The global
financial crisis brought into sharp focus the deficiencies of the regulatory
frameworks in the economies around the world. The genesis of the crisis from
the account of most scholars is the weak regulatory framework in the financial
services sector that was in place prior to the crisis (Norris, 2011). The
increasing movement towards the deregulation of banks and other main players in
the financial services sector is believed to have played the main role in
enhancing the magnitude of the crisis. Calls for more effective regulation have
however had to consider the balance between private interest and the public
good. Regulation can be defined as a mechanism put in place to regulate the
policies and practices of private enterprises to ensure their continual respect
for the public interests (Stigler, 1971). Regulation calls for a balance
between embracing the free market economic models which are known to have the
ability to fuel remarkable economic growth and development; and the need for
governments to intervene in the economies in order to ensure that private
interests are not advanced at the expense of the general public good. As such,
regulation needs to consider two principal theories: the private interest
theory, and the public interest theory (Stigler, 1971). The public interest
theory holds the view that regulation’s main role is to protect and benefit the
larger public (Aikins, 2009). This view is mainly dominant in situations where
market failure is realised, as was the case with the circumstances leading to
the global financial crisis which hit the UK economy in late 2007. The private
interest theory views all interests as private and view regulation as a mere
attempt to divert resources from one group to another (Aikins, 2009). For
instance, organisations with an inferior market positioning could lobby for
favourable regulation in order to suit their growth objectives; and the
political leaders may decide to heed such calls in order to amass political
support for their re-election bids. As analysts observe, financial systems are
as strong as their governing practices, the efficiency of their market
infrastructure and the soundness of their institutions (HM Treasury, 2010).
This forms the basis for the emphasis enhanced need for good regulatory
governance is therefore founded on the premise that strong financial systems
are very instrumental in ensuring that economies can ably withstand economic
crises that are bound to hit the markets on a cyclical basis. Financial
institutions should embrace sound governance practices in order to inspire
confidence among customers in order to spur growth in the national economies
(HM Treasury, 2010). Similarly, regulators have the responsibility to ensure
that their governance and practices are sound in order to invoke the requisite
moral authority necessary to ensure effective execution of their mandates.
Having
originated in the US, the global economic crisis quickly spread to other regions
where the already weak practices in the financial sectors served to aggravate
their situations. The crisis was a result of inadequate regulatory frameworks
in the financial services sector in the USA that was characterised by the
financial institutions making reckless decisions when it came to investment and
advancing of credit (Krugman, 2009). This was especially common in the housing
sector where mortgages were being advanced with little regard for the credit
history of the applicants. This eventually led to excess liquidity chasing
after the available housing units, hence pushing up the prices of the houses,
and making it difficult for those who had secured mortgage financing to make a
sound return on their investment (Krugman, 2009). This resulted in massive debt
defaults which in turn led to a liquidity problem in the financial sector,
causing an economic depression that eventually spread to the rest of the
economy. The plummeting of the securities of organisations linked to the real
estate had marked the beginning of the economic crisis and the global nature of
the world economy helped spread the crisis to other parts of the world: first
to Western Europe, then to the other countries of the world (New, 2010). The
sharp declines in demand levels that characterised the crisis is known to have
contributed to collapse or near-collapse of certain institutions prompting
governments to come up with bailout plans that would steady demand levels and
the sustainability of certain institutions considered to be strategic to the
economies. The USA government is reputed to have taken the lead in effecting
the bailout packages with their bailout budget in 2008 amounting to $ 1.3
trillion (Aikins, 2009). Comparative figures sourced from the European Union
countries placed the tally at $ 2.8 trillion. These amounts were distributed as
follows: United Kingdom ($ 743 billion), Germany ($ 636.5 billion), France ($
458.3 billion), Netherlands ($ 346 billion), Sweden ($ 200 billion), Austria ($
127.3 billion), Spain ($ 127.3 billion), Italy ($ 51 billion), and other
European countries ($110.6 billion) (Aikins, 2009). These measures were first
put in place by the UK with other European Countries appearing to embrace the
model set by the UK. Having taken the measures to insulate the economy from the
adverse effects of the financial crisis, focus shifted on strengthening
governance practices among the financial institutions and the generation of
sound regulatory frameworks that would not only ensure that such crises are
avoided, but also ensure that the financial services sector inspire the level
of confidence needed to promote economic growth (Norris, 2011). The new
approach to the regulation of the financial sector must take into account the
nature of the modern economy where factors of production, especially capital,
are able to move across borders with relative ease (Norris, 2011). National
regulators are therefore increasingly embracing collaboration with their
counterparts in other countries in order to ensure that economies do not suffer
as a result of poor regulatory frameworks in one of the countries. This paper
focuses on the UK’s financial sector, identifies the weaknesses that may have
aggravated the financial crisis and explains the measures taken to ensure that
such weaknesses are dealt with. The paper also seeks to make recommendations on
alternative approaches that can be embraced based on the experiences of other
countries such as the USA where debate on the regulatory frameworks for
financial institutions is relatively advanced.
This research is
titled: The Implications of the Global Financial Crisis towards Enactment of
Risk-free Regulatory Micro-structures in the UK Banking Sector. It focuses on
the banking sector in the UK and the new approaches being taken to strengthen
it in response to the weaknesses brought to light by the occurrence of the
global financial crisis in the late 2007. The study therefore starts by
identifying the loopholes in the banking sector that had led to the crippling
financial crisis. The study then considers the policies embraced by the
regulatory bodies in response to the crisis and seeks to make recommendation
based on theoretical reviews encountered and the experiences of other countries
that may have put some crucial policy improvements into place. The study
therefore seeks to answer the following research questions:
i.
What mitigating factors in the baking
sector contributed to the magnitude of the global financial crisis?
ii.
What regulatory frameworks have the
regulators taken in order to strengthen the financial institutions?
iii.
How effective, if at all, have these
emergent policies been?
iv.
What other policies can the regulators
embrace in order to ensure an even stronger banking sector?
The banking
sector plays a key role in the growth and development of any economy and its
strength should be of great concern to regulators in such economies (Aikins,
2009). The debate on financial regulation in the UK has largely been raging
with divergent views being given on the cost and benefits of various frameworks
that may have been proposed from time to time. The dilemma between the pursuit
for public good and the provision of a fairly free market that enables market
players to go about their business without undue regulation or interference is
yet to be fully resolved. This study takes the view that regulation is
absolutely necessary to ensure the strength of the banking sector and seeks to
use the findings of the study to prove the correctness or otherwise of such a
view. The debate on regulation of the banking sector is far from over. The
study draws its uniqueness from the fact that it takes a UK perspective as
opposed to the bulk of the studies that have in the past tended to include UK merely
as a component of the wider European Union and therefore a gross recipient of
the policies formulated at the EU level.
The information gathered from this study is therefore expected to
provide invaluable insights to players in the industry as well as the
regulators who may want to know how effective the measures they have taken are.
They may also be interested in finding out some alternative measures that could
be embraced in order to ensure that the banking sector is made even stronger.
The findings of the study are also expected to add to the existing body of
knowledge in the field and therefore be an invaluable resource for scholars and
analysts seeking to develop or prove certain theories relevant to the subject
matter.
Regulation is
viewed as the ideal instrument of ensuring that enterprises take care of
certain aspects of their operations that contribute to the realisation of
public good (HM Treasury, 2010). Such regulations restrict what organisations
can or cannot do and the manner in which the activities allowed can be
conducted in order to ensure efficiency and optimal distribution of the factors
of production for a stronger and more balanced economy (Aikins, 2009). The
focus on the banking sector is based on fact that the sector plays a critical
role in ensuring the stability and growth of economies. As a matter of fact,
the performance of the banking sector provides one of the most instrumental
yardsticks for determining the performance of any economy. The regulatory
frameworks embraced by regulators should therefore be adequate to ensure that
instances of unregulated risk taking are put in check. Such policies should
however be implemented cautiously in order to avoid the erosion of the benefits
of enterprise among the investors owning and running such institutions. Excessive regulation can be counterproductive
while inadequate regulation can provide the leeway for the advancement of
private interest at the expense of the stability of the larger economy (HM Treasury,
2010). This therefore calls for a cautious approach to regulation and this
study endeavours to explain the regulatory policies embraced in the UK banking
sector as well as recommendation for any other measures that could help
strengthen the sector even further.
