The Changing Global Economy ( ECON401 ) Assignment

The Changing Global Economy ( ECON401 ) - Assignment Example The firms which had failed in UK allowed their businesses to overextend through risk taking and excessive leverage, over dependence on risky product streams like derivatives or buy-to-let mortgages, poor decisions of management in respect of acquisitions, over reliance on wholesale funding. Unprecedented innovation and growth have been seen in the financial sector over the past two decades as new products and higher returns have been sought by the investors in the era of low interest rates. Banks also had an obligation to understand the risks to which they are exposed. The complexity of certain financial instruments and the interconnected developed global market often did not provide well understanding of the dangers involved with the banks, its investors and boards, central banks and regulators (HM Treasury, 2009). The risk models of banks were proved as flawed which was based on incomplete application of principles of finance. It was believed that risks had been widely distributed throughout the financial system by the method of securitization but it proved as mistaken and risks posed by global increase in leverage were under-estimated. The remuneration policies of banks have contributed to the riskiness of financial system as they focused too much on short term prof it. Market discipline also proved as an ineffective constraint on risk taking in financial markets (Independent Commission on Banking, 2011).There were certain deficiencies in the corporate governance of banking institutions. The board of banks failed to understand this and they got prone to the risk management processes of their firms. The senior management also did not question on the sustainability and nature of achieved higher returns. Many institutional shareholders were not able to monitor the effectiveness of senior management of banks nor did they challenge the decisions of board of bank. Generally, the banks and investors rely on the assessments of credit rating agency but