Financial Crisis in UK: Banking Regulations and Responses Analysis

This report delves into the intricate relationship between banking regulations and financial crises, focusing on the United Kingdom and the case of the Royal Bank of Scotland (RBS). It explores the role of banking regulations in preventing crises, examining the UK's responses to the 2007-2008 financial crisis, including the formation of the Financial Policy Committee, the implementation of Basel III, and the use of bank stress tests. The report analyzes the causes of financial crises, including speculative activities and the US subprime mortgage crisis, and discusses the limitations of banking regulations. It also examines the failure of RBS, its involvement in the housing bubble, and the consequences of its actions. The report provides a comprehensive overview of the UK's efforts to maintain financial stability and prevent future crises, covering banking resolution and capital requirements.

Law Question

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.
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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
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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 banking regulation 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 their various sectors and help the public feel safe when they deal with banks. The role of
regulator arises in form of government regulation.
Bank regulator acts as the primary governing body i.e. The financial Service
Authority(FSA) has two main objective to prevent the banks from financial crisis. Firstly It helps
the customers to deal with fair and accrual basis. It offers services in 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 to other banks. 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 banks to limit their
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working which assurance that they are regulated and major areas of concern are looked upon.
This condition indirectly 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 the auditing services, The government has set some norms for every banks
to be properly audited by an appropriate officer. It brings the 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 accounts which burdens banks
to double their attention towards their financial statement development process.
Second cause is related to Financial 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 to Payment service method. Previously the transaction for cash
and cheque or online transaction are not much in scope but now-a-days people mostly prefer
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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 to Compensation 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
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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
accused Royal banks of Scotland along with many other big banks for purpose of 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 as they 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
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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
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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, establishment of tougher capital standards via restrictive capital
definition, additional capital buffers, higher risk weighted assets and higher requirements for
minimum capital ratios with introduction of new strict requirements of liquidity.
Basel III addresses shortcomings of pre-crisis regulatory frameworks and gives
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
standardised approach with reference to operational and credit risk and would facilitate
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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
of enhancements for capital framework which considerably strengthen minimum capital
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 is changing, so banking factors adopt the online services for making
transaction regarding the cash transfer or FD's more convienient. This enables the hackers to 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.
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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.
Operational Risk arise due to using advancing techniques in the modern times.
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 and information 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.
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REFERENCES
Books and journals
Allen, F. and et.al., 2015. Moral hazard and government guarantees in the banking
industry. Journal of Financial Regulation. 1(1). pp.30-50.
Bjørnskov, C., 2016. Economic freedom and economic crises. European Journal of Political
Economy. 45. pp.11-23.
Campbell, A. and Cartwright, P., 2017. Banks in Crisis: The Legal Response. Routledge.
Caporaso, J. A. and et.al., 2015. Still a regulatory state? The European Union and the financial
crisis. Journal of European Public Policy. 22(7). pp.889-907.
Dagher, J., 2016. Benefits and costs of bank capital. International Monetary Fund.
Freixas, X., Laeven, L. and Peydró, J.L., 2015. Systemic risk, crises, and macroprudential
regulation. Mit Press.
Ioannou, D., Leblond, P. and Niemann, A., 2015. European integration and the crisis: practice
and theory.
Jeucken, M. and Bouma, J.J., 2017. The changing environment of banks. In Sustainable Banking.
(pp. 24-38). Routledge.
Peters, G.W. and Panayi, E., 2016. Understanding modern banking ledgers through blockchain
technologies: Future of transaction processing and smart contracts on the internet of
money. In Banking beyond banks and money. (pp. 239-278). Springer, Cham.
Reason, J., 2016. Managing the risks of organizational accidents. Routledge.
Ugolini, S., 2016. Liquidity management and central bank strength: Bank of England operations
reloaded, 1889-1910.
Online
Bank stress test. 2019. [Online]. Available through <https://marketbusinessnews.com/financial-
glossary/bank-stress-test/>.
Banking Regulation. 2019. [Online]. Available through:
<https://www.economicsonline.co.uk/Business_economics/Banking+regulation.html>.
Financial Services (Banking Reform) Act 2013. 2019. [Online]. Available through
<https://services.parliament.uk/bills/2013-14/financialservicesbankingreform.html>.
New Regulation to prevent financial crisis and improve financial stability. 2019. [Online].
Available through: <https://www.lexology.com/library/detail.aspx?g=f1e65386-068e-
4496-a0af-87ce29c6ba50>.
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Resolution. 2019. [Online]. Available through <https://www.bankofengland.co.uk/financial-
stability/resolution>.
Royal Bank of Scotland collapse. 2019. [Online]. Available through
<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/>.
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