This study has
been organised into six distinct chapters. Chapter one provides the background
for the study and outlines the research topic. It also explains the objectives
of the paper and spells out the research questions that the paper seeks to
respond to. The rationale for the study and the conceptual frameworks guiding
the study has also been explained in this chapter. Chapter two is the
literature review. It expounds on the global financial crisis, its causative factors
and its implications to the economies and the financial services sectors across
selected economies. In this chapter, literature vouching for regulation of
businesses in the economies has also been briefly described in a bid to make a
case for optimal regulation. In chapter three, the methodology used in the
study has been outlined. The research philosophies guiding the research as well
as the research methods have been explicitly outlined. Understanding of the
manner in which the research was conducted is crucial to the inspiration of
higher confidence levels among the users of the information who are then able
to accord the requisite level of integrity. In addition, limitations faced
while conducting the study have been stated. In chapter four, the results of
the study have been detailed and presented in a palatable form in order to
ensure quick understanding among the users of the information. In chapter five,
the results obtained during the research have been discussed. This discussion
compares the findings of the research to previous studies and also explains
such findings in relation to certain theoretical frameworks related to the
study. The paper then ends with a conclusion and recommendations on additional
measures that can be taken to ensure strong financial institutions in the UK.
The global
financial crisis has variously been referred to as the credit crunch or the
subprime mortgage crisis. This crisis is known to have caused adverse effects
in the global economy only comparable to the long depression of the 1890s and
the great depression of the 1930s (Krugman, 2009). This crisis owes its origin
to the USA and is known to have thereafter spread to other countries due to
their prevailing weaknesses in the financial sector regulations. The crisis is
known to have been a culmination of a series of certain events. At first, there
was a rapid reduction in the interest rates due to an exaggerated deflation in
the perception of risks in the USA, especially in the mortgage and the real
estates (Norris, 2011). The low interest rates were followed in quick
succession by easy credit which in turn led to increased debt burden in the
economy. Subprime lending was also on the rise among the players in the
financial services sector (Norris, 2011). These factors led to a situation
where there were mass defaults leading to reduced liquidity in the financial
services sector in the USA. Massive failure of financial institutions then followed,
starting with the players in the shadow banking subsector and later the major
banking institutions in the country. The resultant instability in the financial
services sector led to investor apathy leading to massive drops in the
performance of the stock markets across the USA (Krugman, 2009). This
culminated into the global financial crisis once the effects of reduced
economic activity began to be felt in other countries around the world.
The crisis in
the housing sector in the USA is known to have been the triggering factor for
the crisis (Krugman, 2009). The increasing costs of housing had led to
prolonged vacancies, foreclosures and evictions which had risen to
unprecedented levels. The unregulated practices in the financial sector had led
to a constantly growing housing bubble which had peaked between 2005 and 2006
and was characterised by housing prices being much higher than their values
(Norris, 2011). The housing bubble growth is as illustrated below:
Source: Norris,
2011
The average prices
in the housing sector are known to have grown by over 124% between 1997 and
2006 (Merrouche and Nier, 2010). The relative prices between the income levels
of consumers and the prices of the houses with the ratio rising from 1:3.1 in
2001 to 1:4.2 in 2004 and to 1:4.6 in 2006 (Merrouche and Nier, 2010). The
implication of the rising ratios is that the average pricing in the industry
towards unsustainable levels. The housing bubble had resulted in a situation
where home owners would easily take the option to refinance themselves by
taking second mortgages. However, the reduction of the housing bubble in 2007,
interest rates had begun to rise making it difficult for many debtors to fulfil
their mortgage obligations (Norris, 2011). This resulted in massive defaults
leading to liquidity problems among the players in the banking industry.
Researchers have been able to establish that the number of properties whose
payments had been defaulted in 2007 were 79% higher than the 2006 levels
(Norris, 2011). A closely related factor that contributed to the crisis was the
existence of weak and fraudulent underwriting practices which had been made
possible by the weak regulatory frameworks in the industry. In 2006 alone, the
number of mortgages that were underwritten below the required standards stood
at an all high figure of 60% (Merrouche and Nier, 2010). This had of course led
to a situation where the providers of financial institutions were unable to
price the properties fairly.
Easy credit
conditions are also credited for playing a significant role in the crisis. This
was mainly as a result of the reduction of the federal funds rate to 1% from
6.5% (Nanto, 2009). This allowed banks excessive liquidity which made them want
to lend more funds to the market. This led to the loosening of credit
conditions making it more accessible to more consumers and further pushing up
property prices even higher. Subprime lending also played a role in bringing
about the market failures that led to the financial crisis. Subprime lending refers
to the advancement of credit to customers with a weak credit history and
therefore more likely to default than the average customers (Nanto, 2009). The
value of subprime mortgages had risen quickly to reach $ 1.3 trillion in 2007
making the banking sector exceptionally vulnerable. The proportion of subprime
mortgages had remained constant at about 10% of all mortgages in the decade
leading up to 2004. However, this ratio quickly doubled to reach 20% in a span
of two years to reach its peak in 2006 (Merrouche and Nier, 2010). This rapid
rise was largely unregulated making financial institutions more
vulnerable. The figure below gives a
visual presentation of the growth in the rates of subprime lending between 1997
and 2007.
Source: Krugman,
2009
The deregulation
of the financial services sector also led to a steep rise in predatory lending.
Predatory lending refers to the practice financial institutions enticing
consumers to take unsafe loan facilities which they may not necessarily be able
to repay (Lehne, 2006). This led to a rise in the risk of default-
unaccompanied by a corresponding price premium. The move towards continual
deregulation is said to the pivotal factor in causing the crisis. The lack of
regulation and the opacity with which operations of financial institutions were
being conducted encourage little accountability and transparency hence giving
such institutions the leeway to engage into unhealthy practices that eventually
led to the crisis (New, 2010). The lack of attention on investment banks and
hedge funds also saw a significant portion of the industry go unmonitored
leaving certain unhealthy practices go unnoticed.
The massive
failure of institutions especially in the SME sector as well as the massive
layoff of staff as organisations sought to reorganise their operations and cut
costs further aggravated the problem leading to reduced disposable incomes
among the consumers (Merrouche and Nier, 2010). Those with some income also
tended to avoid spending in fear of losing their jobs and having no savings to
depend on. The resultant reduction in
demand threatened the very survival of the businesses prompting governments
across the world, especially in the developed world, to come up with measures
to insulate certain strategic institutions against the effects of the crisis.
The main recipients of the bailout funds were the financial institutions which
were viewed as the gateway to ensuring quick recovery from the recession. The
USA alone is known to have provided $ 1.3 trillion for the bailout plans which
were distributed as follows: troubled asset relief program ($ 700 billion);
commercial funding facility ($ 243 billion); Freddie Mae and Freddie Mac ($ 200
billion); AIG ($ 112.5 billion); Guarantees for Bear Steams’ losses on investment
portfolios ($ 29 billion); and FDIC takeovers ($ 13.2 billion) (Aikins, 2009).
This package was followed by a $ 787 billion package approved in 2009 to help
stimulate the economy by trying to raise the local demand levels (Aikins,
2009). The striking difference between the USA approach and the approach taken
by the European Union countries was that the EU countries favoured the
channelling of their bailout programs through the financial institutions. The
UK spent $ 734 billion to boost the interbank lending and short term loans with
Germany taking similar steps to inject $ 637 billion to be used in guaranteeing
medium term lending and recapitalisation (Aikins, 2009). France also injected $
483 into the banking system to guarantee bank debts and recapitalisation. Other
bailout packages by other European countries include: Netherlands ($ 346
billion), Sweden ($ 200 billion), Austria ($ 127.3 billion), Spain ($ 127.3
billion), Italy ($ 51 billion), and other European countries ($110.6 billion)
(Aikins, 2009). These packages were agreed upon with the realisation that for
markets to be stable, the governments were expected to play certain key roles
to enable the economies to come out of recessions; and to ensure that such
crises are prevented as much as possible.
Regulation
refers to the mechanism through the activities of private institutions are
controlled in order to be in conformity with the overall public good (Busch,
Jorgens, and Tews, 2005). These regulations are mostly carried out by
governments through various agencies. The two main theories that come into play
when considering regulation and the relationship between regulators and private
enterprises are: the public interest theory and the private interest theory
(Busch, Jorgens, and Tews, 2005). The public interest theory holds the view
that regulation is done in order to protect and bring benefit to the public at
large or a significant portion of such a public (Grand, 1991). According to the
proponents of this theory, regulation is the best response to market failure.
