ABSTRACT Banking regulations are referred to directives which are enforced by the government subjecting banks to certain requirements, guidelines and restrictions, designed for creating transparency in market among banking institution, individual and corporations. The present report is about financial crisis with context to a banking institution in UK as Royal bank of Scotland. Report states that ideal regulation of banking institution will be able to prevent crisis in UK. Further it also includes the preventive nature of some aspects of bank regulation and its limitation addressing to banks. The UK had responded to financial crisis with formation of Financial Policy Committee as its initial responsibility. This committee is responsible to determine, mitigate and monitor risks to financial stability with objective to ensure that regulators undertake holistic approach for safeguarding the financial stability. Moreover, it has shown about UK responses for 2007-2008 financial crisis with context to Basel III, banking resolution, stress testing which was performed by bank of England and capital requirements of European union and these turn to be very effective till date. 1
Table of Contents ABSTRACT.....................................................................................................................................1 INTRODUCTION...........................................................................................................................3 MAIN BODY...................................................................................................................................3 Can banking regulation prevent crisis:........................................................................................3 Bank failed globally in particular UK.........................................................................................4 Causes of financial crisis.............................................................................................................4 UK responses to crisis.................................................................................................................6 Risk and the development of the modern banking:.....................................................................9 CONCLUSION..............................................................................................................................10 REFERENCES..............................................................................................................................11 2
INTRODUCTION Banking is the financial institution which deals with various business, investors and public to invest their money into this sector. They provide security for the investment made by the society at financial level. Banks' duty is to provide loans to the public, provide security to their monetary deposits and also provide access to locker facility to safely handle the public security boxes. They also deal in currency exchange and helps small bank to expand their services through guidance and relaxations. Reputed banks also occurs with financial crisis with this note present report is based on banking crisis and also the case of Royal bank of Scotland. Report will include the interpretation of banking regulation and manner in which it can prevent crisis in UK. Further it also includes the preventive nature of some aspects of bank regulation and its limitation addressing to banks. It also includes the examining of risk and development of modern banking. It includes the cases of Royal bank of Scotland which failed globally in UK. Lastly it includes various norms which causes financial crisis. MAIN BODY Can banking regulation prevent crisis: Banking regulation can prevent the issue arises in form of crisis as they ensure that major areas of concerns relating to financial stability are addressed. The banking regulations is also responsible to look after financial institution and holistic financial sector (Banking Regulation, 2019).Mainly bankingregulation majorly involves three institution i.e.the Financial service authority (FSA), Bank of England and the Treasury.These three institutions helps the banks to regulate theirvarious sectors and help the public feel safe when they deal with banks.The role of regulator arises in form of government regulation. Bankregulatoractsastheprimarygoverningbodyi.e.ThefinancialService Authority(FSA) has two main objective to prevent the banks from financial crisis. Firstly It helps the customers to deal with fair and accrualbasis.It offers servicesin favour of the customers and no results of fraud committed in the services (New Regulation to prevent financial crisis and improve financial stability,2019). Secondly it's the duty of the banks to promote fair and eligible services which helps the banks to grow more in comparison tootherbanks. Customers are usually attracted from the services, trust and security which banking institutions built with the customers. With these aspects, FSA set the standards and norms for every banksto limit their 3
