The Federal Reserve in the Early Stages of the Financial Crisis - Essay Example

? GOVERNMENT AND THE BANKING SECTOR Discussion The past experiences in crises within the global economy and specific to countries, banking sector has always held a central place within the entire crises and plays a critical role in restoration to normalcy within an economy. In particular, following the global economic crises experienced over the period between 2007 to 2010, much has been postulated to blame the banking sector worldwide for having played the eminent role in bringing about the crises. The banks has been central in designing and adopting policy frameworks which facilitate lending and extending credit facilities to borrowers normally the government or the private sector. Loans to small and medium size business ventures form the bulk of the credit facilities offered by banks at any one time and therefore have a critical responsibility in ascertaining the stability of an economic framework. Private developers equally get credit facilities in terms of mortgages and this has been in the rise with the advent of a booming real estate business across the globe. Bothe local and international investors have continuously sought the intervention of banks through monetary assistance through credit facilities which have been termed a critical stimulant to an economy reviving from effects of financial crises or intending to build on internal reserves in finances. In the UK, in the aftermath of the global financial crises, the banks are being encouraged to adopt the lending strategy especially to small business and for mortgages. Moreover, they are required to step up regulatory and precautionary measures in building up capital reserves in order to aid in the smooth operations within the economy. However, an outright dilemma sets in regarding the balance between the safe lending and the ways to build up the capital reserves as required. The government of the United Kingdom plays the role of regulation and creates an enabling environment for the banks and small business enterprises that are the target in the credit facilities. On the other hand, the banking sector within the country has a central role in formulating and adopting favorable policies, which will serve to regulate the credit facilities, advanced while at the same time monitoring the growth of financial capital stocks in the banking sector. Drawing lessons from the 2007 to 2008 financial crises, Gambacorta and Marques-Ibanez draws the conclusion that stability in financial intermediaries plays a critical role in ensuring that there is a smooth transmission of credit facilities between the banks (lenders) and the borrowers (the likes of small and medium size businesses). The strength of bank lending channels plays an important role in provision of credit facilities in that bank-specific characteristics are central in credit provision. However, structural adjustments and changes during the period of crises resulted to favorable outcomes in restoration of sanity within the economy. During the crises, the loan supply suffered restriction greatly from weaker capital positions from banks as well as overdependence on non-interests loans and market funding. This therefore points to the risks that are prevalent to banks over funding liquidities. The conclusion from the lessons learnt support the need of establishing regulatory and monitoring mechanisms on those factors that work in favor of or against monetary transmission more so during periods of crises. The central bank has a specific role that of supervisory role to the other banks and keeping a proper statistical data base of all the banks for monetary regulation and advisory roles (Gambacorta and Marques-Ibanez, 2011, p.1-28). In order to address the rising concerns, there are various tools that can be applied within the banking sector, which would include imposition of monetary policies, deregulation as well as financial innovation. However, monetary policies are argued not to be very neutral from the perspective of financial stability. Financial innovation as well as deregulation has equally been challenged in that they expose banks to higher vulnerability risks in market conditions as well as financial instabilities. Thus, therefore policy formulations to govern the banking sector should be guided and driven by monetary policy consideration as well as by financial stability. Banks also have a responsibility of increasing their resilience in associated risks with liquidity. Counter cyclical security buffer build up are also favorable approaches to shield the banking sector from the adverse effects of losses with business stress and losses. Moreover, bond financing as well as securitization would be unfavorable through constraining banks capacity to extend new loans within times of instabilities in the financial sector. In this respect, my approach would be through empowering the central bank through legal frameworks to develop and maintain confidential statistical frameworks for individual banks in order to offer monitoring and supervisory role to the individual banks effectively. However, the government comes in handy in