For instance, market failure may result in a situation where competition is
inhibited among the market players and regulation may be designed in a manner
that allows for the thriving of such competition. The market failure theory is
instrumental in establishing conditions under which markets become inefficient
as far as distribution of factors of production is concerned. The theory of
market failure states that in a certain set of conditions (and in the absence
of regulation) where the market players act in pursuit of their private
interests, the market ends up in a condition of being socially inefficient
(Grand, 1991). Such inefficiencies may relate to the limiting of the level of
competition when big market players engage in anticompetitive behaviour and
drive other players from the market; the creation of barriers to entry into the
markets; limited consumer information; and inefficient distribution of wealth
and income among others.
Private interest
theory on the other hand views regulation as a means through which various
parties pursue their private interests (Busch, Jorgens, and Tews, 2005). In
their opinion, governments merely use their authority to redistribute wealth
from one party to the other; and in most cases, such transfers may not be
justified. For instance, companies not doing well in a market may choose to
lobby for regulatory policies that suit their purposes in the guise of
advocating for the public good. Similarly, members of the political class may
embrace certain measures seen as good for the larger public just to reap the
benefits of the resultant goodwill from the public. The need for good
regulation is seen as a crucial part of the wider goal of strengthening the financial
institutions which are only as good as the financial soundness of their
institutions and the level of market efficiency in their market infrastructure
(Lehne, 2006). The need to inspire confidence must be observed by both the
financial institutions and the regulators in order to ensure that public
confidence is restored in the financial sector. The embracing of good
governance, transparency and accountability among such institutions help avoid
unnecessary interference from oversight bodies which may be charged with the
responsibility of ensuring the effective functioning of such sectors (Lehne,
2006).
Despite the
general consensus on the need for regulation, regulating bodies are not without
challenges. The main source of challenge is the constant pressure by the firms
being regulated to have policies that conform to their private interests
adopted (Liberals and Democrats Workshop, 2008).
This pressure may be exercised at the political level through the lobbying of
legislators to come up with ‘favourable laws’. This is mostly done through the
presentation of partial evidence on some phenomena and taking advantage of the
fact that such legislators may not be well versed with the subject matter. Such
pressure may also take the form of exerting undue influence on the agency
employees who may then use their influence as regulators to weaken the
regulatory frameworks in the industries (Udaibir, Quintyn and Taylor, 2002).
This is known as the capture of the regulations and is one of the sources of
threats to many financial regulators in economies that are yet to embrace
transparency and accountability. Such market players take advantage of
information asymmetry which makes the verification of information difficult. An
example of such a takeover was witnessed in the USA in the 1990s where the
savings and loans institutions managed to influence the design of the
regulations applied to them (Aikins, 2009). They managed to do so by
influencing both the regulatory agencies and the legislative bodies with
evidence showing that there were conflicting incentives offered to the parties.
Regulatory
arbitration is also known to be rife in countries such as Japan and has been
behind some of the most serious financial crises in history. For instance, in
Japan, cooperative societies were allowed to carry out some of the functions of
the banking institutions but with looser regulations (Barth, Trimbath and Yago,
2004). As a result, these cooperatives engaged in risky activities and relaxed
their restrictions as far as lending are concerned leading to a weakened
financial system in Japan. In fact, some of the problems in the Japanese
financial sector during the global financial crisis are attributed to the fact
that the Japanese authorities failed to fix some of the flaws identified in
their financial systems in the past crises. The 1990s crisis had displayed a
certain lack of independence of the financial regulators as well as their
inability to foretell future happenings in the financial systems and taking
timely policy measures to mitigate the effects of such crises (Barth, Trimbath
and Yago, 2004). As is the case with the USA, the underlying cause of the
crisis in Japan was deregulation in the financial services sector. This was
enhanced by an excessive move to expand asset bases by most organisations in
times of economic prosperity, and inadequate governance and regulatory
guidelines especially when the system is under pressure. The emphasis on
collateral and market share as the basis for making lending decisions was also
faulted (Aikins, 2009). The rapid rise of property prices led to the loosening
of the lending conditions which further contributed to the vulnerability of the
Japanese financial system. Despite evidence of worsening conditions in the
banking sector, the Japanese authorities remained reluctant to take decisive
action for fear of triggering panic in the economy (Aikins, 2009). This fear
was founded on the fact that there was insufficient deposit insurance schemes
in the market and that the legal frameworks did not provide for responsive
structures that could ably deal with any crisis in the financial systems. The
exercise of forbearance was therefore the option taken by the Japanese
regulators. The Japanese experience provided the warning signs which would have
helped to prevent the global financial crisis (New, 2010). However, these
warning signs were ignored and the fundamental weaknesses observed in the
Japanese financial systems persisted among their western counterparts.
Despite the
obvious benefits of appropriate policies and regulatory frameworks in ensuring
a stable and a growing economy, debate still rages on the rationale for
government intervention in cases economic recessions and financial crises
(Gallaroti, 2000). Those in favour of regulation argue that financial crises
are a symptom of market failure and that the governments have the duty to
intervene and restore stability in the economies (Stigler, 1971). According to
them, the government should take appropriate action to ensure appropriate
fiscal policies are in place without compromising on the provisions for the
market forces. Opponents of regulation on the other hand advocate for the
forces of demand and supply as the most appropriate sources of reprieve in such
crises (Rosenbluth and Schaap, 2003). In their opinion, the forces of demand
and supply are bound to adjust the economy to the recession and thereby purge
the inefficiencies within the system hence bring about an automatic correction
of the imbalances. Once the imbalances have been corrected, the economy would
move towards the equilibrium and the strength of the economy would eventually
be regained. This is in line with the theory of Laissez-faire economics.
The
theory of laissez-faire economic is founded on the premise that production of
goods and services is entirely governed by individuals or buyers and sellers
(Zysman, 1983). This theory advocates for self regulated systems characterised
by free flow of information and the principle of exclusion and revealed
preferences. This means that individuals are believed to be fully aware of what
is good for their welfare and their tastes and preferences are known from their
choices in consumption. In other words, this theory believes in the supremacy
of the consumer. The principle of exclusion denotes the manner in which
properties and services are passed from one party to another where the holder
of the title reserves the right to exclude individuals without the desired
ability to acquire such properties from accessing them (Ginsburg, 1979). The principle
of exclusion therefore works in a manner that allows the sellers to decide on
whom to sell their products to; and this is often to the highest bidder. This
sets in motion the forces of demand and supply which in turn determine the
quantity of products supplied to the market and at which price the buyers are
able to acquire them. This theory was prevalent in the 19th century
and was mainly supported by advocates of economic liberalism and the classical
and neoclassical theorists. According to them, market competition is absolutely
necessary in ensuring that markets create sufficient wealth without the need
for state intervention (Aikins, 2009). The predominant economist theories were
at the same time influenced by the political happenings of the day. For
instance, the end of the World War 1 came with an increasing popularity of the
market society and classical liberalism. This gave birth to the interventionist
theories which viewed the state as the protector of public welfare and
therefore duty bound to intervene in times of economic crisis to restore
stability and promote employment within the economies (Owen and Braetigam,
1978). This thinking was reinforced by the occurrence of the Great Depression
which emboldened states to take more decisive and severe measures in terms of
fiscal and monetary policies in a bid to safeguard incomes and employment
levels in the affected economies (Owen and Braetigam, 1978). The great
depression brought with it a realisation that even the strongest capitalist
economies could not achieve growth through self regulation of the markets
(Bernanke, 2000). The culture of state intervention in economic models grew
after the World War with most states engaging in massive deficit financing. The
financial sector liberalisation that culminated into the 2008 global financial
crisis was as a result of the growing popularity of the theory of neo-classical
monetarism. Sweeping reforms were conducted in the public sector especially in
the UK and the USA resulting in massive privatisations, outsourcing and load
shedding of certain major public responsibilities (HM Treasury, 2010). Debate
about the appropriate size of governments raged at an international level with
most government appearing to be in favour of allowing self regulation among
market players as much as possible. The predominant philosophies in
international circles from the 1990s had been moving constantly away from
legally based regulation towards collaborative, voluntary and market based
regulatory instruments (Aikins, 2009). This had been seen as a solution to the
challenges of government-based regulation such as regulatory capture,
arbitration, and forbearance. The liberalisation of financial markets resulted
in the creation of products with considerably high risks without the necessary
regulation to keep the industries stable. Money markets and mutual funds
overtook some more traditional services such as the lending franchises
(Merrouche and Nier, 2010). Banks also securitised the traditional backed
assets such as loans, auto loans, credit cards and mortgages (Merrouche and
Nier, 2010). This was done by repackaging the services into bundles and selling
their shares to investors. Securitisation refers to the repackaging of certain
financial products offered by banks and converting their cash flows into a form
that allows them to be traded as shares. Securitisation provided the incentive
for banks to warehouse their loans for short periods of time and this led them
to lower their lending conditions and to lend to subprime borrowers hence
increasing the risk of default (Merrouche and Nier, 2010). The emergence of new
securities encouraged increased speculative trading with banks opting to
finance investment banks to increase their market activity.
