Domestic and International Banking - Essay Example

?Introduction According to a new survey released a couple of weeks back, the profit of the major banks of UK was declined by 5-15 % compared to the last financial year. The major banks of United Kingdom like HSBC and Royal Bank of Scotland, termed it a result of the influences of the bonus restrictions imposed by the government. This has come a far way ahead as the government of United Kingdom has continuously been interfering in the functioning of the Banks by passing new rules and all that. Banks have always been a very strong point in a country’s economy. Whichever and however the country is, (Big or small, Developing or developed) every country’s economy stands on the banking structure of the country. This is a mechanism on which the whole banking structure is based. This report contains an analysis of the Banking Sector of United Kingdom, Along with the challenges faced by the Banks now a day, like the bonus restrictions imposed by the government which has checked the functioning of the major banks in United Kingdom. Granting Loans and receiving deposits A bank works on the principle of borrowing and landing. In this mechanism, Bank borrows from the General public and the institutions and lands the money to the needy public in terms of loan. After a loan is granted, the banks takes a certain amount of interest for a certain period of time and gives a part of that interest to the public, from whom bank borrows the money initially. “Public” in terms of banks, is defined as the costumers of the bank (either it is an individual or an institution). Role of Banks in Country’s economy: -   As stated above, a bank plays a very important role in the economy of a country. The economy is mainly based on the industries and the income sources available within the country. Bank helps the developing industries to grow with their potential by landing them money and by giving a kind of stability to the market. In a recent example, the economic crisis over the world in 2008 was started because a major private sector bank was declared bankrupted in USA. This bankruptcy of this bank resulted in instability of the market as there were so many companies which had invested in that bank, also there were companies which were totally depend on that bank for their financial security. Once the crisis started spreading its effect in US, major companies were affected badly by it. USA being the world’s most powerful economy that time came on its foot. Millions of the employees were thrown out from the companies, salary was reduced. But this procedure was limited to the industries which could bear this crisis. Other industries which were small scale industries and which needed help from the bank for each and every move they made in the market, were closed. This crisis could not remain in the US itself. Just within no time, the whole Europe, Asia and America saw this effect on their market. Every trading market was down. And it gave a long lasting 1 year, full of tensions in the economic sector of the world. The World Bank came to interfere in it. World Bank granted huge loans to the countries, so that the condition could be in control. Otherwise the condition could have been worse, and the whole world would have been in trouble in no time. Somehow, this problem was shorted out. But this gave an example for the upcoming time of how important the proper functioning of a bank is. If the banking sector is strong and well functioning, it can be a positive sign towards the country’s economy. But if the Banking industry is comparatively weaker, it can turn out to be another crisis kind condition for the country. The Banking Sector in United Kingdom UK’s banking sector, following the US and Japan, is the world’s third largest and considered foremost in terms of: efficiency, dynamism and return on capital. It services 95% of the population with about 3.5% of UK’s total workforce - over a million workers. The decade ending 2005 witnessed a surge of three folds in assets to €5526 billion, lending and deposits more than two fold to €3284 billion and €4984 respectively. The financial sector’s productivity is growing at three times the pace of the economy and reflects an increasing share of the GDP.  Last year, banks and financial services contributed ?70 billion to the country’s national output, equivalent to nearly 7 percent of the country’s GDP – 100 % percent increase from 2003. UK leads as a major international center for investment and private banking, cross border banking and accounts for a fifth of global international lending; with banks in London handling a third of the global foreign exchange business. Facts about United Kingdom’s Banking Sector Banks and financial services provide over 1m jobs Banks and financial services contribute ?70bn to the UK’s national output (6.8% of GDP) Banks and financial services provide 25% of total corporation tax (?8bn) to the UK Government The main retail banks provide over 125m accounts, clear 7bn transactions a year and facilitate 2.3bn cash withdrawals per year from its network of over 30,000 free ATMs  Banks provide cost-effective banking services to 95% of the UK’s population Five UK banks are in the top 15 firms listed in the DTI’s recent 2006 Value Added Scoreboard of Wealth Creating Companies The value of foreign exchange business passed through London every day is ?560bn ($1 trillion) The Bonus Restrictions Imposed by United Kingdom’s Government:- Some of the restrictions imposed by the British Government are 1. According to the major banks of UK, The government has imposed high rate of internal taxes, so that the banks are facing problem in expanding their business with the outer countries like United States. 