The Bank Recession of 2011 - Essay Example

?In 2008, the world witnessed one of the worst financial meltdowns in history, only surpassed by the Great Depression. The wide scale fiscal turmoil brought about speculations concerning the feasibility and sustainability of totally unregulated markets and institutions with government involvement confined to just adjusting monetary and fiscal policies. The inevitable paradigm shift was marked with the advent of increased government regulations on credit policies and heavy financing; seen as the panacea for all financial ills. Ironically, by the end of 2011, it was clear that ‘government facilitation’ was more of any oxymoron, as stringent credit policies and decreased consumer confidence led to another dip in the worldwide economy. Particularly marked by decreased bank lending, which creates the recurring loop of a recessive economy. Three main players are involved in this triangular arrangement of the financial system: The government, the banks/financial institutions and the credit consumers. The government with its increased involvement to regulate financial markets formulates policies for the consumers which are mediated through the banks and financial institutions. Thus, the banks are stuck in a paradox of adhering to government policies and maintaining their own liquidity and capital ratios, which in turn effect the end consumers. During the pre-recession period, credit access was particularly easy worldwide, especially among the G 10 countries which were attributed as pioneers of the ongoing economic boom. (Michael, B., Leonardo, G., & Goetz, P. 2011) Increased mortgaging and borrowing backed by higher expectations from the market were rampant, but to the dismay of economic analysts, this bubble was artificial. And eventually the growth backed by ill securities, bad mortgages and irregular credit ratings suddenly came to a halt with the financial market in doldrums.( Badertscher, B., Burks, J., & Easton, P. 2012) Banks and financial institutions had major investments in the real estate sector, the most effected of these by the financial crisis were those who had had readily converged to commercial construction and land development loans during the boom. (Hays, F., & Ward, S. 2010) Earlier financial crises have demonstrated that a concentration of loans within a single sector is very risky, since the developing sector may turn out to be a fad. It is considered a rule of thumb to diversify the investment portfolio to lower the risk to a minimum. But such was not the case and eventually, with the excess of subprime lending in the real estate economy without much securitization to back it, the banks involved had to bear the brunt of this mammoth of a crisis. Since then bank credit requirements have increased twofold making it harder to borrow and creating a bottleneck in economic injections. And on the other hand dipping credit ratings are naturally creating skepticism in the average consumer’s mind about the credibility of bank loans, creating a demand lag which is evident in the 2011 loan demand figures. Worldwide government efforts have been aimed towards saving major banks and financial institutions by providing much needed capitalization as a measure to increase liquidity. But smaller community banks have had a tough time surviving without much government assistance, and a plethora of risky real estate mortgage loans with an unfavorable market to profit from. Since larger banking corporations are more inclined towards heavier accounts and portfolios, the role of an intermediary played by relatively smaller banks for consumer loans remains vacant. This becomes evident in the form of the supply lag for loans that has been a feature of the banking crisis. The major clients for bank loans are corporate clients which require substantial amounts of capital. This is an area where international banking is prevalent, with loan syndication seen as a common practice among international financial institutions. (Ralph, H., & Neeltje, H. 2011) This may perhaps also be the reason why the recession in the US market shaped itself into an epidemic form and had global repercussions. Non-banking corporations have now taken on a more reserved approach towards debt financing and are now resorting to equity financing. This coupled with cuts in expenditure particularly on capital expenses further creates another lag in loan demands from banks. Yet again, the banks also reciprocate this mistrust as the recent economic crisis has led to the surfacing of many ill securities which were hidden under the garb of false credit ratings, thus piling up the bad debt already being handled by them. This is another form of a supply lag to the lending market as reflected by recent statistics. Some analysts suggest that with the environment now promoting generally risk averse behavior from both the borrowers and financial institutions, a room for corruption has been created. With banks being reluctant to give off loans to risky applicants, the chances for bribery and corruption have also increased. Bribes can perhaps be seen as an incentive to allow a loan to be given in order to offset the generally low confidence that is prevalent. (Weill, L. 2011) Even though this increases the cost of borrowing, the objective of securing a loan in such unfavorable conditions can be achieved. This is another big question for managers of such financial institutions who are already facing a crunching dilemma of a contracting borrowers market and increased risk averseness as reflected in the stringent current policies.