Measures Taken by the Government of Different Countries after the Global Financial Crisis - Admission/Application Essay Example

International Banking Contents Introduction 3 Discussion 4 Review of the terms of recent European initiatives 4 Arguments in favour of universal banking 6 Critical evaluation of the Basel 3 requirements on bank capital proposals for large banks 8 Conclusion 11 References 12 Introduction Banks are the most important financial institution and are the upholders of the financial system and economy of the country. Banks perform two very important tasks such as it helps in circulation of funds from the lenders to the borrowers and second and provision of funds for the payment of goods and services required by the customers. With the advent of globalization banks face lot of additional risks these days. Banks now days are not only affected by the financial risks facing the country but also financial crisis affecting other countries. In fact now a day’s bank are so related to each other that it does not take much time for the financial crisis affecting a particular country and its banks to spread to banks of other countries. A case in point is the global financial crisis that affected the financial system worldwide for 2007-09. Started as subprime mortgage crisis in USA the problem and the financial crisis soon spread to the banks of other countries and it did not take much time for it to result into a global financial crisis. After the global financial crisis countries of different governments and the BASEL committee of banking regulations instituted several rules and regulations to prevent such crisis from occurring in future. Though financial crisis at different times differ from each other in respect of the events that trigger the crisis, the reaction of different countries with respect to how they intervene in order to help the economy recover and soften the impact of these crisis have some similarities. The following article discusses the various measures taken the government of different countries after the global financial crisis in respect of similarities and dissimilarities in the strategies involved. The regulations of BASEL are also included in the discussion and arguments in favour of universal banking and views opposite to the regulations imposed by the various governments are discussed. Discussion Review of the terms of recent European initiatives Over the years several financial crisis have time and again rocked the banking system and global financial sector. Often it has been found over the years that these crises have originated from a particular country and then have gone to impact other countries depending on their amount of exposure and have slowly turned into global financial crisis. Now a day’s these financial crisis are more likely than ever before to turn into a global financial crisis due to the inter linkages of the banks. Over the year different financial crisis have been triggered by different events. But the way different governments have reacted to the crisis at different times with respect to their intervention in order to soften the impact of the crisis have many similarities between them (Contessi and El-Ghazaly, 2011). After the Global financial crisis that affected the entire world starting from subprime mortgage crisis in USA, the governments and regulatory authorities of the banks identified several banks that were too important to fail. BASEL committee of banking supervisions instituted several rules and regulations for the banks in form minimum capital requirements to be held by the banks and increase in banking supervisions. However it was felt that these banks are too complex to facilitate effective regulation and supervision of each of their varied functions. So the proposals by Volcker, Vickers and Liikanen propose structural reforms for the first time regarding restriction of banks in terms of size and the area of activities. Volcker The USA was the first to implement several rules leading to structural reforms in the banking sector. US government adopted the Dodd- Frank Wall Street reform and Consumer protection act collectively in the December of 2013 which came to be known together collectively as Volcker rules. The rules were originally proposed by Paul Volcker and hence are the name. Volcker argued that among the factors that led to the financial crisis, speculative trading by the banks played a major role. So, in order to prevent future financial crisis from happening, Volcker proposed to issue a ban on the proprietary trading by the bank to be imposed as a rule (Viñals, Pazarbasioglu, Surti, Narain, Erbenova, and Chow, 2013). The general terms of the rules are as follows. Impose a ban on proprietary trading leading to its prohibition. Several activities have been allowed and are exempted from the ban. The bank can trade in these instruments provided certain conditions are met. The banks are not allowed to having any relationship of any sort with hedge funds or private equity funds. Vickers Following any Global financial crisis it is found that the governments and parliaments design packages and bailout programs aimed at helping certain specific industries and in some cases to specific organization. These bailout packages have been criticized several times because the tax payers’ money is being used to help particular institutions and there is a fear that the public will have to pay higher taxes as a result. After the bankruptcy of Lehman Brothers and subsequent announcement of bailout packages by the government to help other banks, Independent commission of Banking provided several recommendations that the banks should follow in order to prevent a financial crisis from occurring in future. The report which came to known as the Vickers report was accepted and passed in the UK parliament. The major suggestion put forward by the report is that the banks should separate their main business from their investment arm (Treanor, 2011). The local and retail business activities of the bank should be included in a ring fence and the investment arm and function should be kept outside. However several objections have been raised in the context that ring fencing would give the bank greater license to take more risks with the activities grouped inside the fence would result