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working which assurance that they are regulated and major areas of concern are looked upon. This conditionindirectly help the bank to restrain from financial crisis. Bank failed globally in particular UK/Causes of financial crisis By doing assessment, it has identified that there are several reasons due to which situation of financial crisis occurs in a nation.Hence, occurrence of speculative activity in the financial market is recognized as the main reasons behind global monetary crisis.Thus, US subprime mortgage crisis was recognized as a nationwide crisis which in turn resulted into recession occurred during the period of 2007 to 2009. Such situation arose after huge decline in home prices after collapse of housing bubble.Due to the increasing level of property transactions in USA and Western Europe situation of financial crisis arose. At the time of financial crisis, borrowing level was high due to the rising prices of properties. However, at that time, difference between income and debt level had widened(Allen and et. al., 2015). At global level, rising energy prices resulted into worldwide inflation. Hence, in such situation, most of the borrowers were unable to repay mortgages. Along with this, prices of properties also started to fall which in turn placed negative influence on banking institution. During global monetary crisis majority of the banks were not in situation to repay the amount of loan and interest(Dagher, 2016).This in turn resulted into collapses of mainly USA and UK banking institution. First cause is theauditing services, The government has set some norms for every banks to be properly audited by an appropriate officer. It bringsthe limitation of top prioritizing effective planning and performance of financial statement, as auditors are strict towards the time management and various facts which are to be mentioned in their accountswhich burdens banks to double their attention towards their financial statement development process. Second cause is related toFinancial Ombudsman services(FOS), to implement with this nature of aspects the bank regulator can earn more confidence of their customers. The major effect in terms of banks is that sometimes customer claims for wrongful conduct which exploits the bank image and by this the responsibility of higher authority is to inspect the matters internally and disclose it at the right time. The bank limits the area to provide information to the authority regarding the facts disclosed. Third aspects is related toPayment service method.Previously the transaction for cash and cheque or online transaction are not much in scope but now-a-days people mostly prefer 4
online payment for easier cash flows. Banks regulator are investing huge amount for the security of the customer's money and are also engaged so many techniques to prevent it from the hackers. But the biggest cause is that the hackers have been able to overcome the financial wall built by the banking institutions. Fourth cause is related toCompensation services,As people invest their money in the banks for financial safety and security. But if they suffer loss in business or any other financial setback than it is the duty of the bank to provide customer with compensation for the loss incurred so that bank maintain a trust among the customers. In case they also help other customers to cope up with their problems and invest in other business to recover from their losses (Shapiro and Skeie, 2015). Compensation is the most important criteria to maintain and build trust among the investors and customers. But banks carries some limitation relating to provide payment as their are some standards against which they are not liable to help the customers. This distracts the customers interest towards the bank services. Subprime mortgage crisis and Lehman brothers By doing assessment, it has found that Lehman Brothers, world’s largest bank dissolved during 2007-08. Moreover, such banking institution was involved in investments like mortgages to the large extent. Hence, during the period of greater recession Lehman brothers was affected adversely due to the decreasing prices of real estate. Further, defaults on mortgage also considered as the main aspects due to which Lehman brothers failed to operate in the market. During that time, many efforts were made by the bank in relation to mitigate the impact of concerned situation by issuing stocks. Along with this, such banking institution also compelled to close their subprime lenders during this time period. In addition to this, case of Salomon Brothers is linked with the situation of monetary crisis. Moreover, such brothers created cut- throat corporate culture which emphasized on risk taking behaviour. Further, in year 2008, Royal Bank of Scotland was the third largest underwriter of residential mortgages as it packaged and sold to some investors and securities. It has announced the appropriate issue in new capital offset with outcome of credit market position along with possibility of divesting in some of its subsidiaries for raising further funds, notably its divisions of insurance (Royal Bank of Scotland collapse,2019). There were some allegations that they misrepresented types of mortgages which it directly sold to investors during housing bubble 5
further becoming ultimate reason of financial crisis. The banks' failure affected British region in a significant manner and higher burden of dealing with banking requirements fell upon Northern bank. It had been declared that failure is because of bad decisions, clearing senior management of bank which includes chief executive as well. They pursued the deal with absence of undertaking full due diligence of business for takeover of ABN Amro. The government has accusedRoyalbanksofScotland along with many other big banksfor purposeof not understanding risk and quality of mortgage to investors at height of housing bubble in between 2005 and 2008 (Campbell and Cartwright, 2017). These particular investors bought up tens of billions of dollars in mortgages through RBS and other banks as well and faced massive loans when borrowers failed for repaying housing prices collapsed nationwide. According to government prosecutors, bank failed in informing its investors about risky nature of mortgage backed securities along with borrowers could not repay loans for assessments of properties which were inflated (Royal Bank of Scotland fined $4.9B for housing bubble role, 2019). The bank gave inaccurate data which made loans risky asthey window dressed themselves for image and sale of securities. UK responses to crisis The UK had responded to financial crisis