UK Deregulated Banking and Economic Downturn - Essay Example

?UK DEREGULATED BANKING AND ECONOMIC DOWNTURN Discussion on the UK’s Overreliance on a Deregulated Banking Industry is a Key Factor in the Current Economic Downturn and Suggestion of Economic Policies Which Could Be Used to Avoid a Double Dip Recession. Name of Student Student Number Department Grade Course Tutor’s Name 1st December, 2011 Overreliance of UK on a Deregulated Banking Industry is a key factor in the Current Economic Downturn. According to Fancher (1999-20110), banking deregulation is defined as the removal of regulations which governs the banking system. Arguably, it is clear to illustrate that the United Kingdom’s overreliance on a deregulated banking industry contributed considerably to the economic downturn experienced in the period 2007/2008. According to Economy Watch (2010), the Banking Industry was once a simple and a reliable business; but, deregulation and technology have transformed the industry considerably. Banking regulation ensures correction of market imperfections and unfair distribution of resources (Central Banks, 2011). Therefore, deregulation of financial institutions saw the domination of the industry by the selected few, and they acted according to their selfish gain. According to Lyons (1999-2011), every aspect of banking is regulated by federal or state agencies. The Thatcherism regime in its quest to deregulate the banking industry generated a chain of imperfection towards failure in the financial sector (Enqdahl, 2009). Deregulation is expected to have considerable effects on the real economy if t significant changes were placed in the structure, and efficiency of the banking industry (Strahan, 2002). Overreliance on a deregulated banking system in the United Kingdom saw the large financial institutions dominate the sector across a wider geographical area. This led to loss of local market concentration as they only pursued entering the market rather than consolidating within a local market. Banks play a central economic role; thus, affecting the well being of every sector in the economy (According to about.com 2011). The motivation for bankers to undermine and hinder prudent regulation is inherent in the compensation incentives of bankers (Gilani, 2009). With deregulation, transparency in the activities of the institutions is inhibited. Deregulation of the Banking Industry in the United Kingdom saw rapid growth in credits within the financial sector (The Turner Review, 2009). This was orchestrated by the freedom in the banking sector as banks could formulate their own policies without reliance to the state approval. On the same note, significant wholesale and overseas funding surged the economy into deep crises (Economic crisis and Market Upheavals, 2011). Investment in the market was heightened in the sense that one could access investment in the UK risk-free index government bonds with a yield to maturity over 3% real and this could even surge down to1% (The Turner Review, 2009). In the UK, trading activity was underpinned by the securitized credit model, and as the home of several leading banks, it was affected greatly by the impact of the economic downturn. A number of features increased risks contributing to the credit boom in the upswing and enhancing the nature of the down swing that followed (Economic Watch, 2010). This saw losses and liquidity strains escalate in the financial market, housing problems became widespread, as the prices of houses shot down, and credit supply dwindled down and the eventual problems with funding of the UK mortgage banks intensifying (Economic crisis and Market Upheavals, 2011). Factors that were escalated by the deregulation of the banking industry included among others; massive growth, and complexity of the securitized credit model, increased commercial banks involvement in trading activities, heightened leverage in multiple forms followed (Economic Watch, 2010).. Also, the expanded maturity, complexity of structured credit and derivative system and lack of adequate capital buffers contributed to the escalation of the crisis. Baking deregulation in the U.K. occurred during the end of 1970’s into the 1980’s when the Conservative government headed by Margaret Thatcher backed by the City of London financial interest, introduced the wholesale measures of privatization, cutting down on state budget, moving against the labor laws and deregulating the financial markets (Enqdahl, 2009). Fancher (1999-2011), further defines banking deregulation as the elimination of regulations in the financial industry, giving way to better financial institutions proficient of managing more than just one facet of the finance industry. Thatcher carried out the reforms parallel to similar United States of America moves initiated by the advisers of President Ronald Reagan (Seeking Alpha, 2008). The deregulation was viewed as the solution to curbing the inflation in the country, and then, ease the bloated state bureaucracy (Enqdahl, 2009). Though the deregulation of the banking industry was initiated by the Conservative administration of Prime Minister Margaret Thatcher, it has divided itself evenly across the Conservatives and the Labour governments (Ambler & Chittenden, 2007). The Labour Government also introduced a 2001 Act that produced only 27 regulations in the four years that ensued. The Act was remarkably similar to the 1994 Act introduced by the Conservative administration which saw 26 deregulations in a period of four years (Ambler and Chittenden, 