The
excesses of the liberalisation of the financial markets became noticeable in
the early 2000s but forbearance led to the delaying of appropriate action
(Aikins, 2009). This added truth to the assertion that liberalisation without
the benefit of proper regulation may lead to the collapse of financial systems.
The 2008 financial crisis was caused by regulatory failure where regulators
tried to adapt to the changing market practices instead of taking proactive
action to safeguard the stability of the economies and the overall public good (New,
2010). The regulatory frameworks prior to the crisis had been focussed on
measures such as requiring that banks hold greater capital for assets viewed as
riskier; the disclosure of their trading positions that could not be marked to
the market; and the pressing of dealers to improve openness in their
over-the-counter transactions (New, 2010). These measures were grossly
inadequate in the face of increasingly complex markets at both domestic and
international levels. This liberalisation was also mainly promoted by
regulatory capture where the regulators tended to come up with policies that
tended to propagate the private interest of the players in the industries. Such
regulators focused on measures which would encourage competition without much
regard for the soundness of the resultant practices or the stability of the
economies.
The
enormity of the global financial crisis was such that government intervention
was necessary in countries across the world (HM Treasury, 2010). This
underscored the importance of having a complimentary relationship between
government and the market players; putting to an end the speculations into the
future of the free markets with analysts conceding that the main role of
governments in capitalist markets is to assure the proper functioning of
markets (HM Treasury, 2010). One of the emergent perspectives to regulation was
the realisation that domestic controls were inadequate given the global nature
of financial industries. The acknowledgement of the fact that weak financial systems
in a country could potentially lead to adverse effects on the global economy
formed the basis for the calls to have regional and international regulatory
regimes that would ensure a measure of uniformity in the regulatory
infrastructure of the member countries.
The
UK financial system is reputed as being one of the most open, globalised and
successful in the world. As a result of its global nature, the UK economy was
the most affected the global financial crisis after the USA which was the
epicentre of the crisis (HM Treasury, 2010). The UK market players could
therefore opt to relate their financial woes to the global nature of their
economy. However, financial analysts hold the view that the UK financial
systems had been facing certain fundamental weaknesses that had made their
financial systems unable to counter the effects of the global crisis (Liberals and Democrats Workshop, 2008). The
regulatory agencies in the UK that oversee the financial system include the
Bank of England, the Treasury and the Financial Services Authority. The three
institutions bear collective responsibility over the stability of the UK
financial system. These institutions are however said to have failed to
identify the problems that were building up in their financial systems; and to
take measures to mitigate these problems (HM Treasury, 2010). The structural
weaknesses of the tripartite government agencies have been discussed in the
latter chapters of this study.
The
choice on whether or not to regulate market activities is at the heart of
debate even in contemporary times. However, a general consensus is building
that tends to recognise the role of government as the stabilisation of market
conditions among other functions. Enquiries into the genesis of the global
economic crisis show various loopholes in the regulatory frameworks in most
countries. Governments and indeed most market players are therefore engaged in
debate to establish just what kinds of regulatory infrastructure would be
adequate and whether or not any of these regulations could interfere with the
efficient operations of the markets.
The
objectivity of research findings and the reliability of the information to the
readers draws its roots from the principles and methods used to collect the
data. The research philosophies in use are critical in ensuring the
understanding of the basic concepts under consideration enabling the
appreciation of the various perspectives that may affect the objectivity of the
data collected and the interpretations thereof (Eriksson and Kovalainen, 2008).
This chapter provides the details of the research philosophies used in this
research as well as the methods of data collection and analysis used. The focus
on methodology enables the researchers to make a thorough evaluation of their
information need and come up with corresponding methods that would best ensure
that such needs are met with relative accuracy (Eriksson and Kovalainen, 2008).
With the underlying philosophy in this research being the realist philosophy,
the study has made use of both primary and secondary research methods in order
to obtain its findings as illustrated in the following sections.
While
considering the philosophy of choice for use in this research, various
philosophies were evaluated. These philosophies help to draw light into the
assumptions, dominating perceptions and beliefs that may influence the
objectivity of the study being conducted (Kumar, 2005). The evaluation helps to
identify any potential biases that may exist among the sources of the
information, hence making a great contribution towards the selection of a
population and sample whose collective responses would amount to an objective
approach (Eriksson and Kovalainen, 2008). Under normal circumstances,
qualitative research is more prone to personal biases than quantitative
research. This is due to the fact that quantitative research mainly focuses on
facts with little regard for the interpretations of the parties providing them
(Kumar, 2005). On the other hand, qualitative research mainly dwells in
perceptions and the quality of such perceptions. Given that this study is
mainly qualitative, the corresponding philosophies were adopted.
Ontological
perspectives were taken into account in this research. Ontology is the
philosophical paradigm that calls for the evaluation of the researcher biases
which are a function of their interaction with the environment (Chia, 2002).
The focus on this paradigm enables the determination of objective conclusion by
factoring out the influence of the researcher biases. At this point it would be
prudent to note that the researcher in this study is more inclined towards more
regulation of the financial services sector. This ideological preference was
closely put in check to avoid the suppression of the voices arguing against
excessive regulation on the basis of its potential inhibition of enterprise and
innovation in the economy. The ontological perspective was therefore crucial in
guiding the research process.
Another
crucial perspective in research is epistemology. Epistemology focuses on the
importance of using the right procedures when attending to the research
questions (Chia, 2002). This is in recognition of the fact that the processes
used to collect information may have a significant role to play in ensuring
that the data obtained is not only objective, but also given in a format that
facilitates accurate interpretation and analysis. This process is therefore
crucial right from the onset of the determination of the appropriate research
questions that would effectively tackle the objectives of the research to the
determination of the sample and to the determination of collection methods and
the procedures to be used while doing so (Kumar, 2005). The determination of
the procedures of this research was done with great care in order to ensure
that the sources of the information were reliable. The procedures for data
collection also allowed for the respondents to gather information on their own
in order to provide the researcher with detailed responses.
Research
philosophies can also be categorised into three philosophies namely: the
positivist; the constructionist or the interpretivist; and the realist
philosophy. The positivist philosophy
takes the view that world is made of purely objective systems; and that the
happenings are purely relational and not subject to the interpretations of the
observers (Saunders, Lewis and Thornhill, 2007). According to this philosophical
assertion, the biases of people are not relevant to any research process. This
philosophy has been found to be useful in cases where statistical evidence can
be adduced to prove or disprove a theory (Saunders, Lewis and Thornhill, 2007).
For instance, a researcher may wish to prove that a market is efficient by
monitoring the movement of the prices of the securities in that economy for a
given length of time. This philosophy is therefore inadequate in areas where
the information sought is mainly qualitative.
The
constructionist philosophy takes a sharp break from the positivist view and
simply emphasises the existence of socially dependent realities. In this view,
all realities are a construction of the peoples’ beliefs and assumptions based
on their interaction with the physical world and the members of the society
(Saunders, Lewis and Thornhill, 2007). This means that the where a certain
factor occurs, the predominant societal though conforms to that thought. For
instance, prior to the global financial crisis, most members of the society had
experienced the positive effect of deregulation in the market on the economy
where new products were coming up and capital more available for investment.
The predominant thought was therefore skewed towards the suppression of
government regulation. This philosophy therefore requires continuous enquiry as
underlying circumstances change. For instance, this research seeks to find out,
among other things, whether the financial crisis has changed peoples’
perceptions towards government regulation.
The
realist philosophy on the other hand agrees to the existence of both biases and
an objective world (James and Vinnicombe, 2002). This research embraces the
realist view where it acknowledges the verifiable facts related to the research
questions as well as the perceptions of the various parties based on their
various experiences.
