The Structure, Conduct and Recent Performance of the UK Banking Sector
Before discussing the structure, conduct and recent performance of the UK banking sector, it is useful to provide an insight in the recent global financial crisis caused by the sub-prime mortgage crisis initiated in the US and underline its effects on the banking industry in the UK - The Structure, Conduct and Recent Performance of the UK Banking Sector introduction. It all started with the collapse of the housing bubble in the US, as borrowers were no longer able to meet their financial obligations and as consequence many of these subprime mortgages became default and the market became illiquid while banks were struggling to obtain funds which resulted into devastating losses for banks and mortgage lenders.
Through securitization many of these loans were initially transferred into asset backed securities and were sold to third parties using complex structured financial instruments. In fact, the risks were actually passed on to other large institutional investors. This spillover effect became soon evident in the rest of the world due to the high integration of global markets as well as its financial sector linkages worldwide. In order to better assess the structure of the UK Banking sector, it is important to understand the difference before and after the crisis.
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Hence, the main question here should follow as: what has changed in the financial system and what are the characteristics? In the years prior to the crisis, the use of financial markets to generate revenues, obtain funding for lending and hedge credit risk by major banks is greater than before. This indicates that it’s more vulnerable to credit risk in the case of deterioration of the market. Remarkably, the ‘originate and distribute’ business model where banks can originate loans and sell them off to investors who is willing to expose such risk is growing rapidly and generating high revenues.
Due to their leading role as providers of such leveraged loans, the eventual credit risk retained on balance sheet would appear to be relatively modest. However, there has been some skepticism about their focus on market share while neglecting risk exposures. (Bank of England, 2007) THE EFFECTS OF THE CRISIS AND THE CHANGE IN STRUCTURE The impact of the financial crisis on the UK Banking industry was severely felt. Following the collapse of Lehman Brothers in September 2008, government implemented urgent measures to provide capital injections to financial institutions.
Northern Rock was subsequently nationalized because it was simply relying on funding through the wholesale markets for its mortgage lending. HSBC and Barclays managed to raise capital privately. Some other banks were bailed out as the UK government acquired proximately 70% stake in RBS and 43% of the Lloyds Banking Group. Traditionally, the banking industry was dominated by the following big five: Barclays, Lloyds, Midland, National Provincial and the Westminster Bank. During the past decades there have been significant changes in the size through merger & acquisitions.
The Midland Bank was acquired by Hong Kong and Shanghai Banking Corporation to create the current HSBC, National Provincial merged with National Westminster and was later acquired by Royal Bank of Scotland. Lloyds TSB was formed in a 1995 merger of Lloyds and the Trustee Savings Bank. HBOS (Halifax Bank of Scotland) was formed in a 2001 merger of Halifax bank and the Bank of Scotland. Lloyds TSB acquired HBOS in September 2008, when HBOS held a 20 percent share of the U. K. mortgage lending market.
On February 2 2009, Standard Chartered acquired Cazenove Asia Limited from JP Morgan Cazenove and it completed the acquisition of its remaining interest in First Africa Group Holdings Limited. (Mullineux A. A. , 2009 no. 16), (Mullineux, 2009) CONDUCT Regulatory reform was desperately needed as various policy measures have been implemented by the government in order to ensure recovery of the global economy. Quantitative easing by central banks was aimed to raise the money supply in lending after reducing interest rate to a record low.
The Government introduced the Asset Protection Scheme which provided banks with protection for a proportion of their balance sheets in order to continue facilitating lending to homeowners and businesses. In November 2009 the Financial Services Bill was introduced into Parliament. The Bill builds on the action taken so far by the Government in response to the financial crisis, and delivers wide-reaching reforms to strengthen financial regulation, support better corporate governance and provide protection to consumers.
The Bill calls for a new Council for Financial Stability which is intended to consist of Treasury, Bank of England and FSA officials. It also requires major banks to hold larger capital reserves and to prepare so-called “living wills”. (Maslakovic, 2010) The Basel Committee on Banking Supervision (BCBS) is currently working towards agreement on a comprehensive package of reforms to international capital and liquidity standards by late 2010. These new standards (‘Basel III’) should aim for materially higher levels of capital and liquidity in the banking system. Bank of England, 2010)
RECENT PERFORMANCE According to KPMG’s UK Banking Performance Benchmarking Survey March 2010, the domestic banking sector is divided into 2 groups: RBS and Lloyd (significant government ownership) and the remaining three of Barclays, HSBC and Standard Chartered (privately owned). The latter three has shown a better performance. Investment banking performance was more successful compared to retail banking especially in the first half of 2009 due to better market conditions but it remains a concern whether it’s sustainable. KPMG LLP UK, 2010) CONCLUSION In general, controversial investment practices based on heavy bets which created conflict of interest like in the case of Goldman Sachs, excessive leverage, weak corporate governance and risk management, the lack of transparency in complex structured financial products, high integration of global markets and balance sheet positions of major financial institutions have all contributed to the market failure.
In this essay the impact the global financial crisis had on the UK banking industry and its structure, conduct and performance has been analyzed, with a particular focus on the largest UK owned Banks. One can conclude that innovation in the financial vehicles has changed the nature of its market. The credit crisis has exposed its potential weaknesses as these complex structured financial products. However, the traditional function of the bank has not changed at all.
Northern Rock is a good example of such particular exposure and it demonstrated what should carefully be considered when imposing new law or regulation to tackle such problems. Another issue coupled with the performance nationalized banks underperforms compared to privately owned banks in free market economies as evident in the KPMG benchmark. I believe that consider the severity of the crisis, the bailout by government allows one to carry out due diligence of the troubled bank and allow it to be in good shape before further proceed.