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Question: How bank lending can decrease substantially over the course of an economic and financial downturn and how monetary policy can react to this situation

13 Oct 2022,3:03 AM

 

Write an essay on how bank lending can decrease substantially over the course of an economic and financial downturn and how monetary policy can react to this situation in the light of following questions: -

Using the observations over the Global Financial Crises, discuss critically how credit risk of corporates can lead to a higher external finance premium and how this can further impair the financial intermediation. Support your discussion with specific examples from countries and data.

- Using specific examples from different countries, discuss critically the potential role and effectiveness of different monetary policies to mitigate the decline in financial intermediation during economic and financial downturns. Support your discussion with specific examples from countries and data.

- Critically assess the relevance of monetary policy responses to Covid period in supporting bank lending channel in the economy. Support your discussion with specific examples from countries and data.

Expert answer

 

During an economic and financial downturn, bank lending can decrease substantially. This happens because businesses and consumers are less likely to borrow money when the economy is doing poorly. This can lead to a decrease in the amount of money that banks have to lend, which can cause a credit crunch.

 

Monetary policy can react to this situation by increasing the money supply. This can help to increase lending and improve the economy.

 

Fiscal policy can also be used to help the economy during a downturn. The government can increase spending and cut taxes to try to stimulate the economy.

 

It is generally agreed that the Global Financial Crisis (GFC) was caused by a number of factors, including over-leveraging, poor risk management, and misguided government policies. However, one of the most important underlying causes of the crisis was the credit risk of corporations.

 

As businesses took on more and more debt in order to finance their operations, they became increasingly exposed to credit risk. This credit risk led to a higher external finance premium, which made it more expensive for businesses to borrow money. This in turn impaired the financial intermediation process, as banks and other financial institutions became less willing to lend money to businesses.

 

The GFC highlighted the importance of credit risk in the financial system. It also showed how credit risk can lead to a higher external finance premium, which can further impair the financial intermediation process. This highlights the need for effective risk management in the corporate sector.

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