designing and formulating favorable legal frameworks as the past shows that protection laws have always posed challenges to the banking sector operations. Regulation of bank lending therefore rely on a certain capital, multiple which regulates the levels of loans to be advanced by a bank. The contraction of a banks’ reserve capacity places the bank at a losing end in matters of financial stability and the capacity of the bank to extend loan facilities to borrowers. In an analysis trough the FED policies to counter the global financial crisis, uncertainty in the eventual outcome of the financial crises played a great role in discouraging credit advancement to borrowers. Traditional methods of countering the effects were ineffective and thus necessitated new policy frameworks to restructure the economy. Having the treasury increase its deposit account size the central bank ensures it effectively responds to increasing risk premium as well as the price for risky assets (Cecchetti, 2009, p. 73-74). The macro-economic perspective reveals that an economy fails to affirm its sole role as a self-regulatory body and as such requires the interplay of other factors to bring about its stability. John Maynard Keynes supported the interventionist approach in restoring stability to an economy through public spending. This therefore reveals that when a government indulges in higher spending, more financial resources are injected into the financial circulation. The governments can channel back funds into the economy through extensive buying of public assets, which avails more money into circulation. Moreover, through government buying security bonds from the financial institutions, much money is rechanneled into the capital reserves of these banks and as such, more revenues are available for lending and advancing credit facilities to the private borrowers as well as businesses. Moreover, growth in capital reserves would be realized which would enable banks to extend mortgage facilities as is postulated by the governments. Through increased lending, banks realize higher returns from the interest rates that are prevailing which assists in creation of wealth for the economy. These methods have stood the test of time in bringing about revival of economic performance since the early 20th century. Though the UK has adopted the similar approach to revive its economic performance, uncertainties in the future tax regimes results to fears in actualization of these policy tools. The most critical perspective in reviving the country’s economy is restoration of confidence within the financial markets as well as through the banking sector. Nevertheless, global challenges require global perspective intervention and thus collaboration with international players would be a critical avenue to address the current crisis. Despite the urge by the government to step up lending to small size business ventures as well as through mortgages, there is the need to have higher participation through international frameworks. However, through these efforts, a more highly governed and resilient economic systems likely to be the outcome of these measures as they are postulated and thus requiring further interventionist moves. Deregulation policies may be the most appropriate approach to the financial market through which the economic growth is more likely to be resultant. I therefore highly recommend that financial innovation be curbed through restitution of bureaucratic legislations as well as intervention. This gives the government the appropriate time to develop infrastructure to accommodate the interventionist mechanisms from international monetary systems while at the same time ensuring clear and well-planned economic engineering within the country (Adair et al, 2009, p. 9). Competition has amassed pressure for the banking sector to examine the available channels thoroughly and avenues to realize the effectiveness and efficiency in the operations. Learning from the Europe context, the heightened competition necessitates banks to evaluate the available opportunities in serving and retaining customers through analyzing what products are in need by the customers. Moreover, the modern day banking and retailing frameworks necessitate the banks to restructure and dismiss the unnecessary portion of the customers while at the same time retain the most important portion of the customers (Earnest and Young, 2010, p. 4). In order to gain and realize profitability and competitive edge within the sector, the banks are obliged to focus on profitability on the duo perspective; the customer perspective as well as the banks perspective. In this regard, banks ought to understand that some customer specific needs drive the market and hence the need to differentiate products to suit the needs of the specific customers. The differentiation of products ensures that the banks achieve the service orientation and profitability through meeting their customers’ needs. this is the essence of the recommendation that the banks within the UK need to step up lending capacities to small business while at the same time taking precautionary measures against taking the path taken earlier leading to