( Euro Area Bank Lending Survey, 2011) The stage was now set for a new era of corporate governance with increased emphasis on the notion of ‘stakeholder’ rather than ‘shareholder’. The period leading to the bank lending crisis of 2011 was marked by an introduction of a series of international and local regulatory reforms which called for increased accountability. Notable among these are: Dodd-Frank Wall Street Reform and Consumer Protection Act Basel III Global capital regulatory standards Sarbanes-Oxley act These regulations aim at creating transparency, particularly for the banking sector. Inevitably standardizing certain requirements of performance that banks must adhere to. Important amongst these are maintaining particular liquidity ratios and enhancing the stability of credit portfolios. Another factor that has contributed to discrepancies in the bank lending sector are the respective government’s economic policies which are trying to stimulate the economy by decreasing short term interest rates and mortgage rates with the aim of encouraging borrowing and reinvesting back into the economy. The Project Merlin in the UK and the Operation Twist in the US are manifestations of such policies. This is a necessary incentive to lure consumers who are already low on confidence and are demonstrating risk averse behavior, particularly towards lending. This sentiment is mutual from banks who have become very conservative with their lending policies under the garb of maintaining high regulatory standards and to avoid bad debts and loans which have previously caused irreparable damage. This is evident in the third quarter of the fiscal year 2011 in the Euro-zone where net demand for loans to non-financial corporations declined to -8%, for mortgage loans to -24% and for consumer credit to -15% partially caused by tighter credit policies. (Euro Area Bank Lending survey, 2011) With increased pressure from all fronts, the banking sector faces a situation where it has to accommodate government regulations, obligations to the consumers and make profits; all within a collective ethical framework. Often the debate for ethics in the corporate world is based on the notions of Profit Maximization versus Corporate social responsibility. But the question of operating a business devoid of deception and fraud is deep rooted not just within individual ethical loci but within our constitutional framework as well. The question arises when the fulfillment of legal and ethical obligations superimposes the very purpose of a business organizations existence, profit creation. And the current bank lending slump is an archetype of this issue. With such stringent government policies and transparency regulations, are the financial institutions ethically obliged to comply regardless of the losses being undertaken by the business ? The answer lies in the question itself, the reason why many of these institutions suffered losses were primarily their fraudulent and deceptive practices which led to a crashing financial system and evaporating consumer confidence. The status quo of man being an ‘economic man’ has been rendered obsolete in many cultures and schools of thought. Corporations often operate with an underlying assumption that all their stakeholders are concerned with is profit maximization, with ethical considerations being secondary. Even advocates of pure capitalism and profit maximization like Milton Friedmann exclaim that businesses are allowed to maximize their value, only if they operate within prescribed circles of law and notions of ethics. Market research and literature review suggests that more and more consumers are now concerned about the ethical background of the institution they are dealing with. This is specifically true for the banking sector after the aftermath of financial crisis, ethical reputation of banks has come under jeopardy as sinking consumer confidence is backed by notions of banks being unable to safeguard consumer assets and provide reasonable accountability (Covalence, 2010). While most other sectors of the industry divert countless resources towards corporate social responsibility initiatives and ethical awareness campaigns, the banking sector has remained rather oblivious to this changing trend. The consumer of today is the ‘social man’, equally concerned about the ethical and social implications of an organizations business practices rather than just the economic functioning. (Coomans, M .2005) The dynamics of ethical practices in the banking sector/financial institutions need to be studied in isolation to be understood and dealt with properly. The first step is to understand the role of the financial institution. According to Joseph Stiglitz, professor of economics at Columbia university, ‘Financial markets are not an end in themselves but a means: they are supposed to mobilize savings, allocate capital, and manage risk, transferring it from those less able to bear it to those more able.’ We live in the age of capitalism where everyone aspires to claim their right to consume. Often this consumption is fueled by means beyond the capacity of an individual, thus the need to borrow rises with the belief that the repayment can be made in due time with required levels of interest.( Mehmet, A., 2011) When government policies of low interest encourage borrowing, banks often become the center of activity. But evidently, the most important requirement for a financial institution or a bank to be able to establish itself is trust. The magnitude of business for a financial institution at any point in time is based on the level of confidence prevalent in the market. General optimism, as witnessed during the pre-2007 recession period led to increased economic activity while post-recession the pessimism and skepticism has transcended into market inactivity. For a bank, trust is created by the general market feeling and trends alongside profitable practices; coupled with credibility given by ratings agencies. The ethical situation stems out from the fact that it is often at the discretion of these financial institutions to create hope about certain financial instruments. The dilemma occurs when an ill performing instrument or security is deemed as highly secure. Or in anticipation of unfavorable government policies, the misinformation to the public is not transmitted and banks persist with profit maximization policies. Or the introduction of short time-high rate investment opportunities such as hedge funds and other bonds without full mention of the level of risk involved. After the recession, once the borrowers realized the fragility and affected nature