Research
strategy simply refers to the approaches embraced during the conduct of a
study. It outlines the methods chosen on the basis of their perceived
effectiveness and their suitability in attending to the research questions. One
of the most dominant factors when determining the research strategy is the
nature of the information sought (Kvale, 1996). In this case, the information
sought was mainly qualitative even though some quantitative data may be
obtained in the course of the study. The study was there designed to make use
of both primary and secondary data collection methods. While the primary data
was useful in capturing the current sentiments in the market; the secondary
sources, some of which were more extensive than the scope of this research,
were able to provide the underlying perspectives and the theoretical bases for
interpretation and analysis of the findings (Saunders, Lewis and Thornhill,
2007). The data collection method chosen were also noted as written
questionnaires due to the need to allow respondents time to gather their
thoughts and provide well thought-out responses that would be useful to the
research. The research also took cognisance of the time and resource
constraints in determining the scope of the research. A relatively small sample
of 150 respondents was picked to this end. The design also took into account
the best sources of the information. The main respondents were the players in
the financial services sector; investment groups; and the regulatory bodies
mostly concerned with the regulation of the industry. These groups were
believed to be best placed to understanding the issues being investigated by
the study and therefore provide informed responses. The wide selection of
respondents was believed to be useful in capturing views from all sides of the
debate relating to the regulation of the banking industry. Secondary data was
obtained from various reliable sources which included the regulatory body
publications, related academic research papers, company websites and other
sources viewed as reliable by the researcher. Once the information was
gathered, the presentation and the analysis was done and simplified to ensure
that an average user could read and understand the contents therein.
The
collection of secondary data was done quite simply. The regulation agencies
providing regular updates on the changes in regulatory guidelines were
approached and the publications obtained. Where such publications could not be
obtained physically, the same were obtained from the agencies’ websites. More
information was obtained from previous studies as contained in manuals,
journals, academic research write-ups and company publications as found in
libraries, company offices, and reliable sites in the internet. The secondary
data is useful in a number of ways. Firstly, such data tend to be obtained
through more reliable methods than the ones available to the academics
(Saunders, Lewis and Thornhill, 2007). For instance, a regulatory agency which
is in direct contact with all banks and players in the financial services
sector and investors is likely to present a more reflective opinion and therefore
provide the reference point needed when conducting a research. Secondly, the
data contained in the secondary sources is in permanent form and therefore not
susceptible to loss or misinterpretation (Saunders, Lewis and Thornhill, 2007).
On the other hand, secondary data is mostly insufficient in a research process
due to the fact that they are gathered for purposes which may not be identical
to the research objectives. This makes them less than adequate for specific
research objectives hence making it necessary to conduct primary research
alongside the secondary research.
Primary
research is useful due to its ability to capture the prevailing opinions among
the respondents. It presents their views as they currently are; as opposed to
secondary research which reflect the prevailing views at the time it was past
records were written. The primary research in this study was conducted through
the use of questionnaires. The choice of questionnaires was strategic. It was
based on the fact that the target respondents tend to be very busy persons who
may not be available for interviews during the regular working hours. The
questionnaires gave them the opportunity to give their responses at their own
convenience- when they are most relaxed. This approach was expected to yield
two fruits: the response rate would be high; and the answers would be well
thought out as opposed to when the answers are provided under pressure to
attend to other business (Johns and Lee-Ross, 1998). The information collected
would also be in permanent form hence low risk of loss allowing the researcher
to make interpretation and analysis at a pace not likely to affect the accuracy
and quality of such analyses. On the other hand, questionnaires present the
challenges of interpretation where the respondents may not be able to fully
understand the questions posed and therefore be unable to respond appropriately
(Kvale, 1996). In other cases, the questions may be misunderstood and therefore
answered in a manner that misrepresents the views of the respondents (Kvale,
1996). To avoid this risk, the questionnaires were designed and tested where
mock administration of the questionnaires was conducted across a group sourced
from persons with different linguistic abilities in order to ensure that the
understanding of the questions was beyond doubt. The target respondents were
contacted before hand in order to obtain their permission to involve them in
the enquiry. This advance notification helped assure the high response rates
observed. The questionnaires were administered through a number of modes. Where
possible, the questionnaires were distributed physically. This helped establish
the personal contact with the respondents hence providing them with the motive
to honour their commitment. Where the target respondents could not be easily
reached by virtue of the distance and busy schedules, the distribution was done
via email where they would access them at their own convenience and confirm
receipt. They would thereafter choose whether to return the duly completed
questionnaires through email, mail box address; or call for the researcher to
collect the responses.
The
choice of population was based on the perceived understanding of the issues
under investigation and the ability of such populations to provide informed
responses in the enquiry. The main categories of the population taken under
consideration were the banks. The banking institutions are the main recipients
of the regulation and would therefore the ones whose operations would be affected
the most by any changes in the regulation of the sector. The second category
was the Bank of England where the employees of the institution were targeted
for the research. This institution interacts with all the banks and is
therefore well aware of the practices of the institutions and where regulation
may play a pivotal role or otherwise. The third section to be factored in was
the Financial Services Authority which is the body mandated with the regulation
of the banking sector in the UK. Employees of this institution were targeted.
The fourth category involved the investors. This group is the main recipient of
the services by the banks and their perspectives on the extent to which
regulation should be done were considered to be central to the objectives of
this study.
Determination
of a suitable sample size is crucial to the success of a research process.
Samples need to be large enough to assure the reliability of the findings, but
small enough to ensure that the research can be carried out comprehensively
within the scope of the research in times of time and resources available
(Easterby-Smith, Thorpe and Jackson, 2008). A sample can be described as a
representative portion of the whole implying that the perspectives held by the
members in the sample are the same as those held by the members of the wider
population. The population described above is large and runs into tens of
thousands of individuals who constitute the target population. This research
therefore sought to involve a sample of the same where the sample size settled
upon was 150. Of these, 70 were sourced from the banking institutions and other
providers of financial services; 60 were sourced from various investment
groups; and 20 were sourced from the regulators and the central bank. The sampling was done randomly within the
designated groups; meaning that all members of the population stood an equal
chance of being selected in the sample. Random sampling helps factor out the
researcher biases hence assuring the objectivity of the findings.
The
information gathered needed to be interpreted and presented in a palatable form
to ensure the users of the information understand it with relative ease. To
ensure that quick understanding is enhanced, the use of presentation aids such
as charts have been employed. This ensures the capturing of respondent
sentiments in the simplest manner. The analytical methods were mainly
qualitative in this regard.
A
few setbacks were experienced when conducting this research. Firstly, there was
experienced a certain level of apathy towards the research. This is due to the
fact that many enquiries had been done in related fields due to the interest
triggered by the occurrence of the global financial crisis. This challenge was
however overcome after the distinction between this study and previous ones
were drawn. Secondly, the response rates tended to be quite low with many
questionnaires being returned late hence threatening the smooth conduct of the
research. Constant follow-ups were made to ensure that those who had committed
to participate returned their responses in time for the analysis albeit with a
considerable level of coercion.
This
research also finds that there is very little research aiming at establishing
the direct contribution (in absolute terms) of regulation or deregulation to
the economies and recommends that such comprehensive studies be done to ensure
that more informed decisions are made in future.
This
research comprised of both secondary and primary research. The findings of the
primary research have been outlined in this chapter while those of the
secondary research have been elaborated upon in the discussion of results. This
chapter discusses the findings as per the questionnaires which are mainly
focused on the crucial aspects of the research questions. As would be noticed
in the following sections, there appears to be a significant level of influence
of people’s experiences when it comes to some of the questions being asked. The
results are as documented in the following section.
A
total of 150 respondents participated in the research and were drawn from
various strategic groups which included banks, investment groups and the
institutions responsible for the regulation of the industry. The combined
opinions of these segments were viewed as being largely representative of the
whole economy especially in the financial services sectors.
The
researcher sought to establish the overall attitude towards regulation and
asked the respondents to express their opinion regarding whether or not
regulation was necessary in the banking sector. To this, over 80% of the
respondents expressed support for regulation.
frequency
|
%age
|
|
In support of regulation
|
120
|
80%
|
Against regulation
|
30
|
20%
|
In
order to better understand the responses, the answers were grouped into the
various distinct groups that were subject to the study. The level of support
for regulation was highest among those involved in regulation of the industry
and they were in support by 95% of the surveyed respondents. This strong
support signals that their preoccupation with ensuring proper regulation in the
industry has made them want to justify their existence as institutions. The
element of their experiences may be present as they are likely to have
encountered rogue institutions whose practices have been found wanting and
detrimental to the economy. Among the investors, 83% supported regulation while
the banking institutions had the lowest level of support by 73%. The
differences in the strength of support can be explained by the differences in
goals and interests. 
