Financial Crisis in the UK Banking Sector - Essay Example

? Financial Crisis in the UK Banking Sector Financial Crisis in the UK Banking Sector Introduction Globalization trends have had significant effects on the functioning of the entire society. These are characterized by the free flow as well as movement of goods, information and populations. They have made the society to be increasingly integrated into a single community. The sharing of information and products has greatly affected the standards of living of individuals. Populations that did not have access to quality products previously have had a chance to benefit from the same through the free flows of products across the globe. Likewise, those that did not have access to important natural resources have been able to access the resource base and exploit the same to their advantage. The characteristic advancement of information and technological systems has made it possible for populations, firms and corporations to exploit emergent opportunities with ease. Notably, a significant percentage of the populations are taking practical steps to align their ways of life to the societal expectations with respect to improved standards of living. Apart from benefiting the society positively, inherent globalization has also had adverse impacts on the wellbeing of the society. Perhaps the sector that has been the most affected by the relative changes pertains to the economic segment. At this point, it cannot be disputed that the world economy directly affects the quality of life of the populations. This has further been occasioned by the characteristic integration that has tied local and regional economy to the wider global economy. Thus operations at the global level have direct implications on the performance and general wellbeing of local, national and regional economy. This integration has made the financial sector susceptible to the negative impacts that stem from economic shocks. Coupled with the fragile nature of financial systems, the current economic instability has undermined the ability of the respective systems to cushion themselves against relative negative impacts. One of the economic problems that has posed great challenges to the UK government as well as the global financial system pertains to the 2008-2009 financial crisis. Seemingly, relevant authorities are taking practical steps to reinstate financial stability and enhance optimal performance. This is elemental in enabling them to attain a desirable state with respect to sustainable growth and development. Fundamentally, relative strategies are in line with their economic goals and objectives. Besides the challenges that are related to economic integration, the UK financial sector has been compounded by governance problems. At this point, it cannot be disputed that governance problems contributed a great deal to the financial crisis that the country experienced at this particular time. In a society that is characterized by uncertainty, effective governance is important in enhancing optimal performance. Governance in this regard is all encompassing and ranges from the expertise and policies to the rules and regulations that are established to guide behavior and decision making. These need to be based on informed thought and to bear desirable outcomes; they need to be consistent with the economic changes being experienced in the market. Indeed, the fact that good governance is essential and contributes significantly to the integrity as well as stability of financial systems cannot be overstated. With this asset, corporations and organization can be able to maneuver their way through the volatile economic environment. It is against this background that this paper provides an in depth analysis of how poor governance in the UK financial sector contributed to the financial crisis that it experienced. To enhance coherence, the paper begins by explaining the notion and importance of good governance in the current financial corporate sector. Understanding Good Governance In his research, Hart (1995, p. 54) contends that good governance is requisite for organizational growth and stability. It is an all inclusive concept referring to the rules as well as incentives that aid in effective management and control of an organization. With this, an organization is able to work objectively especially if the respective rules and policy measures are aligned to its goals and objectives. Further, the governance underscores the responsibilities as well as the rights of the management of the organizational management. Besides preventing occurrence of conflicts, corporate governance in this regard is useful in ensuring quality performance. By understanding and appreciating their roles and responsibilities, the shareholders and stakeholders work efficiently and effectively toward the attainment of organizational goals. To this end, Hannah (1986, p. 51) posits that governance aids in controlling the behavior of both the minority and major stakeholders in the organization. This is essential in ensuring that all parties perform their tasks optimally and as required by the law. In this regard, it should be acknowledged that organizations are comprised of various factions that perform different roles. Individual contributions of the respective factions are instrumental in attaining sustainable organizational growth. Definition of their roles is important as it ensures effective performance of relative duties and responsibilities. Also worth mentioning is the ability of good governance to establish a structure for developing, implementing, enforcing and monitoring organizational objectives. The characteristic monitoring is particularly important because it promotes frequent evaluation and analysis of the overall performance of the organization. With this, any weaknesses and problems are identified in a timely manner and addressed accordingly. Ultimately, this contributes to enhancement of quality performance within the respective organization (Lydenberg, 2005, p. 91). Most importantly, the established structures ensure timely attainment of organizational goals and responsibilities because of their ability to foster efficiency. In his research, Summers (2001, p. 61) concludes that an organization that is greatly committed to ensuring good governance is literary