2007). According to Enqahl (2009), the epi-centre of the catastrophe in the global economic crisis unfolding lies with the USA and the UK economies together with others that embraced the free market like the Ireland, Canada, Australia, New Zealand and Iceland (Enqdahl, 2009). The deregulation process has seen a trail of blames between the Conservatives and the Labour administrations. At one point one Vince Cable, a Lib Dem Treasury spokesman, commented that it was not enough to hold hands and apologise without having plans to ensure no mistakes are repeated in the future (International Political Zone, 2010). Former Chancellor, Sir Gordon Brown, also admitted that he made a mistake by not introducing tougher bank regulation during his tenure. According to Enqahl (2009), the results were, an increase in the national debts, soaring unemployment and teetering of the economy on the brink of full-brown deflation. This also goes hand in hand with the fall of the Pound which is not part of the Euro zone currencies and increased government borrowing levels. The economic crises had a number of dimensions incorporating debt build up; both corporate and household, but most specifically the house hold (Kilmister, 2008). This was worsened by the international monetary instability and rejection of the rest of the world to fund the US and UK trade deficits. According to Kilmister (2008), bank regulation is based on the initiative that loans can only be a definite multiple of bank capital, the decline in shares reduced capital significantly. This led to massive decline in lending and threatened the stability of the banking system. The banking crisis affected the main industrialized countries as a whole (Gilan, 2008). The global financial crises started showing its effects in mid 2007 into 2008 with the falling of world stock markets (Shah, 2008). The economic boom of the late 1980’s was not solely to the financial institutions greater freedom to lend to the private sector, but energized by over-optimism on the economy’s performance (Sargent, 1991). This optimism to greater excellence in the economy was diminished with the global economic downturn to the dismay of many. In America, the economic downturn is a different one in the sense that civilian employment base increasing by 9% and national debt by 89% (America’s Current Economic Down turn and the Solution, 2008). Banking panics are widely the results of dearth of banking regulation, lack of deposit insurance, and lack of a last resort (Labonte and Makinen, 2002). According to Antonopoulos (2009), a problem that began as a sub-prime mortgage debacle in the US grew to be the worst international crisis since the great depression. The Greek economy though not a giant among the world’s leading ones, its impact was considerable as it had just joined the EU (Regula, 2011). According to The New York Times (2011), the Greek Government placed 30,000 workers on early retirement and dismissed others to meet foreign lenders conditions. Also, it is clear from the government that it would miss a deficit-reduction target of 7.6% of GDP in 2012. The Greek economy suffered a steep year-on-year reduction for the second quarter of 2011; this brings it to nearly1.5% more than the first quarter losses (Press TV, 2011). The accumulation of debts in Greece are un-payable by it alone, Greece has a tiny manufacturing Industry and thus lacks international competitiveness (Hugh, 2011). According to Brittain (2011), the number of people losing jobs in the 17-nation euro zone is worsening. The highest tally of 16.294 million had been recorded in October since 1995. This makes it even harder for governments to the debt crises. Rise in unemployment means higher socials security payments and reduction in tax receipts (Euro-Zone, 2011). This brings in redundant growth, increase in public borrowing, investors grows anxious and debt crisis worsens. According to Daily Mail (2011), countries that are highly uncompetitive have the capability to slash interest rates while devaluing their currencies to uplift their economy, which is not, possible in the euro-zone. Therefore, weak, peripheral euro-zone members will have to suffer years of infringing deflation tumbling living standards, and budget cuts to adjust to the system (Manolopoulos, 2011). The level of unemployment in Germany hit a two decade low in comparison to increase in the Euro zone, this implies that amid the crises, some of the economies can help avert the recession in the region (Barley, 2011). With the fall of Lehman brothers and Landsbanki, looming economic crisis was felt by the main economic players. According to Wall Street Journal (2011), the main Central Banks of the world have launched a joint action to provide cheap, emergency U.S. dollar loans to banking institutions in Europe and elsewhere. This expounds the growing concern of world policy makers in the quest to solve stresses in Europe and the global financial system. Argentina had suffered through a deep recession for three and a half years. After defaulting its foreign debt and cutting loose from the dollar; it only took it one more quarter and grew 63% in six years that followed (Hugh, 2011). Greece situation is quite complex with accumulated debts and its lack of international competitiveness. The proximate cause of intervention had been an economic or financial or financial crisis. In the UK, the whole dominant exercise of joint-stock, high street banking dates back in the 19th century (Ingham and Thomson, 2000). According to Collins et al (2007), mergers and acquisitions in the banking sector are on the increase as a response to deregulation of the banking industry. This is vital as it consolidates the operations while increasing the capital and market base; thus, try and overcome the effects of economic downturn. The UK banking resolution regime has been set up which facilitates the orderly wind down of failed banks (The Turner Review, 2009). Monetary Policy Committee decision on expanding money supply through large scale asset purchases shifted the focus of monetary policy towards an increase of money volumes, as well as, the price of money (Benford et al, 2009). This was aimed at promoting the aggregate demand in the UK economy. By drawing ideas raised by literature rather than testing, existence of credit channels helps in understanding the dynamics involved in the transmission of monetary policy (Bridgen et al, 2000). On October 8, 2008, The British Government unveiled an $850 billion plan to rescue it banking sector (Nanto, 2009). This included four parts; to cut key interest rates, investment facility to be implemented in two phases, availing guarantees on short and medium term debts to institutions participating inrecapitalisation scheme and improve liquidity in the banking industry. Coming up with new business models and technology that allows cost reduction is of essence (OECD, 2009). The world gross product (WGD) is projected to grow by 3.3% in 2011 and 3.6% in 2012 (UN New York, 2011). In the European market, there were intensified policy measures to curb the prevailing failure in the economy. A number of these policies have been highlighted below; the cutting of interest rates by the European Central bank to its main refinancing operations. Secondly, the European council agreed on principles and approaches for reforming the financial system followed by the adoption of decisions by the commission to increase supervisory powers of the EU financial markets committees (European Commission, 2009). Other policies included endorsement of the de Larosiere recommendations and calls reforms in the financial markets to counter the effects of the economic downturn. Safeguarding of the national tax revenues by the national governments, and enhancing communication on, how risks of derivative markets can be enhanced. The introduction of policies to curb the recession will go a long way in ensuring that a double dip recession is avoided. This is highly vital in the search for possible turning point to the recovery of the economy (Riley, 2009). The inflation rate target in the UK is on the CIP; this is the recipient of the goods and services sold (Churm et al, 2006). In the same context, there is a greater need for more international cooperation in the ongoing supervision of financial economic concepts, as well as, coordination in crisis management. According to Blackstone and Karnitschnig (2011), the euro zone will avoid a double dip recession amid the signs of weakness in the economy of Germany. This is imperative in the sense that with unity, economies can be saved from collapsing, and revival ensured. An excellent example is the recovery of the Greek economy which calls for the euro-zone to chip in and help in the realization of economy sustenance. Cutting of interest rates or any other stimulus of the economy should be heightened. According to OECD (2009), history shows that economic crises are times of industrial renewal; thus, the production sector should be enhanced. Firms that are less efficient fail while dynamic ones emerge and expand. Dynamism should be embraced to ensure that firms get through the hard economic situations and surface to grow with the recovering economy. Adjustment in the fiscal policy means more to increasing the stimulus; more reforms aimed at improving the public finances over a time frame will ensure an escape from down dip recession. This calls for reconstruction of fiscal and monetary policy as well as push on reforms touching supply (The West, Economy, 2011). This also calls for richer countries to squeezing their economies firmer to ensure growth is realized. The insolvency of Landsbanki, shows a weakness in the in the current European approach to the single market in retail banking. This illustrates that branch pass porting rights in the retail business requires review to ensure sustainability (The Turner review, 2009). According to the United Nations New York (2011), developing countries have contributed significantly in the resurgence on the global economy from recession. Therefore, UK should aim at enhancing its investments and fiscal partnership with such countries in Asia and Latin America to enhance economic growth and sustenance. There is increased urge to the Chancellor of the Central bank in the UK to stick to his austerity measures and of getting down the deficit so as to maintain UK’s top rating (Allen, 2011). The introduction of temporary tax breaks will also see the UK economy ease the burden on the business industry thereby ensuring confidence in the sector. This will see a waiver of taxation burden at the time when the business communities, as well as, the manufacturing sector are underneath intense stress to come to terms with the difficult economic times. This will give them a free-span of stabilizing their businesses and getting back to a returns efficient route. This will eventually see the stabilization of the economy, and build confidence in the perfect economy sustainability. References About.com, 2011. 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