, bills, and bonds. The money borrowed by the government fills the gap created by the difference between a country’s revenues and expenditure. A government can borrow money either from foreign lenders, or from lenders locally (Mankiw 2009, p.287).

During a crisis period, there is usually a sharp increase in the level of government borrowing. This causes debt managers in a country to shift or adjust the maturity structure of fresh government borrowing towards a shorter maturity term. There is also an increase in issuance of debts paid in the short-term. At a crisis period, it is very likely that the government’s monetary policy will interact with the public debt management and these results from an increase in debts in the short term. During this period, either the sovereign debt managers prefer to operate at medium or long-term, though it is very likely that government borrowing can interfere with the transmission mechanisms of the government’s monetary policy. If the government relies heavily on short-term borrowing, such as cash management bills and treasury bills, the yield curve gets distorted especially if there is a thin market. This would consequently jeopardize the monetary policy together with other transmission mechanisms eventually causing serious complications to the welfare of the public (Saunders & Allen, 2010 p.38).

Looking at the contribution of credit risk to the Global Financial Crisis, a good number of financial services companies focus more on liquidity while ignoring credit risk, which is the basis for the current financial crisis. Credit risk has forced many banks to limit on individual funding, and focus more on wholesale funding. Considering the fact that credit risk in the past was confined to direct lending sectors and commercial banking, a good number of investment banking firms have increased their level of participation in various financial markets. This has consequently helped such firms to spread risk thereby reducing the negative effects of the global financial crisis (Saunders & Allen, 2010 p.38).

The contribution of credit risk to the Global Financial Crisis can also be understood easily by looking at countries such as America, Russia, and Brazil, which at one time experienced financial crisis. In America, the financial crisis resulted to an increase in bonds to liquidity risk, while Brazil recorded a reduction of credit risk in relation to the overall premium risk. However, it is worthy to mention that the global financial crisis has had significant effects on the global trade. The crisis has reduced the global trade and at the same time led to the closure of many financial institutions leading to increased cases of unemployment. In an effort to avoid financial crisis, many countries have embarked on controlling their financial activities, developed appropriate strategies for managing risks, while monitoring other activities that are likely to put a country at a financial crisis (Saunders & Allen, 2010 p.39).

In conclusion, it is true to say to say that the global financial crisis as diminished the financial liberalization support, and at the same time strengthened the government role in different countries especially in dealing with economic affairs. Given the various roles played by financial institutions, it is evident that the global financial crisis causes serious complications not only to the global issues, but also to the globalization itself.

References

Mankiw, N. G. (2009). Principles of macroeconomics. Mason, OH, South-Western Cengage Learning.

Saunders, A., & Allen, L. (2010). Credit Risk Management In and Out of the Financial Crisis New Approaches to Value at Risk and Other Paradigms. Hoboken, John Wiley & Sons.