empowered. Empowerment in this regard is defined by the ability to control its internal environment, transparency and accountability and definition, protection and upholding of shareholder rights. Certainly, banks that uphold good governance are likely to register optimal performance as compared to their counterparts. Research indicates that in the corporate field, financial firms face unique challenges unlike other corporate entities. For this reason, they can benefit the most from the provisions of good governance. Seemingly, the corporate governance issues that they face are specific to the roles that they play in the economic sphere. Compared to other firms, a significant percentage of their stakeholders are comprised of shareholders, the public sector and depositors (Bakan, 2004, p. 72). They are charged with the responsibility of generating revenue as well as serving their clients accordingly. The sensitive nature of their duties exposes them to various financial risks that stem from misinformation. Further inconsistencies tend to be related to incidences of less transparency, underdevelopment and obscure existence. For this reason, they need to have strong governance. In this respect, Bebchuk and Jesse (2004, p. 71) posit that weak internal structures are likely to cause instability. Indeed, the importance of sound and strong governance in these firms cannot be overemphasized. This desirable state enables the firms to enhance effective performance as well as be able to deal with the existent and emergent challenges with ease. With these structures in place, the respective firms also have a chance to focus closely on the assessment, management and mitigation of the diverse financial risks that they are exposed to. Of great importance however is the ability of good governance to complement effective financial supervision. In a society that has complex and intricate structures, it cannot be disputed that financial supervision is paramount. At this juncture, it is certain that good governance is vitally important in any organization. It enhances effective functioning and ensures transparency and accountability in financial dealing. It also entrenches objectivity especially in critical decision making. The nature of the financial sector requires that relative organizations uphold good values and virtues. These are well defined and underscored in the concept of good governance. In essence, good governance enables the respective firms to attain and maintain stability. This is at the core of the goals and objectives of all financial institutions. In this regard, it is certain that bad governance can contribute significantly to failures in the financial market. Undoubtedly, it contributed significantly to the financial crisis that faced the UK financial sector between 2008 and 2009. The Role of Poor Governance in the Financial Crisis The financial sector tends to be compounded by various risks that undermine effective performance. The management of the respective institutions is responsible for effective management of any form of risks. Reportedly, some of the sophisticate banks in the UK failed dismally to provide good governance for the existent as well as emergent risks in their institutions (Allington & McCombie, 2010, p. 61). This had diverse implications on their managerial systems and structures. In essence, their internal systems employed for identification, measuring and reporting of risks were flawed. This implies that the performance of their boards was compounded by a host of inconsistencies. In this respect, it is worth noting that the management board of any financial institution has the sole responsibility of identifying, evaluating and addressing the risks accordingly. The boards of the UK banks in this respect lacked the ability to comprehend the risks that the institution faced. This compromised their ability to make proper judgments with respect to the effects of the respective risks and probability of their performance. This scenario occurred in different ways. To begin with, Gintis (2009, p. 44) indicates that relevant authorities passed on incomplete reports regarding apparent risks to the board of directors. This culminated in a false sense of security as the board did not recognize the extent to which the risks would affect organizational performance. Notably, there was a lack of expertise in both the executive as well as nonexecutive directors. This is exemplified by their inability to identify the flaws in the reports that they were presented with. To some extent, this also implies that the respective personnel were negligent. Arguably, those that were in position to identify any risks assumed that these were minor and their effects on the institutions were insignificant. This was regardless of their being aware of the fragile nature of the financial markets (Van Treck, 2009, p. 475). Also worth noting is the fact that the board failed to exercise creative and critical thinking options that could generate effective countermeasures to the challenges that they were struggling with. In this respect, they used their capacity for ‘group think’ function rather than developing an appropriate forum for analyzing and assessing strategic risk issues. Thus they did not take any practical measures to expose the reports they were presented with to critical analysis. Coupled with their overreliance on compliance and regulatory mechanisms, Di Benedetta (2009, p. 62) believes that they were unable to identify and measure risks accordingly and in an effective manner. In particular, they did not look beyond the face value of the challenges they were experiencing. Neither did they deeply analyze the risks to determine the extent of the damage that these could have on the financial sector. As such, they failed to explore any options that could enable them address the problems in an effective manner. Rather; they relied on the established regulatory mechanisms that were ineffective. Just like the board members, the managers of these banks failed to adopt as well as integrate vital systems to be employed in identification, management and reporting of risk. They did not capture the risks that were increasingly evolving in their reports and balance sheets. Further, the few risks that were identified were not priced properly at the institutional