Regulatory Response to the Financial Crisis Which Began in 2007 - Essay Example

11th November Regulatory Response to the Financial Crisis which began in 2007 Introduction The period 2007 to was acrucial period in the history of most if not all countries around the world. The crisis which rocked the financial system was described by many as the most severe downturn since the Great Depression of the 1930’s (Chang 2010, p. 1). The problems in the United States financial system triggered almost worldwide repercussions and lead to regulatory responses on both national and international levels with calls for greater cooperation among countries to avert another crisis. In an attempt to prevent a reoccurrence of the situation and to deal with the problems that caused this crisis, both regulatory and market based solutions have been proposed (Chang 2010, p. 1). The debate still rages as to the real cause of the crisis. King (2011, p. 48) indicates that a major contributor to the global crisis was global imbalances which requires rebalancing of global demand in order to facilitate a sustainable recovery. This paper provides a brief synopsis of the events and the regulations which followed in the US, Germany, UK, Netherlands and Spain. According to Blundell-Wignall and Atkinson (2010, p. 2) every banking crisis has been associated with major disruptions as well as recessions and this is the reason for certain bank regulations. New regulatory responses are generated by every global financial crisis (Helleiner 2010). This was no different for the crisis which started in 2007 resulting in what has been described as ‘the Great Recession.’ Regulatory Response in the United States According to the U.S. Senate Republican Policy Committee (2010) a multitude of events led to the Great Recession of 2008-2009. They include the housing bubble which was caused by cheap credit made to persons who would not qualify for a loan under normal circumstances; low interest rates; failure of regulatory agencies; and inflated rating grades provided by credit rating agencies. In order to mitigate the crisis United States government introduced what they described as Targeted Asset Relief Program (TARP) and the Temporary Liquidity Guarantee Program (TLGP) – (Eubanks 2010b, p. 2). The TARP was later expanded to include automobile companies such as GM and Chrysler (U.S. Senate Republican Policy Committee 2010). A number of regulatory proposals were put forward in relation to consumer protection, modernisation of the regulatory system and restoring stability (Eubanks 2010a). These led to the Dodd-Frank Wall Street Reform and Consumer Protection Act of July 2010 and a consolidation of the regulatory bodies. The objective of the act is to “create a sound economic foundation to grow jobs, protect consumers, rein in Wall Street and big bonuses, end bailouts and too big to fail, prevent another financial crisis”. According to Lo (2009, p. 27) there has been a recent proposal to suspend Fair-Value – FASB Statement No. 157. Fair-value or mark-to-market accounting requires the valuations of firms’ asset at fair market prices and not on a historical cost basis. The practice which has forced a number of firms to write down their assets and thus triggering defaults and insolvencies has been blamed for the financial crisis. Regulatory Response in Germany In Germany the single regulator of financial services – the German Financial Supervisory Authority which was established in 2002 in order to improve stability and integrity in the German financial system had its regulatory authority greatly increased in 2009. This was done in order to improve its capacity to manage the financial crisis. The act for strengthening the financial market and insurance supervision became effective on August 1, 2009 (Eubanks 2010b). This act was a measure which had the objective of increasing the preventative, supervisory and intervening powers of this regulatory authority. The act also facilitated the strengthening of informational and reporting requirements for financial institutions, insurance companies as well as insurance holding companies. During the crisis in Germany several institutions became severely undercapitalised and the government intervened in order to recapitalise them. Brown (2009, p. 4) points out that the Emergency Takeover Law which was approved in 2009 gave the government authority to take control of banks that were badly affected by the financial crisis and which would pose a threat to financial stability. The process involved the transfer of securitised non-performing assets to create what was then described as a “bad bank”. In return for this banks received government bonds, debt guarantees and lines of credit which were valued as high as 90% of the securitised debt. Bailout funds were provided by Germany’s Financial Market Stabilization Fund (Brown 2009, p. 9). All these actions by the government required the approval of the European commission and were appropriately received. The government also provided support to banks ranging from a low of 0.5 billion euros to 18.2 billion euros. A financial package for the automobile industry which was similar to the bail out given to the automobile industry in the United States was also implemented. This package was triggered by drastic reduction in demand for automobile worldwide. Additionally, the government pledged a 100 million euro credit line in order to allow struggling businesses to obtain bank loans (Eubanks 2010b). Regulatory response in the United Kingdom (UK) In the UK the regulatory response to the financial crisis which began in 2007 was carried out through the Financial Services Authority. This agency was formed in 1997 when the government of the UK consolidated nine regulatory bodies into one. The FSA was therefore given the authority to regulate almost every aspect of financial services (Eubanks 2010b, p. 11). The UK government responded to the financial crisis in a similar fashion as the United States government. Both the Bank of England and the FSA tried to slow the financial turmoil in order prevent a further economic recession. Approximately 500 billion pounds was injected in the UK’s eight largest banks and savings and loan associations (Kleinman 2008). Kirkup (2010) indicates that the program