with formation of Financial Policy Committee as its initial responsibility which is responsible for determining, mitigating and monitoring risks. The ideal fulfilment of this responsibility will assure that financial stability of UK and making sure that regulators undertake holistic approach for safeguarding the financial stability (Caporaso and et.al., 2015). In this aspect, UK bank had continued for building capital resources from the financial crisis, more than doubling ratios of risk weighted capital. In addition to this, there are in line with judged level appropriate through FPC for banking system of UK for withstanding the major losses. Stress test The Bank of England has conducted yearly stress tests of banking system for ensuring that banks could withstand periods of severe stress. The bank stress helps in identifying that how well a bank may withstand an economic crisis (Bank stress test,2019). It either analysed the bank or put it via a simulation which considers some circumstances which happened during crisis, any catastrophic event or both (Peters and Panayi, 2016). The test evaluate that whether bank has 6
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presence of enough capital for withstanding adverse events and also see for staff training. In year 2016, FPC has passed a judgement that banking system is an aggregate capitalised for supporting real economy in broad, synchronised and stress scenario. In this aspect, this scenario comprised synchronised UK and global recession with linked shocks to prices of financial market along with independent stress of multiple misconduct costs. It shows that bank also runs an exploratory scenario with context to complementing yearly cyclical scenario with objective of biennial explanatory scenario would be probe for resilience of systems to risks that might be not neatly associated to financial cycle. Banking resolution The United Kingdom has carried many reforms with objective to ensure that in any event that banking system does fail, it could be managed in a way which provides protection to broaden economy along with financial sector (Reason, 2016). Resolution is known as process through which authorities could directly intervene for managing failure of company in such manner that it allows failing within disorderly solvency. Furthermore, on basis of banking resolution UK government has taken steps which are stated as implemented a comprehensive regime of banking resolution and passed financial services (banking reform) Act 2013. With context to implementation of comprehensive bank resolution regime, a banking Act 2009 was introduced and extended with several pieces of legislation. The banking act offers a set of objectives that bank should have regard while preparing and carrying resolutions. These are widely very consistent with principles in Financial stability boards. This special regime gives authorities with tools for managing failure of financial sector firms as it considers powers for bank of England for 'bail-in' shareholders along with creditors of failed banks (Jeucken and Bouma, 2017). The Bail-in tool is preferred resolution strategy for most complex and largest firms as it engages writing off the equity and writing down of firm's debt for absorbing losses and transforming debt into equity for recapitalising business. It ensures censorious functions offered through firms are maintained and to use own resources of firms. In the recent era, UK banks have directly issued substantial amounts of loss absorbing instruments of debt directly suitable for this purpose. On basis of passed financial services (Banking Reform) Act 2013 that had made significant reforms to regulations of UK financial services. Specifically, it offers HM treasury and PRA powers for implementing recommendations of independent commission on banking on 7
requirements of ring financing for banking sector (Financial Services (Banking Reform) Act 2013,2019). In the same series, it required the largest UK banks for separating core retail banking services through their investment banking activities by year 2019. Generally, these reforms directly enables authority of resolution for resolving investment and retail banking activities separately as per requirement and ensures that core retail banking services could be treated separately through large balance sheets which offers support to investment banking activities. Basel III In the same series, Basel III has also played role to respond the financial crisis in UK as it is internationally agreed set of measures developed through Basel Committee on banking supervision in 2007-2009 crisis. The objective of such measures are to strengthen regulation, risk management and supervision of banks (Ugolini, 2016). This crisis has prompted the Basel committee to revise its accord for purpose of capital requirements and placing an emphasis on importance of standards of liquidity. In December 2010, there was issuance of new document related on global regulatory standards Basel III for limiting type of risk taking to global financial institutions that precipitated crisis whereas original tow Basel accords had attained failure for prevent (Resolution,2019). The Basel capital requirements has destabilized the financial system by offering incentives to banks to obtain loans off their book through securitizing then instead of setting aside high capital for back them. The G20 has endorsed framework of Basel III at group's summit and is expected to be directly phased in through national governments among 2013 and 2019.Simultaneously,establishmentoftoughercapitalstandardsviarestrictivecapital definition, additional capital buffers, higher risk weighted assets and higher requirements for minimum capital ratios with introduction of new strict requirements of liquidity. BaselIIIaddressesshortcomingsofpre-crisisregulatoryframeworksandgives regulatory foundation for a resilient banking system which supports the real economy (Allen and et.al., 2015).The key objective of revisions directly incorporated into framework and intended to decrease excessive variability of multiple risk weighted assets. On the peak of global financial crisis, broad range of stakeholders lost faith in banks and reported risk weighted capital ratios. This framework will definitely lead to enhance risk sensitivity and robustness of different standardisedapproachwithreferencetooperationalandcreditriskandwouldfacilitate 8
