• The Bank of Japan announced that, in a step similar to that taken by various European governments, it would supply banks with unlimited amounts of dollars at a fixed rate against appropriate collateral in an effort to bolster liquidity in the market. 
  South Korea said it would use its foreign exchange reserves to help with loans.
• Australia announced it would guarantee all bank deposits for three years and guarantee wholesale funding to Australian banks in an attempt to combat the global credit crisis. 
• China announced a major stimulus plan to offset slowing global growth.

Even the oil-rich Middle East has felt the impact of the crisis.

Even in jurisdictions where banking systems themselves were not impacted significantly by the crisis, there is growing concern about the likely impact of the crisis on exports to the United States and Europe and how that may soon affect these jurisdictions.

How have the main European public bodies and regulators reacted to the crisis?
Reactions to the financial crisis are taking a variety of forms that can be grouped into two broad categories: emergency and structural responses. 

Emergency responses typically have been effected on a national level since each crisis was unique to the financial structure of the country, as were the remedies. However, common principles of approach have emerged, with various national variations, based on a combination of injecting equity into institutions in return for various commitments, providing liquidity support, guaranteeing retail deposits and underwriting interbank lending.

There have been calls for the creation of a single European financial regulator that would watch over the continent’s biggest banks, and a pan-European bailout fund to rescue them. Thus far, however, European countries have been unable to agree on a pan-European rescue fund. 

Should we expect additional legislation related to the financial crisis?
In the United States, both additional consumer protection and regulatory reform legislation will be debated in 2009. Many other jurisdictions also are likely to consider regulatory reform but it will take some time before draft legislation is produced, particularly if the outcome is a more consistent global framework.

Why did the U.K. government decide to inject capital directly into the U.K. banking system?
The U.K. authorities determined that the injection of capital directly into the system, along with providing additional loans and loan guarantees to its banks, were necessary to stabilize the market. The U.S. government and other European governments subsequently followed suit.

What conditions did H.M. Treasury impose on the U.K. banks that opted into the government’s capital plan?
The U.K. banks that have agreed to participate in the government’s capital plan will grant the U.K. government a capital stake and will commit to limitations on executive compensation and the payment of dividends until the government’s capital is repaid.

Is the crisis likely to impact the application of the Market in Financial Instruments Directive (MiFID) in Europe?
Not directly. MiFID is concerned mainly with enhancing the European single market in securities trading and in ensuring minimum standards of investor protection across Europe in relation to sales and trading practices. It does not cover capital, solvency or liquidity rules, or – in any detail – risk management requirements. These are dealt with by the separate revised Capital Adequacy Directive, based on Basel II. However, the impact of consolidation of major banking and securities players on competition, new perspectives on the suitability and appropriateness of complex securities for investors, counterparty risk as a relevant factor in choice of execution venues, and the MiFID requirements on internal control, compliance management and conflicts of interest are all examples of MiFID issues that will need to be reconsidered in light of the consequences of the current financial crisis.

How has the financial crisis affected the U.S. dollar’s role as the world’s main reserve currency?
Despite many predictions in the earlier days of the economic crisis that the U.S. dollar would lose its role as the world’s designated reserve currency, it has surged against most major currencies in recent months. This may seem ironic and counterintuitive to anyone who recalls how previous financial crises devastated local currencies. The explanations provided for this phenomenon are varied, but most seem to hinge on a combination of the theory of lesser evils – there’s just nowhere else to invest that isn’t also suffering the impact of the crisis. There is a view that since the U.S. dollar was the first to fall, it will be the first to recover, and there also is a concern that the European response has not been coordinated, thereby adversely affecting the euro.  

Beyond participating in and engineering rescues of large financial services companies, have governments done anything else to try to settle the markets?
Governments globally have undertaken a variety of actions to try to address the effects of the economic crisis. These have included, but are not limited to, guaranty programs for deposits and mutual funds, prohibitions against short-selling of financial company shares, loan guaranty programs for small businesses and other affected industry sectors, and direct capital injections into financial companies and companies in other hard-hit sectors.

What is the magnitude of the actual and proposed economic stimulus packages from countries around the globe?
In addressing the recessionary economic conditions globally, the governments of many countries either have already approved or proposed spending billions of dollars to jumpstart their economies with an intent to foster a turnaround in recessionary market conditions. Among the largest of any government stimulus plan is the recently passed U.S. $787 billion stimulus. 

How does the new U.S. $787 billion plan rank among other U.S. government programs or initiatives?
To put the United States’ $787 billion stimulus plan into perspective:

How has the crisis impacted European countries?
The crisis has severely impacted banks in European countries in a number of ways that are not dissimilar to the impact on U.S. banks. The effects include:

• >Major writedowns and losses on holdings of U.S. subprime securitizations and other related subprime assets;
• Losses on assets arising from the downturn in property values (residential, in particular) in their own countries; and
• Funding difficulties as a result of the freezing of global interbank money markets, resulting in significant liquidity problems. Many institutions have funding mismatches, which means they have to refinance large parts of their balance sheets every quarter. During periods of market uncertainty, banks are reluctant to lend. As a result, an institution with a large funding mismatch can find it difficult to attract funding.

Similarly, Europe is being affected by economic recession and fears of deflation and depression, marked by a series of high-profile businesses going into administration, such as – in the United Kingdom – Woolworths, MFI and Waterford Crystal/Wedgwood.

What is the estimate of the cost to the U.S. government of dealing with the financial crisis?
According to a report published by CNN, as of January 2, 2009, the U.S. government has allocated US$10.8 trillion to rescue the economy, of which US$2.1 trillion has already been spent.  Included in these amounts are, among other things, costs associated with the problems of the financial services and automotive industries, as well as the extension of unemployment benefits.

How is the credit crisis affecting the financial strength of governments?
State and local governments in the United States have been affected significantly by the crisis. As 2009 began, governors from five states (New York, New Jersey, Massachusetts, Ohio and Wisconsin) asked the federal government to provide US$1 trillion in aid to help the country’s 50 states pay for education, welfare and infrastructure as they deal with growing budget deficits and a deepening recession.  This request came on the heels of the worst year for municipal bond financing since 1999, with the sale of long-term bonds down 9 percent in 2008 and expected to fall another 6 percent in 2009.  With the passage of time, the economic woes of state and local governments have continued to grow.

In addition, we have seen more and more countries, including Pakistan, Hungary, Iceland and the Ukraine, turn to the International Monetary Fund for assistance as their economies are affected by the crisis.

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Up next...Updates to previous segments and Part 7: The Role of Fraud in the Crisis

To read other installments in this series: Protiviti Financial Crisis Series FAQ Home Page

To view the full Protiviti bulletin: The Current Financial Crisis: Frequently Asked Questions