in more risk of facing a default (Goff, 2011). Liikanen The European union have also issued certain structural recommendation as part of the recommendation by Erkki Liikanen led expert group that was formed to look into the matter. The recommendation made by the Liikanen led expert group is to be applied to about 30 large banks that have been identified as having global importance. The recommendations are Proprietary trading should be ring fenced and a separate legal entity should govern that. The Banks are should cushion their deposits significantly from their investment arm to avoid and mitigate any impact on the deposits if investment arm comes down (Burgis, 2012). The committee recommends the use of more robust risk management tools. Arguments in favour of universal banking The global financial crisis that affected the financial systems time and again focuses on the fact that all the different financial institutions of different countries are interlinked and interrelated to each other. In fact the banks are interrelated to each other to the extent that financial crisis affecting a particular financial institution in a particular country affects all other financial institutions in different countries. However the degree to which the financial crisis facing a particular bank affects the banks of other countries depends on their degree of exposure to that particular bank. The banks argue that they have to expose themselves to the assets of other banks and securities in order to diversify their risks. However regulators feel that the bank’s exposure to investment banking and trading of securities is the major reason and factors leading to risk of defaults. So the regulators feel that in order to prevent and shield the organization from risks of default and in order to prevent global financial crisis from happening again a structural reform is required. The major portion of the structural reforms as designed by the 3 regulators in USA, England and EU states that the bank should create a separate legal entity in order to separate their investment arm. The banks should ban proprietary trading. The gist of what they are proposing is that the banks give up universal banking in favour of being less risky. However EU recommends that the banks should not give up their Universal Banking but create a ring facing around their primary business so as to cushion it from the risks faced by their investment arms. However there is a counter school of thought that states universal banking does more good than it causes harms. First universal banking provides advantages to the banks in terms of economies of scale. Secondly after the financial crisis of 1930s it was found that the banks which failed were not large banks but were those which were small and did not have security linkages (Casserley, Härle, and Macdonald, 2012). It is also argued that any modern and sophisticated economy of today requires a large bank which provides all types of services. It is very easy to say that investment banks are the root cause to all the problems associated with financial crisis that affects the banks. So it is better to hive them off. However if the matter is looked deeply it will be found that the issue is not so simple and is in fact pretty dicey. The main reason is that many of the large banks have already invested a good amount of money in swaps or other derivatives and most of these investments can only be divested after about 20 years. To contain the risks of these investments banks have to employ the services of economists, mathematicians and traders who regularly device new techniques to hedge the risks. The problem that now arises is that if these investment arms of the bank were to be suddenly separated or is winded up then the bank will find very hard in attracting talents who will manage these investments. The challenges faced will be in terms of higher salary that has to be paid to these employees because the banks will need to compensate the people who will be working towards a cause that will ultimately lead to their job losses. Another problem is that among the various investment banking arms that several banks have very few are mighty enough to stand on their own. So if these investment banks are separated or a separate entity is created to distance them from other banking functions, they are likely to face a more uncertain future (The Economist. 2012). There is another fact in point that should be carefully examined before pulling the socks on separation of the investment banking arm and ring fencing for the bank to focus on their local business. If the banks are forced to solely focus on their local business then there is a probability that the banks will become very desperate and will take on extra risks in the local market to increase their competitiveness. However this situation may ultimately lead to the same effect and the banks will still be prone to defaults and the governments have to bail them out. Critical evaluation of the Basel 3 requirements on bank capital proposals for large banks Basel committee of banking supervision was instituted in the aftermath of the failure of Breton wood system of international exchange mechanisms. The period was dominated by wide scale failure of banking companies. In the light of these events The BASEL committee was set up by the G10 members in order to be guiding body instituting and setting up rules and regulating the functions of banks in order to prevent future bank failures (BIS, 2014). After it was founded the BASEL committee has given out new regulations guiding bank functioning time and again. The following figure shows the changing rules and regulation from one Basel accord to next. In the recent recommendation that the BASEL committee has recommended in BASEL three it has taken into consideration the latest financial crisis. The present financial crisis started as a subprime mortgage crisis in USA quickly spread to the financial institutions and banks of other countries. It soon turned into global financial crisis. In deciphering the risks and its probable solutions the BASEL committee have identified that the major cause which led to the global financial crisis of the banks was their interconnectedness. The BASEL committee have identified certain financial institutions and banks that they