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The Prices of unprecedented events in History

Firstly, a little bit of background knowledge. In October of 2008, the Financial and Capital Market Commission assessed the liquidity of Parex Banka’s assets and loan portfolio.  As the assessment continued, and increased deposit outflow began at Parex, due to the worldwide trend of worsening of the borrower’s creditworthiness. On the 29th of October, the trend reached its summit, when more than 29 million Lats were withdrawn from the Bank in that single day. The Cabinet of Ministers decided to take action, and on the 3rd of November, V. Krasovickis and v. Kargins in a first ever government bailout in Latvian History, turned over the Parex Banka to the Latvian Government.  Hereby, I will try to examine whether the bailout was necessary to the Latvian government.

Firstly, let’s look on the positive side of the story. If not for the Cabinet of Ministers, then according to the FCMC, the Parex Banka would default in the next months. As a result, the Government would be obligated to pay guaranteed compensations to the Banks creditors. The total sum of the compensations added up to 660 million Lats. Of the sum, 577 million would have to be paid out the Budget. Unfortunately at the time, Latvian Budget lacked the necessary funds to fulfill these obligations and did not yet open a credit live with the IMF. Additionally, the Parex Banka had 13.8% of all financial assets in the Latvian State. The bank played a significant role in the country’s economy, and its collapse would undoubtedly cause lower GDP rates and a decrease of deposit volumes in the country. Hence, by overtaking the Parex Banka, the Latvian government has stabilized the country’s financial sector, and eliminated the domino effect that could take place if the Parex Banka fell, since all of Baltic banks have had assets in Parex and vice versa.

On the contrary, the government has involved itself into a risky venture; reason being that it was not fully aware of the bank’s whereabouts which were uncovered after the takeover. First, the Parex Bank took two big loans, 500 million Euros in June of 2007, and 275 million Euros in February of 2008. The repayment was scheduled for the August of 2009, but the Bank did not have the necessary funds to repay the debt. The overtaking meant that the government had to pay back for the Bank. The sum would be 542,500,000 Lats, which is relatively insignificantly cheaper than allowing the bank to collapse. Additionally, the government deposited 287 million Lats to the Parex Banka from the treasury to ensure the liquidity of the bank, raising the government’s expenses in the venture to 829,500,000 Lats.  Further, another 120 million Lats were invested by the European Union and the IMF to help restructure the Bank, which also adds to the government’s expenses.  Hence, once can draw the conclusion that the government has developed a more fund consuming bailout than it should have, because according this plan, the Parex depletes about 1/5 of the annual government’s budget.

As a concluding remark it is safe to say that government involvement here was not as effective and as resource efficient as it could be. Despite the fact that Parex had problems with depositors, the government would be much better off with subsidizing Parex to restructure their bank, rather than taking responsibility for all of their debt and assets.  As a result, the government would still support the financial sector; prevent Parex from collapsing and all of that for a much minor price than already paid. To the Cabinets of Ministers defense, it was the first ever precedent of a government bailout in Latvia, but nevertheless their efforts entail brute flaws in governments decisions.

All statistics from the Financial and Capital Market Commission of the Republic of Latvia

Category: IB1 Economics | Views: 320 | Added by: DanDomanevski | Tags: Parex, Crisis, bailout | Rating: 0.0/0
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