Question

Question 4 [25 marks, limit 1200 words]:

In the wake of the global financial crisis, governments in many countries (including New Zealand) announced sovereign guarantees for banks’ wholesale funding (e.g. interbank loans). Explain the logic behind this policy measure and discuss its potential pros and cons.

Answer 1

Sovereign funding for banks is assured in anticipation of protection of smaller and commercial banks and their balance sheets from corrosion.

The biggest pros are it leads to financial stability in system, helps commercial banks become viable in long run, ensures higher credit availability, keeps sytem liquidated and cash flow issues at bay, helps firm cut down losses, reduced unemployment as cascading effect.

However, cons like inflated balance sheet for government, higher deficits, reduced budegt for structural reforms are visible.

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