The
investors are more interested in a less risky economic environment and are
therefore keen on ensuring that regulation takes effect to ensure that not
disruptions occur in the economy to cause the kind of losses experienced during
the crisis. The banking institutions on the other hand tended to prefer self
regulation and were only in support of regulation where the said regulations
would not be construed as a barrier to the exercise of enterprise and
innovative service to the market. According to 85% of the bankers, regulation
should be done but only limited to the determination of reserve ratios and ensuring
accountability in accounting practices. The underlying argument for this view
is that regulating services provided would introduce an unwelcome level of
uniformity in the market that would make it increasingly difficult for
differentiation strategic positioning in the market.
Respondents
confirmed that the financial crisis that affected the UK in 2008 played a role
in affirming their beliefs on the necessity of banking regulation with about
85% of the respondents answering to the affirmative. The arguments among some
of the respondents were skewed towards the realisation that the stability of
the economy must be assured at all times if sustained growth and development
are to be realised.
Opinions
were divided on the extent to which the UK banking regulatory weaknesses
contributed to the financial crisis in the UK. However, opinion was generally
in support of the assertion that the regulatory framework flaws contributed to
the crisis with about 83% of the respondents holding that view.
was the financial crisis caused by regulatory frameworks?
|
frequency
|
%% age
|
Yes
|
124
|
83%
|
No
|
26
|
17%
|
The
dominant view blamed the UK regulatory systems for the crisis. However, the
dissenting views were emphatic that market forces were generally responsible
where they cited the occurrences in the USA where the crisis had started from
as the main course. In their opinion, the global nature of the UK economy made
them vulnerable to the happenings in other countries, especially the USA whose
economy was closely related to theirs. The failure in the USA, according to
this view, resulted in massive drops in demand for products and a sharp decline
in the confidence of the investors hence triggering the crisis. The call for
more regulation was therefore seen as unjustified and an unnecessary
restriction of the market’s ability to correct its own inefficiencies. These
respondents cited the rapid economic growth that had been accompanying the
deregulation of the sector in the previous years. The contrary opinions however
held that despite the fact that the genesis of the crisis was in a different
economy, the extent to which the UK felt the crisis would have been lighter if
the UK had been maintaining sound financial systems through effective
regulation.
The
most commonly quoted reason for the financial crisis was the deregulation of
the banking sector which had been done systematically since the 1980s to reach
its most visible form in the 2000s. This deregulation resulted in banking
institutions engaging in practices such as securitisation, off-balance sheet
risks and poor pricing of risks as well as the loosening of the loaning
conditions which drove the liquidity to unsustainable levels leading to rapid
price appreciations and subsequent demise of the financial systems. The growth
of the shadow banking system which many respondents attributed to the influence
from the USA also played a significant role. This subsector was largely
unregulated and was responsible for some of the presumably thoughtless risk
taking activities that later led to the paralysis of the system. The existence
of global imbalances and the inability of the UK regulators to restrict the
inflow of excess liquidity from emerging economies were blamed for the
aggravation of the liquidity issues. While the movement of capital was becoming
more and more easy across national borders, the regulatory bodies remained
largely disjointed making it difficult to regulate the activities of the
multinational institutions. This factor was commonly cited with the inflow of excess
liquidity from China being specifically fronted as an example of poor
frameworks for controlling the extent to which the global nature of the UK
economy can interfere with the national economic stability.
The
attitude of the UK regulators towards the practice of creative accounting also
contributed to the crisis. While countries such as the USA had strictly
criminalised ‘creating of accounts’, the practice was still largely acceptable
with many companies creative false perceptions about their financial status.
The use of creative accounting as seen with the increased movement towards
securitisation tended to shift focus away from the potentially bad-looking
balance sheets to the ‘good looking’ cash flow statements. The adjustment of
financial statements by banks and other institutions in the economy where the
companies continued to show impressive results or had impressive explanations
for any declines made it difficult to detect that the economy was heading in
the wrong direction. An early detection of such occurrences would have
prevented the crisis in the magnitudes that were experienced. Poor mechanisms
for detecting system failures were also virtually non existent. Respondents
also cited the failure of the regulatory agencies to ensure that banks continued
to hold liquid assets that would be sufficient to cover all their obligations
in the event that a significant proportion of their loans became bad debts. The
massive debt failure resulted in the crippling of most banks hence making the
market incapable of correcting its inefficiencies in the available time. The respondents were then asked to
comment on some of the steps taken to ensure that the banking sector in the UK
was better regulated. The responses were varied albeit with a convergence of
certain key points. To start with, the global financial crisis triggered the
realisation that the flow of capital is no longer restricted to the national
borders. This realisation has triggered a general sense of cooperation between
regulatory bodies in regions and internationally to ensure that a certain level
of uniformity is observed to ensure that the banks in each of the countries in
question do not engage in activities that may destabilise global economy.
Several meetings hosted by the UK and the USA have been focused on eradicating
some of the rogue banking industries that have been known to provide a safe
harbour for money laundering and criminal activities with the realisation that
such industries were capable of causing liquidity problems in the global
economy. The IMF was assigned the role to monitor financial services sectors in
various countries and make recommendations on the necessary changes that would
enable the stabilisation of the same. Most respondents held the view that the
establishment of supervisory colleges for multinationals was a step towards
ensuring accountability at an international level and a way to curb the
influence of weak financial systems.
Some
of the other changes implemented relate to the reforming of the risk management
calculations with aspects such as underwriting and valuations receiving
particular attention. According to the respondents, this focus was made to
ensure that there is accurate pricing of risks and therefore shielding the
banks from unnecessary losses. Focus has also shifted to crucial risk pricing
instruments such as credit ratings with the government regulating the manner in
which such ratings are to be done. This considerably brings discipline in the
banking sector and enables proper pricing of the securities.
The
responses on whether or not the respondents would advocate for more regulation
were varied with only about 55% of the respondents calling for more regulation.
This pales as compared to over 80% who were in support of current regulations
as recorded above. The conservative support for regulation is weighed between
the need to secure the industry from potential collapse as was the case with
the global financial crisis, and the need to continue maintaining an economic
environment attractive to investors. While bankers significantly opposed the
introduction of additional regulation, investors were somewhat equally divided
with the regulators being strongly in support. This difference of opinions may
be is an evidence of the influence of personal experiences on the outlooks of
the respondents.
The
effectiveness of the current measures was lauded by a majority of the
respondents as quite effective in the current circumstances. The focus on
improvement of transparency in governance and accountability of banking
institutions has been crucial to restoring the much needed confidence in the
banking industry. The responses were almost unanimous when it pertained to the
impact of the regulatory changes on the banking sector. The distinctive view
among the bankers was that the regulation was good in the sense that it was
introducing some level of uniformity which made it possible for them to compete
without any government-induced advantages or disadvantages. The move to
regulate the shadow boxing sector has also been lauded by bankers who view the
move as crucial in stabilising the industry. However, this strong support must
be seen as a function of the bankers’ private interest in light of the fact
that lack of regulation levels the playing ground and denies the shadow banking
players the opportunity to bend rules with an aim to eating into the market
share of the mainstream banks. The bankers also lauded regulation in terms of
standardisation of credit ratings and underwriting practices where the banks are
better equipped to accurate pricing of risks hence avoiding any unnecessary
risks of default. The frameworks that have been developed to enable sharing of
information between bankers and between industries have also been lauded as
important in ensuring credit ratings of prospective borrowers are accurately
traced enabling them to do an accurate assessment of risk.
The
respondents were then asked whether the regulations introduced were sufficient
to prevent the occurrence of another financial crisis. Opinions were almost
equally divided in this regard with only about 51% agreeing that they were
sufficient to prevent the occurrence of yet another financial crisis. Those in
favour contended that the triggering factors of the previous crisis had been
identified and sufficiently dealt with. Issues such as an unregulated shadow
banking sub-industry, unregulated policies in credit rating, and inaccurate
pricing of risk through problems of fraudulent underwriting have been
adequately dealt with. The fading confidence in the banking industry which had
reduced way before the crisis has also been restored through transparency and
accountability in the governance practices and accounting. The introduction of
an information-sharing platform among banks in the region is also an important
factor that has enabled the proper analysis of the borrowers’ credit histories
thereby effectively reducing the risks of default.