low capital reserves. Besides, banks are advised to take the advantage of the real estate and property development in advancing mortgage facilities within the country. In sum the crises that arise within United Kingdoms relating to the recommendation of adopting policy frameworks that encourage greater lending in credit facilities to small businesses and of mortgage facilities has been the balance between the lending practices as well as the expected build up of the capital reserves within the individual banks. Many proposals and approaches to the crisis can be postulated to revolve around formulation of policies and imposition of regulatory frameworks by the government and the central bank. Nevertheless, the different proposition has equally associated shortcomings which necessitates correction and improvement in order to realize the desired outcomes while encouraging borrowing and lending while at the same time ascertaining capital build up by the responsible banks. Moreover, the policy instruments must be aware of the competition forces within the sector and as such formulate favorable policy instruments that would boost performance of the bank to counter stiff completion by other banks. Among other positive tools that would be favorable and appropriate to use while addressing this dilemma would be deregulation, financial innovation as well as securitization. The above discussion analyzed some of the instances where the policy tools have been used in the past especially while addressing the financial crisis outcomes within various countries. Deregulation is a policy tool used to refer to removal of restrictions by the government to the operations of banking sector (Kroszner and Strahan, 1999, p. 1437-1438). Through applying the deregulation tool, the government creates, an enabling environment through which banks are empowered to formulate own policies and adopt them without the input of government policies. Through this mechanism, I therefore suggest that the banking sector in the country would realize the expected returns through higher lending to small businesses as well as through mortgages. Besides regulation is the financial innovation, which refers to the ability of banks to invest in research and development, through which they are able to understand the markets properly (Arnaboldi and Rossignoli, 2009, p. 1). Good understanding of the prevailing market circumstances are instrumental in placing the banking sector in a position to design more competitive products targeting the existing as well as new customers meant to have a positive effect against competition within the industry. This is another tool that can be effectively adopted within the country in efforts to realize the set targets by the banking sector as well as by the government. Finally, this paper suggests the adoption of policy frameworks that encourage securitization within the banking sector in the country. Securitization refers to packaging common assets with general predictable cash flows together and transforms them into interest bearing assets (Anon, nd, p. 405). This is done through such collaterals as the home mortgages, leases, commercial mortgages as well as through home loans. Our commendation of the policy provision is because it is favoring both the government as well as the banking sector. Through these securities, the interest serves greatly to build up capital base as required while at the same time generating cash to be credited to borrowers and mortgage bearers. Therefore, the analysis of this paper commends the interplay of the three policy tools; the deregulation, securitization as well as the financial innovation. Bibliography Anonymous. nd. Chapter 16: Securitizations. Available at: < http://www.fdic.gov/bank/historical/managing/history1-16.pdf>(Accessed on 4 July 2013) Arnaboldi F. and Rossignoli B. 2009. Financial innovation. Theoretical issues and empirical evidence in Europe. Available at: < http://host.uniroma3.it/eventi/wolpertinger2009/37.pdf>(Accessed on 4 July 2013) Adair et al, 2009. The Global Financial Crisis: Impact on Property Markets in the UK and Ireland Report by the University of Ulster Real Estate Initiative. Available at: < http://news.ulster.ac.uk/podcasts/ReiGlobalCrisis.pdf> (Accessed on 4 July 2013) Cecchetti S. G. 2009. Crisis and Responses: The Federal Reserve in the Early Stages of the Financial Crisis. Journal of Economic Perspectives, 23(1) pp. 51–75 Earnest and Young. 2010. Understanding customer behavior in retail banking the impact of the credit crises across Europe. Available at: < http://www.ey.com/Publication/vwLUAssets/Understanding_customer_behavior_in_retail_banking_-_February_2010/$FILE/EY_Understanding_customer_behavior_in_retail_banking_-_February_2010.pdf> (Accessed on 4 July 2013) Gambacorta L. and Marques-Ibanez D. 2011. The bank lending channel: Lessons from the crisis. BIS Working Papers. Available at: < http://www.bis.org/publ/work345.pdf > (Accessed on 4 July 2013) Research TeamKroszner R. S. and Strahan P. E. 1999. What drives deregulation? Economics and politics of the relaxation Of bank branching restrictions. The Quarterly Journal of Economics, pp. 1437-1467. Read More