The Banking Code and CSR - Case Study Example

Supervisor Given the existence of corporate governance s, based presumably on some ethical considerations, among British PLCswhy do we still observe crises and failures of, for example, the Northern Rock type. By: November, 2003 TABLE OF CONTENTS 1.0 Introduction 1.1 The Banking Code and CSR 1.2 Why the Northern Rock Crisis Happened 1.3 Conclusion and Recommendation 1.0 Introduction Major Banks in the United States and Europe have recently suffered significant losses as a result of the recent credit crisis. This calls into question the adequacy of baking regulation both at the national and international scene. (Avgouleas, 2008). For example, Northern Rock, a medium-sized Mortgage provider in the UK almost collapsed as a result of the credit crunch. In like manner, Bear Stearns an upper tier US investment bank was only rescued from the crises by the Federal Reserve Bank. (Avgouleas, 2008). In addition other major investment banks such as Merrill Lynch, Citigroup, UBS, and JPMorgan have all announced negative earnings in their last financial reports as well as plans to lay off a significant number of workers. The paper first of all looks at the regulatory environment of Northern Rock; Corporate social responsibility (CSR) refers to the awareness, acceptance, and management of the implications and effects of all corporate decision‐making, taking particular account of community investment, human rights, and employee relations, environmental practices, and ethical conduct. (Park, 2007). According to Hsueh (2008) CSR has received much attention in recent years and more and more businesses are taking CSR to improve their corporate image. CSR activities show consideration for the environment, consumers, charity, minority groups, employee welfare, community development, women empowerment, etc. (Hsueh, 2008) For example car manufacturers across the globe are responding to the major global concern of Carbon dioxide (CO2) emission which is tremendously depleting the ozone layer and increasing the risk of cancer and other diseases that come as a result of ultraviolet light. The next section looks at the banking code in relation to corporate social responsibility. 1.1 The Banking Code and CSR “The practice of CSR is subject to much debate and criticism. Proponents argue that there is a strong business case for CSR, in that corporations benefit in multiple ways by operating with a perspective broader and longer than their own immediate, short-term profits”. (Sacconi, 2004) “Critics argue that CSR distracts from the fundamental economic role of businesses; others argue that it is nothing more than superficial window-dressing; still others argue that it is an attempt to pre-empt the role of governments as a watchdog over powerful multinational corporations”. (Bulkeley, 2001; Sacconi, 2004). Today more and more companies are engaging in corporate social responsibility reporting, which helps major stakeholders to better understand how the company interacts with its society. (Sacconi, 2004) Law (2006) define social responsibility reporting (corporate social reporting) as the reporting of social accounting issues by a business. These may be discussed in the annual accounts and report or form the basis of a separate report. Social responsibility costs are the costs to the business of e.g. equipment donated, sponsorship given, or charitable donations. The monetary quantification of social benefits is much harder to measure and necessarily subjective. Owing to the concerns of consumers, investors, and other stakeholders, companies are increasingly obliged to be environmentally and socially conscious Figure 1. Major Stakeholders of an organisation. Source: adapted from: Brignall and Ballantine (1996). The banking code revolves around ethical aspect of the business as it touches all the various stakeholders. These codes set the guiding principles and provide a flexible ground for institutions to operate. The banking codes are developed to guard the interest of all the stakeholders provided in the stakeholder mapping above. Attention however, on the personal statement that most of these institutions make is on the customers. These codes though are monitored by independent organisation; different institutions come up with their own models as the situation of the northern rock. Banking regulation in the United Kingdom is performed by the Financial Services Authority (FSA). The FSA was set up by the Financial Services and Markets Act 2000. (FSA, 2007). The aims of the FSA are classified under three main headings as follows (FSA, 2007): 1. Promotion of efficient orderly and fair markets; 2. Ensure that retail consumers have fair dealings with financial institutions; and 3. Improvement of business capability and effectiveness. The FSA is responsible for the regulation of most financial service markets, exchanges and firms in the United Kingdom, setting standards that must be met and taking action against financial institutions and firms that fail to meet the required standards. (FSA, 2007). To meet its objectives, the FSA, has a wide range of rule-making, investigatory and enforcement powers. The FSA currently regulates 29,000 firms with a diverse range of size and activities. The scope of the FSA’s work has been increasing with time Using Northern Rock as example, we will examine what happened and why it happened. There after, we will see if the same position can still happen. 