Several
arguments were however raised to counter the perception that a financial crisis
could be prevented by the regulatory changes already implemented. The main
argument raised was in light of the fact that economic recessions which
eventually lead to financial crises do not necessarily come from the problems
in the financial sector. For instance, where any occurrences substantially
change the demand levels in a country, organisations may be forced to lay off
workers in mass hence further reducing the disposable incomes available to the
average consumer. As a result of the economic upheavals, the investors may opt
to refrain from engaging in investment activities in fear of losing their
investments hence further aggravating the financial problems. Examples of
financial crises are therefore many and in many cases in need of regulatory
frameworks that generally focus on entire economies and as the respondents
contend; banking regulation alone is not sufficient in preventing the
occurrence of a financial crisis. In regards to regulation, some of the
measures taken were cited as insufficient. For instance, the move to pursue
greater synchrony in global regulation of financial services sectors which was
temporarily set aside due to political considerations left the globe vulnerable
to such crises in the future. This threat is compounded by the fact that any
moves to implement restrictive policies in individual countries may be
counterproductive to the gains already realised from the growth in
globalisation of trade. This vulnerability must be tackled at a political level
and regulation at industry level can only be fully effective in markets that
are largely non-globalised. However, the respondents were unanimous that in the
presence of sound regulatory frameworks, the financial systems would remain
stable and retain the potential to restore normal economic activity through the
workings or the market forces. The respondents also cited the practice of
creative accounting which accountants have used in the past to create
perceptions that are not reflective of the true and fair value of the companies
has not been explicitly outlawed. As opposed to countries such as the USA which
regards the practice as fraud, the UK continues to maintain the area as a grey
area to be judged on the basis of established levels of seriousness. This means
that the practice is bound to return to the pre-crisis levels once the jitters
in the banking sectors subside.
Further
recommendations on the steps to ensure that the sector is stabilised mainly
dwelt on the global nature of the UK economy and the need to ensure that the
domestic economy is safeguarded against global practices that may put their
financial sector at risk. Practices such as money laundering that occur on a
global scale were cited as some of the threats to look out for. The approach
taken by many countries around the world to pursue exclusive policies in
financial regulation were cited as a major hindrance and respondents
recommended that such policies should be brought into conformity with agreed
global principles. Respondents also recommended the streamlining of the
International Accounting Standards in order to get rid of loop holes for
creative accounting thereby getting rid of potential loopholes that can be used
to destabilise financial systems in at individual countries which in turn
affects countries such as the UK.
The
results outlined in chapter four only capture the perceptions of the
respondents and have not taken into account any theoretical frameworks or
indeed the input of other works done in related areas. The chapter factors in
the analysis of various secondary data encountered while conducting the study.
The discussions are as described below:
The
global financial crisis adversely affected the financial systems to a level
that of imminent collapse, a situation that prompted the government to come up
with rescue measures to revamp the financial services sector. The UK government
spent over $ 743 billion at the height of the crisis: funds that were mainly
channelled towards the strengthening of the banking industry (Lapavistas, 2009).
After the near collapse of the industry, it became necessary to examine the
regulatory frameworks and the systems that had led aggravated the seriousness
of the crisis. On the face of it, it would appear that the financial crisis
experienced in the UK was an imported crisis having first been triggered in the
USA and spread to the rest of the world through the workings of global forces
of demand and supply (Guillen, 2009). The crisis in the USA had been triggered
by the existence of excess liquidity that had seen financial services providers
relax their lending rates hence prompting massive debt defaults. These
practices were made worse by the fact that the industry was largely unregulated
and the fact there was a shadow banking subsector whose activities were not
being monitored with the same level of seriousness as the mainstream banks
(Lapavistas, 2009). Activities of institutions such as investment banks,
providers of hedge funds, mutual funds and insurance institutions were
previously subjected to minimal regulation and the impact of their activities
on the stability of the financial systems had received little attention. Their
regulation therefore sealed an avenue through which the financial systems in
the economy could be substantially weakened. The rising prices of housing led
to a situation where borrowers were no longer able to sustain their debt
obligation leading to the massive defaults that rendered most banks paralysed
(Overseas Development Institute, 2008). A quick spreading of the crisis to the
securities market further aggravated the crisis adversely affecting the global
demand levels for goods and services.
In
as much as the crisis in the USA contributed to the occurrence of a crisis in
the UK, a closer review of the financial systems in the UK reveal that various
fundamental weaknesses existed in the UK banking sector, making them unable to
pull the UK economy from the crisis it was in (Chartered Institute of
Management Accountants, 2010). The close relationship between market
philosophies and the thinking among market players in the USA and the UK was
evident when the causes of the crisis were analysed (Chartered Institute of
Management Accountants, 2010). The regulatory weaknesses that dominated the USA
financial systems also seemed to be present in the UK.
For
instance, the real estate prices were on a rapid rise fuelled by high levels of
liquidity in the market. This liquidity had mainly as a result of unregulated
banking practices where banks had greatly reduced the minimum requirements for
accessing credit facilities (Financial Services Authority, 2009). It is also
recorded that the practice of predatory lending was on the rise where banks
would scout for customers with poor credit histories and induce them to take
loans which they would provide at relatively low interest rates (Financial
Services Authority, 2009). This was clearly a violation of any standards of
decent practice and a sound regulatory framework would have certainly stemmed
the practice. The practice of subprime mortgage lending was also on the rise
(Overseas Development Institute, 2009). Borrowers were allowed to take
mortgages even though their credit ratings were not adequate enough for them to
qualify for the mortgages under normal circumstances (Chartered Institute of
Management Accountants, 2010). Again, this practice was so rampant that any
serious regulator would have noticed that it would be unsustainable over the
long run and possibly lead to more problems in the financial systems. Securitisation
among banks was also common where banks would repackage some of their
receivables and sell them as securities in the market hence portraying the
firms as more stable than they actually were (Lapavistas, 2009). This misled
investors and led to a creation of a bubble that was bound to burst at the
earliest sign of trouble. There was also a problem of excess liquidity which
was coming from economies such as China and Japan which were booming at the
time. The Chinese government had resorted to buying of foreign securities as a
measure of controlling liquidity in their domestic markets (House of Lords,
2009). This meant that they offloaded their excess liquidity to the USA and the
UK markets hence increasing the liquidity in the economies. The currency
fluctuations had also allowed speculators to buy the Japanese currency and
offload them in the USA and the UK in order to capitalise on the currency
disparities hence further aggravating the liquidity problem (House of Lords,
2009). These liquidity issues led to the sky rocketing of the prices in the two
economies. Instead of taking proactive action by raising the reserve ratios,
the regulators chose to maintain the prevailing credit ratios hence offering no
avenue for the absorption of the excess funds in the market (Lapavistas, 2009).
These collective failures in the regulatory frameworks culminated into the
crippling financial crisis that hit the UK in the late 2000s.
The
review of the historical development in the UK revealed that the UK had been
steadily moving away from state controlled regulation in favour of market
regulation where market players could organise themselves into bodies which
would then check their practices (Trades Union Congress, 2011). The fundamental
flaw in this move, according to analysis, is that whereas the state is
primarily tasked with the responsibility of securing the public interests, such
regulatory bodies would be largely influenced by the bodies being regulated
hence become tools of advancing private interest (Lapavistas, 2009). The
regulatory frameworks developed were therefore devoid of any moves restricting
the activities that were deemed as good for the banks (Lapavistas, 2009).
Having
identified the regulatory flaws that led to the financial crisis, a number of
regulatory changes were put in place to ensure that the weaknesses identified
are dealt with. To start with comprehensive regulatory frameworks were put in
place to ensure better compliance within the shadow banking subsector (Trades
Union Congress, 2011). This move was made to ensure that all providers of
financial services acted in a manner that would not be prejudicial to the
financial status and the well being of the whole economy. Practices such as
fraudulent underwriting that had led to banks pricing risks inaccurately were
curbed. The accountability and transparency thresholds in the banking industry
were raised in a move aimed at restoring the public confidence in the financial
institutions (Bank of England, 2011). This confidence was necessary to get the
public to continue using the banking services for the stability of the whole
economy. Practices such as predatory lending were highly restricted and the
frequency with which the practice was being undertaken was a pale shadow of the
past (Bank of England, 2011). The financial services authority which is the
main regulator in the banking sector in the UK also introduced measures such as
the raising of the threshold for securitisation.
The
regulators also moved to improve the quality and quantity of capital
requirements for banking institutions (Deringer, 2011). This move was aimed at
ensuring that sufficient funds existed in the banks to cover depositors in the
event that the bank ran into liquidity issues through mass defaults as the ones
experienced during the financial crisis (Deringer, 2011). Despite the fact that
the move greatly lowered the rates of return on equity, it was viewed as
crucial in assuring the stability of the banking sector. The FSA also moved to
raise the threshold of practices such as securitisation. This was done by
requiring substantial raises in the capital requirements before a bank could be
allowed to securitize its receivables (Financial Services Authority, 2009).