2. One of the most important restrictions imposed by the government is, regulating the salaries of Bank Employees. Even though being in financial sector, the employees expect some good amount of salary from a job of this kind, but due to this move of the government, the employees are quitting their jobs from the banks. 3. One of the main concerns of the banks is the new tax levy imposed on U.K. banks by the David Cameron government. The levy puts an additional tax on certain lines of a bank’s global balance sheet with the goal to establish a “security fund” that could be used to bail out a bankrupt bank instead of using taxpayer money, as occurred during the recent financial crisis.  RBS (Royal Bank of Scotland) estimates that the levy alone could cost it around 225 million pounds (US$365 million) in 2011 and 400 million pounds (US$648 million) total, which would easily put a strain on its after-tax income. In June 2010 the Chancellor of the Exchequer George Osborne unveiled an emergency austerity budget that set out plans to increase taxes and cut public spending by ?17 billion within five years. Pivotal to this budget’s success is the necessity for a freeze on public sector pay and benefits spending cuts. The U.K. government is a majority shareholder in the Royal Bank of Scotland (RBS) and technically has the ability to challenge the right of the bank to decide whether staff bonuses are allowed. Yet even with this mind the RBS continues to hand out exorbitant bonuses as though immune from government rulings, begging the question whether the bank is exempt from the parameters imposed by the austerity budget to which everyone else in the country must follow? Latest European Union Legislation: According to the Daily Mail on 8 July 2010, The European Union intends to cap banker bonuses and may even ask for them to be returned under fresh EU legislation. Only 30% of any bonus will be made available in any one year while the remainder will be spread over a period of up to 5 years. The legislation is due to take effect on 1 January 2011. The EU intention is to prevent a repeat of the infamous Fred Goodwin bonus scandal in which the Royal Bank of Scotland Chief retired with a ?2.7 million bonus. Goodwin received this bonus in early 2009 after the RBS had been bailed out with public funds. He was asked by government ministers, including Gordon Brown the then Prime Minister, to return the money but refused. Additionally he was also to receive an annual pension of ?703,000. In June 2009 Goodwin caved in to public opinion by accepting a smaller pension that RBS claims is now ?342,500. In 2009 Shaun Springer, chief executive of Napier Scott, an executive search firm, stated that in general bankers receive a salary of about ?100,000 per annum. In regards the sub prime-mortgage market or trading derivatives that caused the crisis only a few bank staff were directly responsible. Many others were producing handsome returns and for that reason their expectancy of a bonus was considered justified even after the bank fell into crisis and the money used came from the public. Additionally, a Commons inquiry claimed that there was evidence of banks continuing to operate using "undesirable practices" against customers who had fallen into debt while at the same time starving viable businesses of credit. The European Commission document dated 12 May 2010 titled: "Communication From The Commission To The European Parliament, The European Council, The Council, The European Central Bank, The Economic And Social Committee And The Committee Of The Regions" clearly states under Reinforcing economic policy and coordination that: "The euro area's governance and coordination of economic policies must be improved. This will involve both deepening and broadening economic surveillance arrangements to guide fiscal policy over the cycle and in the long term and, at the same time, address divergences in growth, inflation and competitiveness." The European Union has the mandate and power to seek improvements in a banking system it has identified as possessing weaknesses due to compliance failures with fundamental rules and principles as well as inadequate monitoring but its legislation will not come into force before 1 January 2011. However before 2011 the Chancellor's June austerity budget should ensure a consistency by all employers to adhere to salary restrictions which include bonuses. Pros and Cons of the Bonus restriction After a bailout that has made the British government Royal Bank of Scotland's largest and most influential shareholder, the bank’s once cosseted executives are adjusting to a life that is both leaner and meaner. Instead of casually plunking down the company credit card, R.B.S. bankers around the world now must get approval before entertaining clients, and must pick up their own tab for meals on business trips. And no more kicking back in a costly town car: British oversight means that even American employees riding into New York from the bank’s local headquarters in Greenwich, Conn., are expected to take the train. As the banking industry buzzes about how to get around President Obama’s compensation restrictions for firms leaning on taxpayer support, Britain’s decision to take an active ownership role in R.B.S., which recently accepted a ?20 billion ($29 billion) capital injection, leaves the bank with little room to focus on anything but clawing its way back to profitability. One senior R.B.S. manager said he had been told this week to further slash a bonus request for his producers — after already submitting a proposal that was a reduction of 50 percent to 80 percent from 2008. For a bank that came to define Britain’s banking boom with its deal making swagger