level. Since the Banks affected were sophisticated and assumed top positions in the market, this implied that the respective risks were equally not priced at the market level. As such, the returns on the risks that were actually being experienced in the market were neither analyzed effectively nor reflected accurately. Consequently, important capital was not allocated effectively. In this respect, it did not capture and was therefore not reflective of the actual risk that was being experienced in the market. Further, Gintis (2009, p. 72) indicates that the structuring and planning of liquidity and funding was improper. In this regard, the established measurement systems placed undue emphasis on risks that were readily identified and recognized. This compromised their ability to conduct surveillance of risks that were hidden and which could not be readily identified. This was further compounded by lack of autonomy of the risk management units. Notably, this made it difficult for these institutions to identify institution-wide risks and compel the management to take prompt action in a bid to address them. Seemingly, the flawed managerial structures undermined the ability of the banking institutions to identify and the risks and put in place practical measures to counter them in a timely manner. Arguably, the banks with better monitoring systems were able to weather the risks accordingly and effectively. The risk management models that were employed by the institutions were also reportedly complicated. These did not clearly outline the roles as well as responsibilities of all the stakeholders. In addition, they did not clearly underscore the implications of the risks to the entire wellbeing of the organization. In his review, Gintis (2009, p. 51) indicate that they did not provide clear measures that would be employed in making accurate predictions regarding institutional performance in the sector. Most importantly, they failed to provide benchmarks that could be useful in establishing viable performance standards. Basically, financial management institutions employ wide ranging models in guiding their behaviors and practices. These provide the required guidance especially because they are considered to be objective and accredited. Usually, they are believed to have been developed basing on comprehensive, consultative and conclusive researches regarding the behavior of previous organizations. They are actually akin to theories and assumptions that are useful for guiding decision making under varied situations. For this reason, the models need to be objective and exhaustive. There application needs to yield definite results as opposed to creating a state of uncertainty in the market environment (Brand, Costello & Osborough, 2005, p. 56). This is particularly important in the financial sector in which relative decisions have lasting impacts on the holistic wellbeing of the institutions as well as on the broader market. At this point, it is certain that the flawed nature of the risk models contributed to the crisis. This implies that the management of the organizations also failed to review their practicality and effectiveness in addressing emergent challenges. Undoubtedly, this implies that the performance of the banks was limited by lack of sufficient expertise. Another governance issue that contributed to the crisis pertained to significant limitations in shareholder engagement. According to OECD (2004, p. 46), good governance practices involve shareholders in critical decision making. The shareholders have certain rights that they are entitled to as part of the stakeholders in the respective organizations. In particular, they are entitled to rights to vote or appoint directors in key leadership positions, rights to participate actively and directly in organizational decision making, and rights to prevent the management of their institutions from implementing and enforcing decisions that are not in line with their interests or do which not conform to organizational goals and objectives. The Basel Committee on Banking Supervision (2006, p. 33) contends that the institutional investors also have an active and informed role to play in decision making. Notably, these own a significant percentage of the shares that are usually traded in the market. For this reason, they have a right to be involved in decision making. The performance of their shares in the market directly affects their wellbeing. From a moral point of view, the financial firms and institutions are obliged to inform them about the performance of the shares. They also need to be enlightened about the implications of market trends on the performance of their shares in the market. This is because ultimately, they solely shoulder the relative losses. For this reason, they need to be provided with relevant information regarding the performance of their shares in order to ensure that the decisions that they make are objective and based on informed thought (Thornton, 2008, p. 44). Basically they should be given a chance to participate in the entire process of governance actively engage themselves with the institutional management and responsibly vote their shares. This desirable status can only be attained if the management of the institution is flexible and willing to partner with all the stakeholders for sustainable growth and development. In their informative review, Klein and Zur (2009, p. 187) ascertained that most firms that were affected in the UK frequently infringed on the rights of their shareholders. In particular, they took minimal practical measures to exercise and uphold good managerial practices. For instance, nationwide research ascertained that most of them did not involve the shareholders in elections regardless of them having a stake in their companies. Thus their election processes were limited by negative influences from the key management. Such practices were in most instances pursued by the leaders who had selfish vested interests in the firms. As such, this culminated in conflicts that undermined the ability of the firms to perform optimally. As indicated earlier, supportive work environments contribute significantly to the growth of the organizations. This is because the personnel in all departments have a chance to work comfortably. Their efforts are appreciated