This effectively corrected the creative accounting element of securitisation
where the banks would have under normal circumstances used securitisation to
portray their status in a better light that they actually were. The changes to
the trading book capital also ensured that banks were less willing to take unnecessary
risks hence reducing chances of the occurrence of massive defaults as
experienced in the last financial crisis (Chartered Institute of Management
Accountants, 2010).
The
regulators also introduced some controls restricting absolute amounts of certain
categories of capital in the banking institutions. Some of the regulations that
have been introduced by the regulators are such that for any institution to be
fully compliant, the minimum component of the Core Tier 1 capital would stand
at 4% (Financial Services Authority, 2009). There were also moves to ensure
that the Tier 1 ratio is adjusted to 8%. This dynamic approach was estimated to
generate an additional buffer at an equivalent figure of 2-3% (Financial
Services Authority, 2009).
The
FSA also moved to manage liquidity in the banks and in the industry in view of
the fact that liquidity issues were at the heart of the financial crisis. Banks
were required to reveal more information about their operations that were
likely to significantly affect their liquidity positions and thereby affect
other banks due to the interconnectedness of the institutions (Deutsche Bank
Research, 2009). Such information would include an analysis of the off-balance
sheet activities that could impact on liquidity, analysis of the liquidity of
trading assets, and detailed maturity ladders among others. The FSA would
continue to be intricately involved in monitoring liquidity by receiving the
banks assessments of their liquidity positions and in turn receive from the FSA
liquidity guidelines (Chartered Institute of Management Accountants, 2010).
These measures also transferred the definition of stress signals from the
individual banks to the FSA which would raise the alarm at an appropriate time.
This is unlike the individual bank systems which would either fail to detect
the stress signals in time or just choose not to raise the alarm for fear of
sparking a confidence crisis in their status.
An
approach to guarantee international cooperation among the regulators of
financial industries across the world was also put into perspective. Earlier
suggestions involved the establishment of a college that would oversee the
financial activities of multinationals across national borders and advise on
the national regulatory frameworks in place (Financial Services Authority,
2009). The suggestions were in realisation of the fact that financial systems
are increasingly globalised and capital can flow across national borders with
much more ease than at any point in history. Countries therefore remain vulnerable
to any financial problems in other countries where excess liquidity and
significant changes to the levels of demand affect the whole globe albeit with
different intensities (Chartered Institute of Management Accountants, 2010).
This suggestion was however soon dropped in favour of a global financial
regime. This new system would however come under strain from countries which
were keen to protect their sovereignty (Chartered Institute of Management
Accountants, 2010). In their opinion, a global financial regulatory regime
would require that they give up crucial elements of their sovereignty and that
would essentially make them gross importers of policies which may not
necessarily be geared towards the advancement of their country-specific
objectives.
As
analysts would observe, the regulatory changes have been crucial in ensuring
that the public confidence is restored in the sector, hence becoming very
instrumental in the recovery from the financial crisis. The changes were also
lauded in enabling the country to have early detection systems to ensure that
future crises are prevented, or at least have their magnitudes substantially
weakened (The Treasury Committee, 2011). The involvement of the FSA in
monitoring liquidity is seen as a crucial element of regaining control over a
sector that had hitherto been in the control of private interests. Other
changes such as the raising of the quantity and quality of capital as well as
restricting the book trading capital have been variously lauded as good
incentives for ensuring that the banking institutions act with more caution.
However,
more steps could be taken to ensure that the crises such as the one in 2000s do
not recur. Earlier suggestions such as the creation of counter cyclical buffers
would need to be put in place and in a format that did not discourage
investments. These buffers can be created by letting the capital levels to
increase during booms and letting them decrease during recessions in a manner
designed to reduce the amplitude of the cycles (Financial Services Authority,
2009). Such a move would help secure the financial systems. Observers also hold
reservations on the nature of the relationship between the FSA, the bank of
England and the Treasury where each of the institutions tend to handle specific
aspect of the financial systems without a very well developed information
sharing platform that would enable early detections of instability and a
collective approach to pre-empt such dangers (The Treasury Committee, 2011). As
analysts observe, this fundamental weakness must be catered for to ensure that
the country is better prepared for any unfortunate eventualities.
This
chapter provides a summary of the contents of the research paper. It revisits
the objectives of the study, recaptures the research questions and goes on to
outline how the findings of the study have answered the research questions. In
other words, it simplifies the content of the paper to display findings at a
glance.
This
research sought to establish the implications of the global financial crisis on
the enactment of risk free regulatory micro-structures in the UK banking
sector. The research then made use of primary and secondary data collection
methods to answer to the following research questions: What mitigating factors
in the baking sector contributed to the magnitude of the global financial
crisis? What regulatory frameworks have the regulators taken in order to
strengthen the financial institutions? How effective, if at all, have these
emergent policies been? And what other policies can the regulators embrace in
order to ensure an even stronger banking sector?
The
causes of the financial crisis that are specific to the UK have been identified
to have their root in the move by the UK to essentially deregulate its banking
industry. These poor regulations also extended to the shadow boxing subsector
whose activities further led to the aggravation of the crisis. Practices such
as subprime lending were on the rise buoyed by the increased liquidity in the
market that was both a function of the greatly reduced reserve rates and the
inflow of excess liquidity from the Asian countries such as Japan and China.
Banks also started in engaging in unethical practices such as predatory lending
which saw them identify persons with poor credit ratings and induced them to
demand for the loans hence ending up with many borrowers with little ability to
repay the loans. The excess liquidity in the market led to rapid rises in prices
in the real estate sector making it difficult for many of the borrowers to
honour their obligations. This led to massive defaults which literally
paralysed the banking sector. Practices such as securitisation which were
rampant at the time also went unchecked leading to a situation where the banks
used their cash flow statements to portray themselves as healthier than they
actually were hence suppressing any chances of early detection of the weakening
of the financial sector.
As
a result of the crisis, several measures were taken to ensure that the
financial sector is restored to normalcy. Some of the initial measures taken
involved the requirement for greater transparency and accountability in the
accounting and governance practices in the bank. This move was essential in
returning the public confidence to the banking industry. The Financial Services
Authority also moved to make some changes in the requirements of the quality
and quantity of capital in the banking sector in a move to ensure that banks
were not inclined towards taking unnecessary risks. The threshold for
securitisation was raised significantly where a given addition to the trading
book capitals would be required. This effectively meant that any image
improvement as portrayed by the liquidity of the banks would be backed by real
value in the institutions. The investors would therefore be confident that the
good images portrayed were real and not just mere fabrications. The FSA also
took up a more serious role in monitoring liquidity and ensuring that any signs
of strain were quickly highlighted in order to trigger timely corrective
mechanisms. The shadow banking subsector was also accorded the attention due to
it in recognition of its ability to stabilise the financial systems.
Additional
measures that were yet to be fully implemented involved the generation of
mechanisms to create a buffer through the adjustments of capital requirements
in the boom and recession periods. Suggestions to raise capital requirements in
booms and reduce the same in recessions were viewed as essential instruments
for reducing the amplitude of the economic cycles and therefore essential to
assuring the financial stability of the economy. The embracing of a new system
of pricing risks was also suggested. The new system suggested proposed the use
of cyclical rates as opposed to the on-point system currently used. This system
would however need intricate application in order not to appear like a price
control mechanism which most market players in the UK abhor.
It
is also important to take cognisance of the fact that financial systems are
increasingly globalised with most people able to transfer capital from one
country to another with more ease than at any point in history. This brings
forth the interconnected nature of financial systems globally implying that a
financial crisis in one country is bound to adversely affect the financial
systems in other countries, especially the ones with whom they have more
economic ties. In recognition of this fact, the UK and their counterparts in
the G20 have been proactively looking for ways to ensure domestic financial
regulations are well synchronised. Analysts view this approach as the most
reliable one and which should be pursued with maximum efforts. This approach is
however faced with lots of challenges especially from countries which view
themselves as les influential in the global arena. In fear of the fact that
they would have little say in determining the policies to be enacted, such
countries have resorted to quote claims of compromised sovereignty to avoid
taking part in such a regime. Measures to involve the IMF remain largely
ineffective and in the absence of any global regime, the threat of financial
crises remain real despite the comprehensive regulatory changes made in the UK
and in most of their developed counterparts.
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