Reflection on the World of Finance

World has seen many financial sector turmoil in past, be it Black Friday (September 24, 1869), Wall Street Crash of 1929, Japanese asset price bubble, 1997 Asian Financial Crisis, 2008 Financial Crisis, or the latest Dubai debt crisis. Always financial sector turmoil has triggered a re-examination of the existing theories and metrics about the financial sector developments of the past. Questions are being asked and answers being sought to some of the key issues regarding leverage, transparency, and liquidity underlying at the heart of the crisis.

What the current crisis has done is to question the very fundamentals of the entire financial framework. Instead of looking at the long term perspective markets are driven more by the myopic behaviour such as greed and fear. There seems to be a high correlation in all assets class during the crash. Each crash has seen the herd behaviour driven by sentiments.

We live in age of turbulence and it is becoming a routine today. Today changes are accelerating and surprises are increasing, both unpleasant and pleasant ones. There are many risk which are causes of these turbulences and together they multi fold to become even large. One has to move fast with these changes by trying to understand them. One has to understand the risk like

* Country Risk: A collection of risk associated with investing in foreign countries.
* Systemic risk: Risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system.
* Credit Risk: A Risk of counter party failure.
* Market risk: A small possibility of losing large.
* Liquidity risk: A risk growing from the lack of marketability of an investment that cannot be bought or sold quickly enough to prevent or minimize a loss.
* Risk due to lack of transparency.
* Concentration risk: Risk of loss arising from heavy exposure of one asset class.

Due to all these the importance of containing risk which is under the control has been underlined. There is need for some reforms in financial sector to prevent such turmoil.

* Financial market reform measure must be headed by an assessment of the resultant leverage for the system in quantifiable terms.
* It is also necessary to understand the substance of a product and not merely the nomenclature.
* People should take risk on the basis of risk of unknown probability rather than known probability.
* There is a need for strengthening of capital adequacy norms.
* Avoid creating moral hazards which give speculators no incentive to avoid excessive risk.
* There is critical role of governments to provide good governance of banking institutions and a reliable legal and judicial environment