and vast global ambitions, the blunt new reality has created a financial twilight zone of sorts that goes well beyond the pay and perks. The bigger issue is how global commercial banks like Royal Bank of Scotland will function once they are majority owned by the government. Britain will soon own 70 percent of R.B.S., raising questions about whether it is a global financial institution trying to make a decent return on equity, or a purely British bank with the primary charge of offering more mortgages to hard-hit homeowners. The United States government, by contrast, says it wants to stay out of the business of running banks, and has taken a far smaller stake and a much less active role in Citigroup, Bank of America and others. R.B.S. brought in a new chief executive, Stephen Hester, last fall to rein in a culture of excess that turned it into a target of public ire. But the bank’s immediate financial fate rests in the hands of John Kingman, a brainy government technocrat earning ?110,000, whose primary private sector experience was as a financial journalist. The 39-year-old career civil servant oversees United Kingdom Financial Investments, or U.K.F.I., the body established last year to manage banks receiving taxpayer money, including Lloyds Banking Group, in which the state has a 43 percent stake; and Northern Rock and Bradford & Bingley, which were nationalized last year. With such a large portfolio, Mr. Kingman, educated at Oxford, is now seen by many as the most influential figure in the City of London. Under pressure from the Labor government to increase domestic lending, Mr. Kingman and his team will soon release a report tallying how much R.B.S. has kept its domestic lending at 2007 levels, a requirement of government aid. The report will also look at how much capital R.B.S. is allocating to small and medium-size lenders in the United Kingdom, the number of mortgages approved and the size of down payments being required from home borrowers. None of this has escaped the attention of RBS’s jittery traders and bankers, who are also concerned that the government may dictate that bonuses be deferred for a year, if not more. “The real fear is that this decision will be owned by the government,” said a senior executive, who was not authorized to speak publicly. “The government cannot be seen as doing anything less than doling out significant pain.” Indeed, the increasing government role in R.B.S. has not been embraced by investors. The bank has a market capitalization of ?8 billion — a fraction of the government’s ?20 billion investment. “People can see that the government is interfering and damaging their interests,” said Roger Lawson, spokesman for the U.K. Shareholders’ Association, which represents private investors. “So investors are steering clear.” Response of Banks and Bankers Britain's financial regulator is putting the banking industry in jeopardy by gold-plating bonus rules while rival countries pay them lip service, senior industry figures have warned. Leading bankers are claiming to be so hamstrung by bonus restrictions that they are threatening to relocate overseas. Anger about the Financial Services Authority's (FSA) strict implementation of the G20 code on pay follows the Treasury's decision to impose a bank tax unilaterally, and has raised questions about whether the UK is the right place to be headquartered. Bankers claim the FSA is the only regulator to be enforcing the bonus rules for domestic banks' international operations, making it difficult to compete in foreign territories. They also say the regulator's definition of who qualifies as having "significant influence" captures more than twice as many staff as in rival countries. "Significant influence" staff has to take proportionately less pay in cash and defer a larger element for three years. Conclusion As discussed in the above report, the increasing influence of British Government is somehow not very good according to the Banks like HSBC and RBS. As a result of the bonus and salary restrictions imposed by the government in last couple of years, the banks have shown decline in their annual and quarterly profit as compared to last year. The Employees are planning to get rid of Bank Job because of salary restrictions. If British governments kept continue to impose such kind of restriction, the banking sector of UK will soon be like as of a developing country. References 1. Glenn Hubbard r. Palia D. Columbia Business School, Executive pay and performance: Evidence from the U.S. banking industry. Columbia University New York, NY 10027, USA. Received March 1993; final version received December 1994 2. K. Wozniak A. Product Markets And Paychecks: Deregulation’s Effect on The Compensation Structure in Banking. University Of Notre Dame. March 2006 3. K. Wozniak A., Product Markets and Paychecks: Deregulation's Effect on the Compensation Structure in Banking, Department of Economics, University of Notre Dame Woznia. 4. Cunat V. Guadalupeb M. Executive compensation and competition in the banking and financial sectors. The London School of Economics. Columbia University, CEPR and NBER. August 2008. 5. http://uk.finance.yahoo.com/news/bankers-threaten-to-move-abroad-over-bonus-restrictions-tele-3d871a4ca012.html 6. http://www.answers.com/topic/government-regulation-of-business 7. http://www.suite101.com/content/banker-bonuses-to-be-limited---a-european-union-initiative-a259375 8. http://www.ft.com/cms/s/0/cd46e424-b8f9-11de-98ee-00144feab49a.html 9. http://www.infosys.com/finacle/finacle-connect/issue_07/images/kali.doc 10. www.guardian.co.uk/commentisfree/2011/jan/24/curb-the-banks-government-propped-them-up 11. www.guardian.co.uk/business/2009/dec/10/brown-and-sarkozy-tax-bankers Read More