economics revised

8/6/2019 Economics Revised

http://slidepdf.com/reader/full/economics-revised 1/9

Critically assess the structure, conduct and recent performance

of the UK banking sector.

By Ambika G.

Introduction

UK¶s banking sector has grown at an average rate of 2.3% annually since 1990 from £1,266 billion to £7,616 billion in 2009 and is one of the most important sectors of the country¶s

economy. Over 50% of the assets in the UK are owned by foreign banks. The banking sector iscurrently in a state of crisis which according to most economists was caused by the large

surpluses and deficits in the current accounts of the balance of payments of many countries.

Historically, the banking firms in UK were confined to retail banking and were limited to certaintypes of business and Since1960s, retail banking in the UK has been dominated by the ³big four´

Barclay's, Lloyds, Midland and National Westminster who were accused of being an oligopolyand of cross-subsidization. Thus began a slow process during which policies changed and the

UK government encouraged greater competition in the banking sector by loosening uprestrictions in banking industry. After deregulation, the free market economy helped to generate

hypercompetetion (Zuboff 1996). Traditional lines within the sector were broken down and gave birth to wider product range. (Thwaites1991).

Root cause of Crisis ³The root of the problems of the British banks is the same as that of American banks: shaky

mortgage-backed securities´ (Richard Anderson,2009). These assets which were valued as AAAweakened by the rising mortgage default rates and their values dropped sharply.



Effects of Crisis

1.By March 2009,because of the major slowdown in the UK economy, Bank of England reducedits base rate to 5.5% which was 5.5% on Dec 6th 2007. to 0.55%(see figure no. 2),

Source:- bankofengland.co.uk last accessed Feb,21st ,2011

Source:- bankofengland.co.uk last accessed Feb,21st ,2011



2. Evolution of loan loss provisions

During the time of economic downturns, banks face external financial frictions such as financial

crisis; during this period it becomes difficult for banks to immediately restore reduction in equity

capital.

Source: www. Reuters.com, last accessed 21stFeb ,2011

3. Evolution of capital to assets ratio Capital to assets ratio determines the amount of capital that a bank needs to maintain in theform of shareholders asset. This determines its ability to meet the time liabilities and other risks

such as credit risk, operational risk.

Source: - www.reuters.com Last accessed Feb 21st, 2011



4.Return on Equity The efficiency of banks can be measured through the use of the return-on-equity (ROE) ratio,which shows to what extent banks use reinvested earnings to produce future profits.

Source:-www.reuters.com last accessed 21st Feb,2011

Post Crisis

The British government aggressively planned to resolve the financial crisis issue through variousmeasures, precisely through mixed system of capital injections and asset guarantees. One of the

major steps taken by UK government was recapitalization and asset insurance for some banks.The U.K. government has introduced a mixture of bank recapitalization's and asset insurance for

some banks. The government elicited a promise from the banks that they would maintain their lending to small, medium-sized enterprises and households in exchange of capital injections. The

UK government also introduced ³Asset Protection Scheme, a program to provide protectionagainst credit losses occurring on specified pools of assets above a certain

threshold´(Huertas,T,2010).

Following mergers and acquisitions took place in the mid of 2009.

y In June 2009, Temasek sold its entire stake in Barclays.

y In 2009, Lloyds banking acquired HBOS and Lloyds TSB Group and was renamed asLloyds Banking Group.

y On January 14, 2009, RBS sold its entire 4.26% stake in Bank of China.y On February 2 2009, Standard Chartered acquired Cazenove Asia Limited from JP

Morgan Cazenove. On July 1 2009, it completed the acquisition of its remaining interestin First Africa Group Holdings Limited.



Post-crisis business model drivers

Post-crisis operating environment changes

1. Some regulatory and policy initiatives were taken on different areas of banking sector. Theseareas include, activity and asset mix, funding and liquidity, leverage level and quality of capital,as well as some business practices, risk governance and management.(Huertas,T,2010)

2. Higher and better Quality capital requirements were improved when higher credit cost for

private sectors were implemented.