of the economic boom, confidence level in these institutions naturally dipped. And since this is one of the most important factors in running a banking business, figures were bound to plummet. Several ethical loopholes were pointed out after the recession, especially among managers of banks and financial institutions whose malpractices have been attributed for the current recession. Undue as this blame might be, but the course is set for this sector to introduce ethical reforms and set a precedent for future purposes so that such a crisis is averted. If the market is to function back to its growth cycle, borrower confidence has to increase. In order to do so, banks and financial institutions will have to play a pivotal role otherwise net lending is bound to remain low in accordance with current market conditions. Financial experts and governments have identified certain objectives in response to the banking slump which deal with certain ethical and structural objectives. They identify protection of financial stability, depositor protection, and protection of public confidence, public funds and human rights as pressing issues that need to be managed. ( Barbara, J., A. 2011) The issues in the banking sector also include introduction of mandates to reaffirm stakeholder and credit holder rights, so that rights are ensured and trust firmly set back in to these institutions. An increasing number of organizations have realized the benefits of tapping into the area of consumer trust and confidence through marketing themselves as socially responsible organizations and acting accordingly. Numerous theories have been formulated which support the nation of ethical practices being beneficial for a business both in the long and short run. The stakeholder theory suggests that ethical business practices not only lead to a successful business but also a stable financial system, which is important for pivotal sectors of the economy such as banking; also keeping in mind the global connections of trade and commerce and the transcontinental ramifications of the recent economic crisis, the Caux Round Table (CRT) Business Principles emphasize on global mutual cooperation on ethical issues, particularly the sound functioning of the capitalist system around the world with a uniform ethical code in operation. (Francis, C., 2010) Since monetary capital is internationally mobile, the banking sector needs to achieve such international ethical coherence in terms of practices as well. Once the need for ethics is established, it needs to be understood that business ethics do not stand as an entity independent of the organizational dynamics. They are a part of the inter and intra organizational operations. The initial precedent needs to be set as part of the corporate culture, the onus of which lies on managers by virtue of being policy makers. Ethical practices should be encouraged and regarded as mandatory, defiance of which should be dealt with accordingly. In the banking sector, financial statements have been a major issue of concern for stakeholders who are aware of the room for fraud. Escalated profits, boosted ratios and unauthorized credit ratings were seen as major culprits in brewing the recent economic turmoil. Thus, if the banking sector is to win back the trust of its market, strict policies should exist and practices be made part of the organization that make it compulsory for employees to adhere to a code of conduct that reflects truthfulness and transparency. The other level where ethical practices for the banking sector are a need is with the external environment which includes the regulatory authorities and the customers. Firms should confirm to by-laws of fair banking and create accountability mechanisms within the organization to ensure that malpractices are curtailed. And in the world of today where the customer is central to a company’s strategy, the banking sector should be particularly open and honest with its customers as that is the most important group the bank is dealing with. (Harvey, B. 1995) The third area for development of the banking sector in terms of ethical practices relates to marketing and communication. The banking sector being unable to defend itself or take a stance in the heat of the recent criticism of its malpractices has further dented its image. Proper measures need to be taken to manage the image of the sector and convey messages to the public to ensure that the impression being built is conducive to the sector’s business aspirations rather than causing hindrances. Marketing experts suggest that banks can use their philanthropic funding to developmental programs in order to highlight their involvement in community building and pose as a socially responsible sector. Since this is is a feat no other sector can claim, this is a unique selling proposition that remains unused by the financial sector. Unless such trust building exercise don’t become a norm, the consumer confidence level towards banks will undoubtedly remain low, as is reflective in recent trends. As a final note, it should be kept in mind that ethics aren't a fad. They shouldn’t just be emphasized on in the time of crisis, but should be an ongoing part of the banking sectors practices. This will help this sector in running a successful business and also help sustain economic prosperity that is based on ground reality figures and not fragile figures and expectations. Bibliography HARVEY, B. 1995, 'Ethical Banking: The Case of the Co-operative Bank', Journal Of Business Ethics, 14, 12, pp. 1005-1013. COOMANS, M .2005, '"Fair Play" or "Loyalty and Coherence" A Source of Performance and Value Creation through Business Ethics', EBS Review, 20, pp. 30-47. BADERTSCHER, B., BURKS, J., & EASTON, P. 2012, 'A Convenient Scapegoat: Fair Value Accounting by Commercial Banks during the Financial Crisis', Accounting Review, 87, 1, pp. 59-90. HAYS, F., & WARD, S. 2010, 'Fantasyland revisited? Bank construction and development lending and the financial crisis', Research In Business & Economics Journal, 3, pp. 1-24. 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