say are too important to fail. BASEL committee of banking supervision has recommended two important recommendations in order to minimize the risks faced by these large financial institutions. The two main recommendations are increasing the amount of supervision on banking activities of these financial institutions and introducing structural reforms. While recommending increased regulations and supervision of the banking activities of these large scale financial institutions BASEL committee found out that it was very difficult to impose regulations in certain fields of the banks activities because it was very difficult to access risks in those areas. So the BASEL committee introduced structural reforms to enforce limits on the banks scope and activities. Other recommendations of the BASEL committee included enhanced regulations, higher capital adequacy ratio, includes liquidity ratio to measure liquidity related risks, encourage transparent disclosure of information and strengthening the cushion against market related risks. By introducing and recommending structural reforms the committee meant that the banks should hive off their investment banking arm or in other words change their universal banking status. However the recommendations are not easy to follow and not necessarily will lead to lesser risk perceptions. There are two counter arguments in this respect doing the rounds at present. The first school of thought says that it is important that the banks hive of their non core banking related functionalities in order to be less risky. Surprisingly mast head of many large banks are subscribing to this view. However there is a counter argument that says if the banks hive of their investment arms as required by BASEL 3 norms they will incur heavy losses. Secondly through their investment arms the banks already holds large positions in derivative and swap markets which are not easily liquefiable. Thirdly universal banking facilitates diversification of risks and historically those banks have failed which did not investment banking businesses. Fourthly if investment arms of the banks are forced to hive off the banks will play a more risky game in their local front and then the risks of defaults will increase many fold. Fifthly if the banks break their relationship with their investment arms then the investment arms will likely face a greater risk and wouldn’t be able to survive. The other requirement that requires the banks to have higher capital adequacy ratio to keep as a buffer is good from one perspective. But if the banks have to maintain that high amount of capital then it will be able to lend less to its customers. Without being able to lend, it will be very difficult for them to sustain their business. If BASEL three guidelines are adhered to strictly it will result in the small banks gradually winding up or be merged to the large banks in order to remain competitive and be able to compete. Conclusion Banks always have a major role to play in the economy of a country and the whole world in general. Banks are the regulators of the economy and they will always be there because they perform two important functions. 1. To supply money from lenders to borrowers, 2. Provide funds for the acquiring or purchasing of goods or services. Historically however banks in particular and entire financial systems in entirety have been rocked by financial crisis that have often turned into global financial crisis. The main problem with banks is that they are liked with each other in more than one way. So a particular financial problem affecting a particular bank in a particular country soon has its impacts on the banks of other countries and the problem soon turns into a global financial problem. When the banks fail the government and monetary authorities come up with measures in order to lessen and soften the impact of the crisis. Whereas the monetary institutions come up with new regulations governments or parliaments most of the times come up with capital infusion programs. Capital infusions by the governments have however been criticized. In view of the recent global financial crisis that impacted the entire world starting from its origin in America, the regulatory authorities instituted structural reforms to limit the bank’s exposure to business that were considered risky. However the measures have been received with mixed reactions with a school of thought applauding the efforts, the other school rallying against in with their view of universal banking. After discussing both the pros and cons of the institution of structural reforms it can be concluded that a lot of thought should be put into before implementation of the new reforms. References Bank for International Settlements, 2014. History of the Basel Committee. [Online] Available at: http://www.bis.org/bcbs/history.htm [Accessed 27 November 2014]. Burgis, T., 2012. The Liikanen report decoded. [Online] Available at: http://www.ft.com/intl/cms/s/0/0ff0b3a4-0c8a-11e2-a73c-00144feabdc0.html#axzz3KG9d1dJD [Accessed 27 November 2014]. Casserley, D., Härle, P. and Macdonald, J., 2012. Should commercial and investment banking be separated? [Online] Available at: www.mckinsey.com/App.../Commercial_and_Investment_Banking.pdf [Accessed 27 November 2014]. Contessi, S. and El-Ghazaly, H. S., 2011. Banking crises around the world: Different governments, different responses. [Online] Available at: https://www.stlouisfed.org/publications/re/articles/?id=2096 [Accessed 27 November 2014]. Goff, S., 2011. Just the facts: The Vickers report. [Online] Available at: http://www.ft.com/intl/cms/s/0/7321c692-dd16-11e0-b4f2-00144feabdc0.html#axzz3KG9d1dJD. [Accessed 27 November 2014]. The Economist, 2012. Universal banking together, forever? [Online] Available at: http://www.economist.com/node/21560577. [Accessed 27 November 2014]. Treanor, J., 2011. Vickers report: Key points. [Online] Available at: http://www.theguardian.com/business/2011/sep/12/vickers-report-key-points. [Accessed 27 November 2014]. Viñals, J., Pazarbasioglu, C., Surti, J., Narain, A., Erbenova, M. and Chow, J., 2013. Creating a safer financial system: will the Volcker, Vickers, and Liikanen structural measures help? [Online] Available at: www.imf.org/external/pubs/ft/sdn/2013/sdn1304.pdf. [Accessed on 27th November 2014]. Read More