comparability of capital ratios of banks (Schimmelfennig, 2018).There is presentation of constraints with application of internally modelled approaches and complementing the risk weighted capital ratio with finalised leverage ratio and robust and revised capital floor. EU Capital requirement With context to capital requirement's response in July 2009, committee has introduced set ofenhancementsforcapitalframeworkwhichconsiderablystrengthenminimumcapital requirements for purpose of complex securitisations (Dagher, 2016).There is an inclusion of higher risk weights for exposure of resecuritization to better show the risk inherent in these products and increasing capital requirements for certain capital exposures to off-balance the sheet vehicles. The committee is also in need that banks must conduct high rigorous credit analysis of external exposure of rated securitisation. Increment in regulatory capital for trading book has been very crucial element of reform program of committee. In July 2009, it has substantially strengthened the rules which directly govern capital requirements for exposure of trading book (Shapiro and Skeie, 2015).The revised framework of trading book on average, needs banks for holding additional capital around 3 to 4 times then the old requirements, thus better aligning regulatory requirements of capital with risks in trading portfolios of bank (The Government’s regulatory response to the financial crisis,2017). Henceforth, these higher capital requirements for derivative, trading and securitisation activities reinforce stronger definition of capital. Risk and the development of the modern banking: Cyber hacking risk is the major factor which comes up with the modern banking strategy. Usually the times ischanging, so banking factors adopt the online servicesfor making transaction regarding the cash transfer or FD's more convienient.This enables the hackersto get more details of the account holders and can easily track the account. Vast technologies result in increased chances of fraud which can take infringe the whole saving of the people (Ioannou, Leblond and Niemann, 2015). Due to adoption of modern technologies the preciseness of hackers are also expanding and they also use upgraded technologies to commit such crimes which results in 80%chances of failure.But it results in the development process to the people. They are more comfortable in learning new technologies and allotting in the fastest moving days. 9
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The load for bank holders are now less and they spend more time in leaning new technologies to utilize their money in the best places. Reputation Risk arises due to becoming popular among the banks and be on the top of all the banks. The result is that in order to be a market leaders and increase familiarit with customers they mostly neglect the government norms which affect the reputation and goodwill of the banks in the modern times (Freixas, Laeven and Peydró, 2015). Mostly cases arises due to ineffective customer service or mismanagement in the banks which reflects the customers interest towards the bank. But its development is that if they fulfil all the condition of the customers they are at the top of the global. OperationalRiskariseduetousingadvancingtechniquesinthemoderntimes. Technologies are changes from time to time and to adopt these new techniques various creative thinking are carried out which helps the bank to adopt the changes. Operational risk is associated with failure of IT / Software system to integrated data, transacting data andinformation security. But on a positive note, adoption of technology helps the banks to know the customers background before providing him mortgage amount (Bjørnskov, 2016). As this process helps the banks to secured their money and store as many data in the systems. CONCLUSION From the above report, it had been concluded that regulations of banking could prevent crisis if there implementation and execution is appropriate. It had shown that financial crisis was related to high risk loan on basis of sub-prime mortgages appeared to be very profitable business for one who were capable for collecting the upfront fees. In UK, Royal Bank of Scotland was third largest defaulter in giving mortgagee to investors and securities. Moreover, it has shown about UK responses for 2007-2008 financial crisis with context to Basel III, banking resolution, stress testing which was performed by bank of England and capital requirements of European union and these turn to be very effective till date. 10
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Resolution.2019.[Online].Availablethrough<https://www.bankofengland.co.uk/financial- stability/resolution>. RoyalBankofScotlandcollapse.2019.[Online].Availablethrough <https://www.telegraph.co.uk/finance/newsbysector/banksandfinance/8933151/Royal- Bank-of-Scotland-collapse-the-10-questions-the-FSA-must-answer.html>. Royal Bank of Scotland fined $4.9B for housing bubble role.2019. [Online]. Available through <https://www.foxbusiness.com/markets/royal-bank-of-scotland-fined-4-9b-for-housing- bubble-role>. The Government’s regulatory response to the financial crisis.2017. [Online]. Available through <https://obr.uk/box/the-governments-regulatory-response-to-the-financial-crisis/>. 12