FSAs Role towards the Collapse of Global Financial Services Industry - Essay Example

? FSAs Role towards the Collapse of Global Financial Services Industry Introduction The collapse of the global financial services industry in 2007 isalso known as global financial crisis. By mid 2007, the financial disorder with its rigorous liquidity and credit crunch seemed to detain to financial markets and institutions. It resulted in the failure of the key businesses, downturn in the economic activity directing to the 2008-12 global recessions and the decline in the consumer wealth. During this period economies globally slowed, as international trade declined and credit tightened. The explanation of the financial crisis is that hasty loans in the form of mortgages were made to people who do not have any possibility of paying them back. These loans were enclosed up into exotic financial products that were specified with high ratings by credit rating agencies, and were sold to investors thus looking for high yields at low risk. When default on the mortgages began to grow in large numbers, it led to unexpected losses on the products. A chain of bankruptcies, government providing emergency credit lines, balance sheet write downs, insurance and nationalisation of several institutions followed. Investors were inattentive in their understanding of what they were actually purchasing and sub-prime borrowers were insincere in taking out loans that they should have known they could not finally meet the repayments on. The crash reveals a quick drying up of liquidity following a huge expansion in credit issued to consumers and financial institutions in a number of countries. The investors have suffered harsh experiences with currency attacks and collapses, thereby negatively affecting the balance sheet of their financial institutions and corporations due to high degree of liability dollarization, therefore deepening the crisis further. Enormously disruptive to economic development and growth, in emerging market economies, these experiences have made policy makers aware of the massive cost that they have to bear by participating in the financial globalization process. By the middle of 2007, over dependence on market forces without proper regulatory systems and mechanisms in place to govern the globalization process led to emergence of huge cracks intimidating the stability of world economy on the two fronts: global financial crisis and the sharp increase of the primary commodity prices. The commodities have registered a sharp rise in prices in 2007, with extreme volatility. The increased prices of commodity hit the world when most Western economies were making effort to get away from recession and a sharp economic downturn amidst the credit crunch that had engrossed the financial institution and markets in the Western Europe and United States. There was a huge fear that the on-going financial crisis may turn into global depression of the 21st century. However, Central banks and governments responded with monetary policy expansion, unprecedented fiscal stimulus and institutional bailouts. Having lost room for additional interest rate cuts like a monetary policy instrument, most of the Central banks have engaged in hostile quantitative easing, through purchasing commercial securities and government bonds and generating an asset in the central bank account against which bank lending can be continued. By increasing money supply through this channel, it is expected to re-establish confidence in financial markets and institutions and unlock frozen credit lines. This paper will focus on the role of UK Financial Services Authority (FSA) for the reform of financial markets in the UK. It will lead to the build-up of the UK economy and the international economy. Effects of the Global Financial Crisis on UK Economy The effect of the financial crisis is on both the commercial and residential property markets in the UK. Over the first half of 2008, the economic activity in the UK had slowed down, thereby reaching at decline stage by the end of second quarter. Initially the government investment has provided some stimulus but the labour market weakened radically, leading to a considerable increase in unemployment. Across all the sectors of the economy, the reduction in output has intended that the job vacancies are at their lowest levels. There was a sharp decline in the production activity as well as in the manufacturing sector. The manufacturing sector was badly affected with a fall of 2.9% in the level of output. In the fourth quarter of 2008, the UK economy constricted 1.5% and the second contraction was 0.6% in the third quarter. Over the last two quarter of 2008, the national income tightened by 2.1%. The UK’s recession had four key drivers: a loss of confidence in the financial institutions, the price of oil, the housing market and a contraction in bank lending. There was downturn in the UK housing market quoting that the rise in the prices of house was unsustainable. The house price growth was due to low interest rates, strong level of employment and constraints in housing supply. The lack of credit was considered as the main factor for the downturn in the commercial property market. Financial Services Authority (FSA) UK The Financial Services Authority is the UK’s financial regulator, initially set up as the Securities and Investment Board in 1985 and it became the FSA in October 1997. It aims to promote orderly, efficient and fair financial markets to help the retail customers in order to achieve a fair deal and to improve its business capability and effectiveness. It regulates and supervises the non bank financial institutions and the international financial services sector with best international practices and various governing legislation to ensure that these sectors can contribute towards the economic and social development. It is ruled by the Financial Services and Market Act 2000 (FSMA). It is accountable to the Treasury Ministers and Parliament. It is independent of government and is also funded completely by the firms it regulates. It is a transparent organisation and gives full information for consumers, firms and others about its plans, objectives, policies and rules. Within the scope of Financial Services and Market Act, the Financial Services Authority is responsible for the supervision and authorisation of financial services firms, including investment firms, banks, building societies, credit unions, brokers and insurance companies. It also applies conduct of business regulation for insurance, pensions, mortgages, long term savings and investment intervention activities of these firms. In 2010, government sketch out its proposals for a new regulatory system. During the last year, FSA remains as the sole regulatory authority which is functioning within the current legal framework of FSMA. Role of Financial Services Authority of UK The role and responsibility of Financial Services Authority of UK are as follows: protecting consumers generally while encouraging their understanding about the financial system and therefore helping to reduce financial crime and maintaining market confidence in the financial system. Therefore the Financial Services Authority promotes efficient orderly and fair markets, improves business effectiveness, provide public and political accountability and assist in providing legal accountability. It has the power in relation to unfair contract terms and brings fairness within consumer contracts for financial product and services. In this way, it can protect the investors who were inattentive in their understanding of what they were actually purchasing and also the sub-prime borrowers who were insincere in taking out loans that they should have known they could not finally meet