also involved a 100 billion pound mortgage-backed securities guarantee. The government also purchased preferred shares in banks in a similar manner as the government of the United States. The government of the UK had to nationalise Northern Rock Bank plc in February 2008. This was the first failed bank in the financial crisis. This was done because of the run on the bank in September 2007 which resulted in a loss of deposits at an unsustainable rate. Emergency assistance was received via a 49 billion pound loan from the Bank of England (Eubanks 2010). This involved the use of tax payer’s money which the Bank of England and the FSA later sought to recover through an auction but without success. The end result was therefore nationalisation. Control was also taken of Lloyd’s Banking Group plc and Royal Bank of Scotland Group plc (House of Commons Public Accounts Committee 2009). The European Union approved the UK government’s recapitalisation programme as well as their credit guarantee programme. However, Northern Rock was not apart of this programme because of its insolvency status (Eubank 2010b, p. 13). Northern Rock’s situation was pretty similar to the United States Fannie Mae and Freddie Mac). Like all the other authorities in the USA and Germany, the FSA in the UK issued rules relating to liquidity requirements for banks. This was aimed at preventing banks from taking short-term liquidity risk that were considered as excessive. These new rules require banks operating in the UK to diversify their assets comparably less than they had in the past and to hold higher amounts of government bonds. The FSA was harshly criticised for its failure to prevent the crisis and on June 16, 2010 George Osborne, the Chancellor of the Exchequer announced that the FSA would be abolished in 2012 (HM Treasury 2010). Gonzalo (2010) indicates that by 2012 the Chancellor has plans for the creation of a prudential regulatory authority as a subsidiary of the Bank of England. This authority/agency will work with the UK Treasury and there will also be a committee responsible for financial policy as well as a consumer protection and market agency at the Bank of England. Regulatory response in the Netherlands The Netherlands financial system was highly exposed to the financial crisis which started in 2007 (Eubanks 2010b, p. 15). Prior to the crisis the country had very low unemployment levels, a large stable and current account surplus, low government debt and a budget surplus (Eubanks 2010b, p. 15). However, while the UK had a 40% exposure the Netherlands had a 66% exposure to the United States. Therefore the effects of the crisis in the United States on the Netherlands were almost immediate. In October 2008, Fortis which is a Belgian-Dutch bank began encountering liquidity problems and requested help from the government. The government responded by nationalising the Dutch portion of the bank and insurance division by agreeing to a 16.8 billion euro agreement. The government guaranteed all the bank savings up to 20,000 euros and prepared plans to guarantee all savings up to 100,000 euros because of a run on savings accounts at the bank (Essen 2008). The regulatory responses to the financial crisis by the Dutch included amendments to the Netherlands’ Financial Markets Supervision Act (FMSA). The recommendations made were also similar to those made in the UK and across the EU of which the Netherlands is a member. Regulatory response in Spain Spain’s response to the crisis was the establishment of a “Fund for Ordered Bank Restructuring (FROB)” in June 2009. This fund was set up to strengthen the Spanish banking system as well as to prevent them from becoming insolvent. Unlike the US and other EU member countries such as the UK, Germany and the Netherlands the financial regulations initially focused on the savings bank sector in a limited way even though this sector was the most highly exposed all over the world to the financial crisis when compared to other sectors. The explanation given by the IMF is that Spain was not negatively impacted in the initial stages as other EU countries had been. However, in 2010 the government was forced to bail out the savings banks as well as other issuers of covered bonds. This was similar to earlier events in the United States and EU member countries (Eubanks 2010b). International regulatory responses The Basel III Accord which sought to address the shortcomings of Basel I and Basel II was officially endorsed by the G20 member countries on November 12, 2010 at the Seoul Summit in Korea. It represents one of the key international regulatory responses to the financial crisis. The arrangements include: i. better quality and higher levels of capital ii. more adequate risk coverage iii. introduction of a leverage ratio as a backstop to the risk based requirements iv. measures to facilitate the build-up of capital that can be drawn on in times of stress v. introduction of two global liquidity standards The Basel III when implemented will increase the Tier 1 capital ratio and the Core Tier 1 capital ration from 4% to 6% and 2.5% to 4% respectively. This agreement will be implemented on a phased basis starting January 2016 and will be fully implemented by January 2019. Basel III has also introduced a Conservation Capital Buffer, Countercyclical Capital Buffer, and Capital for Systematically Important Banks only (Basel III Accord 2009). In March 2009 the International Accounting Standards Board (IASB) and the Financial Accounting Standards Board (FASB) agreed to work together towards standards that deal with accounting for financial instruments and activities on the balance sheet (IFRS 2009). These have been ongoing as both bodies have been working towards convergence since 2005 (FASB n.d.). To date, over 100 countries have adopted the International Financial Reporting Standards (IFRS) and others to join in 2012 (Eccles and Krzus 2010). Conclusion International standards setting bodies have achieved some amount of success in terms of harmonising standards but there is still some way to go as some countries are not willing to allow the disclosures that it requires. The United States have not accepted all of the IFRS but have been working at convergence. 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