and this greatly boosts their morale. Comparatively, such organizations tend to be more productive than their counterparts. Organizational conflicts limit effective performance because of their ability to strain relationships. They encourage violence and aggressive behavior that prevent rational decision making. At this point, it is worth appreciating that rational decision making in the financial sector is vitally important. Monks (2008, p. 102) believes that decisions made at any given point in the financial market have lasting implications on the respective organization as well as on the entire market. The outcomes of the decisions can either build or destroy the company. For this reason, it is important to exercise sobriety when making key decisions. This cannot be attained if the work environment is characterized by frequent conflicts. The passive nature of the investors in most financial institutions has had varied impacts on the performance of financial institutions. To begin with, the lack of involvement by this faction of the population in key decision making made them to leave the decision making responsibility to the management of the banks. These yielded negative outcomes especially considering the fact that the board members sought to further their individual selfish interests. Research evidence shows that this also increased the susceptibility of the banking institutions to the risks especially because the market environment was already compounded by the negative impacts from the failing economy. Counterarguments in this respect maintain that to a great extent, shareholders of the financial institutions also contributed to the crisis. According to OECD (2009, p. 22), they deliberately refrained from engaging in key decision making especially at the initial stages of the crisis. They left the decision making responsibility to the management of these institutions whose options were increasingly becoming limited. In addition, they compelled the management of the organizations to pay them their dividends as usual during the crisis (Di Benedetta, 2009, p. 46). This was regardless of their knowledge about the failing economy and the implications that this had on the short term as well as long term financial goals of the institutions. In this case, they directly contributed to the fall of the respective organizations. Another governance related problem that contributed pertains to poor remuneration practices as well as incentive alignment. In their research, Ahlering and Deakin (2007, p. 865) indicate that for organizations to realize optimal results, the remuneration of their executive boards needs to be consistent with long term organizational interests as well as the interests of the shareholders. The salary package for instance needs to be satisfactory in order to enable the personnel to perform optimally. In his research, Bratton (2002, p. 1276) believes that sufficient salaries encourage the personnel to work better. Relative incentives go a long way in encouraging organizational loyalty. The personnel feel more attached to the organization and therefore perform extremely well in order to ensure it sustenance. At the same time, the respective packages need to be reflective of the economic capability of the respective organizations. In this regard, the allocation of packages should not compromise the financial performance of the organization. Equally important is to ensure that the respective packages are reflective of the market trends as well as conditions. An evaluation of the reasons that led to the failure of UK banks at this particular period indicates that their executive directors placed undue emphasis on the attainment of short term goals at the expense of organizational value and stability (Allington & McCombie, 2010, p. 54). In this regard, they sought to improve their wellbeing by increasing their financial packages. This was inconsistent with the financial goals and objectives of the institution. The problem was further compounded by a focus on short term incentives that were designed for business lines and traders. The relative returns were minimal and could not offset the expenses that the firms had experienced. By the time the organizations attained their short term goals, they lacked the financial capacity to effectively venture into viable practices that would enable them address challenges and attain their long term goals. Thus their sustainability was at stake. In certain instances, the conditional nature of the established structured compelled the organization to offer bonuses to low salaries regarding of the fact that organizations at this point in time were performing poorly. Another governance issue that undermined the ability of the financial firms to attain important goals included lack of professionalism especially amongst board members. In their consultative review, Campbell, Collins and Wightman (2003, p. 44) ascertain that the wellbeing of financial firms is highly depended on the ability of their authorities to perform duties objectively. Assumption and use of objectivity in decision making enables the directors to make credible decisions and exercise their powers effectively. Further, this aids in eliminating tension in the production practices. In this respect, it is worth appreciating that tension undermines the ability of organizations to perform effectively. In essence, it undermines the wellbeing of work environments by creating an atmosphere that is not supportive of effective functioning. Relative scenarios pertain to restrictive conditions that have direct negative impacts on the ability of firms to exercise critical and creative thinking. In this consideration, it should be appreciated that innovation is paramount to effective problem resolution. In the banking sector, Graham, Harvey and Rajpol (2003, p. 63) ascertain that innovation is important in credible decision making. It enables organizations and firms to explore various opportunities and employ these for addressing the challenges that they encounter. The practice of creative thinking is particularly important to this sector because it generates viable solutions to the emergent complex problems that the industry grapples with. To attain this desirable status, the financial firms need to ensure effective leadership because the preceding