the repayments on. Financial Services Authority is the lead regulator for financial services. It reduces the administrative burden on firms and make information available to firms and consumers and delivers risk-based regulation. Financial Stability Under the Financial Services Act 2010, the FSA was provided with a new statutory objective which required it to contribute towards the protection and improvement of the stability of the financial system of UK. It will reduce the probability of the firm to fail by strengthening their capital and liquidity regimes, their controls and systems and their governance. The financial stability is measured through the cost of credit. The three month Libor-OIS spread is a measure of perceptible counterparty risk in relation to a short term inter-bank funding market. Since April 2011, it was an upward path, as fears of contamination from the euro crisis have shove up LIBOR rates. For the UK government, the ten year gilt yield signifies the cost of long term funding. Financial stability can also be measured by examining the number of failures by firms. If the numbers are more, then the Financial Services Authority will put more effort in strengthening their system and controls. It can be also measured through the UK banks CDS spreads. CDS spread of banks are signal of the market perception of credit risk. Due to the decline in the UK and the global macro outlook, the year start saw some narrowing effect but spreads have once more begun to widen towards the end of March 2012. So, in order to get control over all types of risk, FSA aims to build a strong risk analysis, modelling and infrastructure model. It had declared that the protection of client money and client asset would remain a regulatory priority. They dedicated to a supervisory and regulatory approach in order to increase their oversight of the UK market through improved reporting and notification requirement for firms and to raise awareness of client asset sourcebook among firms. The FSA also aims to require the smaller deposit taking firms in order to produce Recovery and Resolution plans. Delivering Market Confidence The aim of Financial Services Authority is to deliver clean, efficient, orderly and fair markets that remain sustainable and attractive in UK. Transparent, high quality and open markets remain crucial for the position of UK as a leading international financial centre. FSA’s priorities were: supervisory programme including a review of their supervisory standards in relation to market infrastructures; domestic policy initiatives, involving policies that prevent misconduct and therefore deliver fair and efficient markets through initiatives on market cleanliness, market integrity, reporting rules, insider dealing and market abuse and listing rules improvements; and international policy initiatives counting on commodities and various financial instruments, and other policies for example on short selling and credit rating agencies. As supervisory initiatives, it brings changes to the UK regulated covered bond regime and it is regarded as a positive step in improving overall quality and transparency of the regime. Financial Services Authority also focused on probable prevention through intended enforcement action to combat market abuse and insider dealing. In order to reduce counterparty risk, they reform over-the-counter derivatives and this enables synchronizing standards for clearing house and more transparency of over-the-counter markets. Delivering Consumer Protection Financial Services Authority is making efforts to prevent consumer loss through regulatory actions in order to make retail market to work better for consumers with enhanced flow of information to consumers, more strong supervisory interventions with better enforcement and a focus on protecting redress for consumers. It also focused on product and product design controls at firms. FSA has sought to circumvent events generating consumer loss above ?250m. Delivering a Reduction of Financial Crime Financial crime can be reduced through preventing criminals from using the financial services industry, advising investors about the dangers which they might face and by promoting the regulated industry to reinforce its defences. Apart from this, Financial Services Authority also takes into consideration to design the future regulations of financial services in order to reduce the probability of future financial crisis. The macro economic imbalances of the global financial crisis have enthused demands which have been met by a wave of financial innovation which mainly focus on the origination, trading, packaging and distribution of securitised credit instruments. Loans and credit spread on a broad range of securities falling to insufficient levels, volatility seemed to have turned down and therefore the price charged for the absorption of volatility risk was falling and these falling volatility prices and spreads are pouring up the marked to market value on the books of banks, current value of a range of instruments, investment banks and hedge funds stimulating in turn higher bonuses and higher apparent profits and as a result strengthening traders and management confidence that they must be doing the right thing. Financial Services Authority also takes on responsibility to design short-term policies in order to restrict the adverse impact of deflation and deleveraging on the real economy in order to solve the problem of the financial institutions and the over-leveraged banks in UK. The FSA also suggested operation of new prudential regulation requirement for financial institution of UK which would further require the UK firms to go through the ongoing stress test. It is designed to measure whether UK institutions could endure liquidity stress which is arising from adverse changes in market condition. UK institutions are required to examine their liquidity position across different risk drivers, including: intra-group liquidity, wholesale funding, cross-currency liquidity, off-balance sheet liquidity, retail funding, marketable assets, franchise-viability risk and funding diversification. Ongoing monitoring of stress test results represents a significant change to existing arrangements for financial institutions. The liquidity proposals of FSA are designed to improve reporting process as well as to enhance and strengthen the liquidity position of the financial institutions. To attain improved liquidity it is expected that UK’s financial institutions are required to diversify their funding sources with the intention that there is less dependence on short term wholesale funding. Conclusion The global financial crisis which have affected the commercial and residential property markets in the UK and resulted in loss of confidence in the financial institutions, the price of oil, the housing market and a contraction in bank lending have generated the role of FSA in order to strengthen the UK economy. There was a sharp decline in the production activity as well as in the manufacturing sector in UK. There was also a downturn in the UK housing market quoting that the rise in the prices of house was unsustainable. In order to attain improved liquidity, FSA had proposed various measures and in order to avoid the reliance on international wholesale credit markets, the FSA has advised the UK financial institutions to restrict the source of fund flowing from foreign counterparties. To attain this rebalance, UK financial institutions and banks should attract great proportion of retail deposits from domestic depositors as well as improve the quality and amount of stocks of liquid assets (“Annual Report 2011/12” 1-44). Work Cited Financial Services Authority. Annual Report 2011/12. London: Financial Services Authority, 2012. (Print). Read More