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EFFECTS OF GLOBAL ECONOMIC MELTDOWN ON BANKING INDUSTRIES IN NIGERIA

CHAPTER ONE

INTRODUCTION

1.1. Background of the Study

The world is in the midst of a economic crisis which threatens a worldwide economic recession. The ‘Credit crunch’ as it has come to be known brought panic and turmoil in the summer of 2007 to the world’s economic markets causing the United States’ housing market bubble to burst. The crisis threatens a worldwide economic recession, potentially bringing to a halt more than a decade of increasing prosperity and employment for western economies and potentially wiping a staggering $1 trillion off of the value of the world economy. The global economic crisis started as a economic crisis in the United State of America in 2007. It has it root in credit contraction in the banking sector due to certain laxities in the US economic system. The crisis later spread to Europe and now has become a global phenomenon. The economic crisis at the early stage manifested strongly in the sub-prime mortgages because households faced difficulties in making higher payments on adjusted mortgages .

Accordingly, Aluko as referenced in noted that this development led to the use of credit contraction by economic institutions in the US to tighten their standards in the light of their deteriorating balance sheets. Like all previous crisis much literature has once again been written about the causes of current crisis. Many economists and commentators have highlighted the causes of credit crisis due to lack of proper regulation, legislation and transparency [4-6]. In addition, economic institutions stopped lending and recalled their credit lines to ensure capital adequacy. Furthermore, this credit crunch has also highlighted the fragility of capitalism and the free-market economy, as the fallout from the credit crunch and the wider economic crisis continues, demands for alternatives are certain to grow.

Historically, banks used only the money they received from depositors to lend to borrowers. They were not able to obtain money from other sources other than depositors. However, in recent years, banks have been able to rely not only on depositors but also on the wholesale money markets, where they could borrow money from other banks and then resell it to their borrowers at a higher interest rate. This secondary market was in part made possible by the creation of “credit default swaps” (CDSs). These allowed a bank to effectively insure itself against the risk that a borrower might not pay back a loan. This led to an illusion that loans were now much lower risk and allowed such loans to be bought and sold. This then led to the creation of collateralized debt obligations (CDOs), which were bought by banks as interest-bearing investments.

According to Goodhart & Charles the sub-prime lenders then invented another way of making money in a sector which was already highly risky. Many lenders wanted to ensure they did not lose out on possible money making opportunities in the sub-prime market and they developed a number of complex products. This was achieved by breaking down the value of the sub-prime mortgage market. In the name of the securitization, debt was sold to a third party, which would then receive the loan repayments and pay a fee for this privilege.

The economic crisis has proven very clearly that the apparent strength of modern economic markets was illusionary. The happy-go-lucky mood evaporated instantly, with the write down of losses accompanied by the sackings of executives and

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