concerns can only be pursued by informed leaders. As such, the directors need to ensure that their personnel have sufficient skills, knowledge and experience to perform tasks effectively. Lack of efficient expertise compromises the ability of the financial firms to respond to risks accordingly, address management problems with ease and maintain objectivity when dealing with emergent as well as existent problems. In his review of the performance of major banks in the UK, Di Benedetta (2009, p. 28) established that failing banks exhibited lack of professionalism in their undertakings. This was apparent at different levels of organizational performance. To begin with, the positions of the Chief executive officer and the chairman in the respective firms were integrated. In this respect, it is worth noting that the two principles play distinct forms in the financial sector. Integration of these positions makes it difficult for some important tasks that ideally need to be performed by either of them to be compromised. In addition, Aoki and Jackson (2004, p. 2) indicate that the respective positions are merely imperialistic. From this point of view, their entrenchment in the system only wastes resources that could have otherwise been employed for other important matters related to investment. An evaluation of the boards of the affected institutions indicated that there were relatively very few executives on the boards (Van Treck, 2009, p. 475). This state has various implications on the governance of the banks. In essence, it shows that the authority of the banks is vested in the hands of very few individuals who assume the imperialistic positions as chairmen and Chief Executives. To a great extent, this undermines objective and effective decision making as important views are unlikely to be captured accordingly. In this regard, Gugler and Yurtoglu (2008, p. 82) argue that since boards are solely responsible for decision making in the firms, they should be represented by sufficient experts. Persons assuming relative positions in the board need to be knowledgeable and skilled. They need to apply creative and critical thinking skills in decision making. Thus effective representation at this level ensures that decisions adopted by the organizations are based on informed thought. With reference to Northern Rock bank, OECD (2009) ascertains that it did not have sufficient expert representation on its board. The chairman of the bank did not have essential knowledge in banking. Then, it had only one executive who was knowledgeable in technical expertise regarding banking trends and financial performance of banks. Arguably, this particular individual was overburdened and could not perform effectively. Moreover, the individual was unlikely to voice critical concerns during board meeting. The inherent underrepresentation undermines the ability of such individuals to voice concerns accordingly (Deakin & Konzelmann, 2002, p. 136). Another problem that is related to professionalism and which contributed significantly to the fall of the UK Banks pertained to lack of autonomy in decision making on the board members. In some instances, IE Consulting (2008, p. 61), indicates that the boards have sufficient expert representation. However, their ability to make objective and independent decisions is limited. This is due to the direct influence of the chairmen or chief executive officers of such institutions. In this respect, the former believe that they own the institutions and therefore have a right to control decision making. This is regardless of whether they are conversant with the relative trends and market expectations. The relative lack of independence of both mind and spirit makes it difficult for the experts aboard to make decisions with ease. Also worth noting is the negative impact that direct influence has on the general work environment. In such an environment, the board members focus on pleasing the chief executives at the expense of effective and positive organizational functioning. Conclusion In conclusion, financial markets are very fragile and susceptible negative implications that stem from market shocks. For this reason, relevant authorities need to exercise objective and informed decision making. As it has come out from the study, the decisions that they make have direct impacts on their performance. The UK financial institutions suffered detrimental effects during the financial crisis that hit the world from 2008.Althogh this was influenced by the globalization trends that affected the global economy, poor governance equally contributed significantly to this crisis. As aforementioned, the institutional governance was undermined by lack of expertise. Thus the decisions that they made were deficient and of poor quality. Also, their risk measurement strategies were weak. Likewise, this is attributable to the lack of knowledgeable individuals that could develop and implement more effective models. As indicated earlier, the management failed to involve key stakeholders in critical decision making. This non-involvement culminated in conflicts that compromised effective functioning. Furthermore, this undermined effective decision making as well as coordination between the stakeholders and management of the institutions. In the long run, this trend made it difficult to implement objective decisions. Finally, the remuneration and incentive strategies employed by the institutional management placed undue emphasis on short term goals as opposed to long term rewards. This was further compounded by the tendency of the managers to pursue their selfish interests. In sum, it cannot be disputed that indeed, poor governance contributed a great deal to the financial crisis that these firms experienced. List of References Allington, N. & McCombie, J. (2010) The Cambridge Handbook of Applied Economics, Cambridge: Cambridge University Press Ahlering, B. & Deakin, S (2007) Labor Regulation, Corporate Governance and Legal Origin: A Case of Institutional Complementarity? 41 Law & Society Review, p. 865. Aoki, M. & Jackson, G. (2008) Understanding an Emergent Diversity of corporate Governance and Organizational Architecture: An Essentiality-based analysis, 17 Industrial and Corporate Change, pp. 1-4 Bakan, J. (2004). 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