4. Less chances of arbitrage.

5. Financial firms have been trying hard to cut costs and improve efficiency .However, Therewill also be upward pressure on costs in several areas, like a higher degree of regulatory

compliance, newI

T and other infrastructure investments, and spending related to preserving thequality of services provided to consumers.(Huertas,T,2010)

Retail and commercial banking Retail and commercial banking will continue to be liability-driven. There may still continue touse the covered bonds and may limit the usage of securitization.

Wholesale and investment banking WIB firms responded by divesting and refocusing their business models on core activities byreducing costs and restructuring their most severely impacted assets. There is likely to be a shift

from high-margin products to lower-margin products.

Building societies and other mortgage lenders

In the broader European landscape, Some of the mortgage market such as Germany, France,

Spain, Italyand other countries have moved from independent to group banking system few years

ago, However UK building society still retains its old method of being independent specialized

mortgage lenders.



IMPROVING BANKING STRUCTUR E

According to Dr.Thomas F. Huertas there are many reasons for financial instability. He quotes

the Modigliani ± Miller and explains the concept:-

y In perfect markets, the value of the firm is invariant with respect to its choice of

financing.y Increase in leverage should not be calculated as increase in value of the firm, as the fall of

value of debt may offset the value of equity.y The market is perfect- It means that imperfections (Taxes, bankruptcy costs) exist and

this would not affect the capital structure of banking industry.y However these concepts are based on certain assumptions: - the value of the firm is not

dependent on liabilities that firm issues. Secondly, it assumes that market is perfect.

Source- www.fsa.gov.uk, last accessed 23rd Feb,2011



CONCLUSION

The global financial crisis has revealed the weaknesses in the financial regulatory system. Some

of the important areas of regulation which involve the current regime for the regulation of bank

capital ratios like ratio of shareholder equity to total assets, it is crucial because equity is the powerful tool that absorbs losses in the event of write-offs of non-performing assets. So a clear change in the system is needed. Statutory frameworks needs to be revised and a new regulatory

system must be encouraged. The major objective should be cutting costs and reducing thesystematic risk by focusing more on benefits over costs. Under the risk-weighted capital

regulation regime of Basel 2, the use of backward-looking models for risk assessment creates aunstable tendency for capital. The effectiveness of risk mitigation techniques should be

systematically reviewed and revised periodically.



References

1)Bank of EnglandFinancial Stability Report

Monetary and Financial Statistics

www.bankofengland.co.uk

2)Brunnermeier,M.k.(2008), ¶Deciphering The Liquidity and Credit Crunch 2007-08¶,, The

National Bureau of Economic Research, NBER Working Paper No. 14612 (accessed November 11¶2010)

http://www.nber.org/papers/w14612

3)Huertas, T(2010),¶Changing dynamics for banks¶ and building societies¶ business models¶,Financial Services Authority 2010¶

http://www.fsa.gov.uk/

4)Huertas,T.F,2010 ¶I

mproving Bank Capital Structures¶,BankingSector,FSAhttp://www.fsa.gov.uk/pubs/other/th_18jan10.pdf

5)http://iimc-finclub.com/,

Finance club,last accessed 23rd

Feb 2011

6)Ifsl Research

Banking 2010

http://www.ifsl.org.uk/media/2372/IFSL_Banking_2010.pdf

7)www.Reuters.comhttp://uk.reuters.com/sectors/industries/significant?industryCode=128&categoryId=225

8)Thwaites,D.,1991³Forces at Work: The Market for Personal Financial Services,´ International

Journal of Bank Marketing (9:6), pp. 30-36.a

9)Trading EconomiesCountry Ranking By Central Bank Interest Rates

http://www.tradingeconomics.com/World-Economy/Interest-Rates.aspx

10)Zuboff, S. 1996³The Emperor¶s New Information Economy,´ in W. J. Orlikowski, G.

Walsham, M. R. Jones, and J. I. DeGross (eds.), Information Technology and Changes inOrganizational Work , Chapman & Hall, London.

economics revised

Documents