1.2 Why the Northern Rock Crisis Happened Northern Rock According to an article by Heather Connon (2007) published in the Guardian Media Limited, Northern Rock has very few banking branches approximately 70 branches. As a result its mortgage lending is funded through the wholesale debt market as opposed to the more traditional approach of recycling customers’ savings accounts practiced by most banks. This business model has been successful for a very long time because institutional investors have been very willing to provide Northern Rock with funding because of its juicy terms. In addition Investment banks have been dreaming of securitizing and selling mortgage loans in the secondary market. (Connon, 2007). However, this business model of Northern Rock seems to have landed it into problems. This is mainly owing to the wave of defaults among US mortgage borrowers given that the model has helped to multiply both the risks inherent in such loans and the number of places they can end up. Since Northern Rock relied heavily on the wholesale money market for funding its mortgage lending, the credit crisis led to a disappearance of its principal funding sources as banks became skeptical about one another’s ability to repay its debts. Inter-bank lending was therefore significantly reduced and Northern Rock had no option than to turn to the lender of last resort – The Bank of England. (Central Bank). (BBC, 2007). A BBC News report of Sunday 17th February 2008 quotes Chancellor Alistair Darling as saying that “Northern Rock got itself into problems last year because its business model left it ill-prepared for the global crisis”. (BBC, 2008). Northern Rock therefore found it difficult to continue operating as a result of its business model of not funding its loans with customers’ savings accounts. News of Northern Rock’s borrowing from the Bank of England even made matters worse as potential bidders Virgin Group and JC Flowers became concerned the sustainability of these debt from the Bank of England. (BBC, 2007). The BBC reports that as at Friday 2nd November 2007 Northern Rock’s outstanding debt from the Bank of England stood at approximately £23billion, which is approximately £730 for each tax payer in the United Kingdom. (BBC, 2007). To a greater extent one can attribute the crisis on institutional influences. Northern rock had business models that enabled them to depend a lot on the wholesale market for their funding. Liquidity in the market suddenly dried up following the credit crisis. For example, Northern Rock could not secure funds from institutional investors when it was subsequently clear that the company may not be able to repay these loans given its huge outstanding mortgage loans. In like manner Bear Stearns in the States was unable to get additional funding from the wholesale market. However, to a lesser extent, systematic influences too played their role in the crisis. These can be blamed in the area of regulation. Regulatory authorities seem not to have properly defined minimum risk compliance requirements for banks and thus these banks too on excessive risks which suddenly led to their present predicaments. 1.3Conclusion and Recommendation Based on the analysis above, one can conclude that both Northern Rock and Bear Stearns were significantly affected by the credit crisis as a result of their heavy reliance on the wholesale credit market. As a result it suddenly became difficult for them to secure funding from this market given the tight liquidity in the market following the credit crisis. In addition regulatory authorities failed to describe minimum risk compliance requirements for banks. In the US for example, banking regulation is done by a multiple number of regulators, which in turn may lead to confusion. This paper therefore recommend to both Northern Rock and Bear Stearns to change their Business models. Regulatory authorities must also take measures to ensure that these crisis do not occur in future. Mayes (2000) drawing from examples on banking regulation in New Zealand suggests a number of policy measures that may be adopted by the UK Financial Services Authority (FSA). These include ensuring the quality of corporate governance of those financial institutions wishing to be registered as banks, with high accounting and independent auditing standards; public disclosure of substantial information about the risks individual banks face so that market disciplines can be applied – including extending Value at Risk measurement to the whole of the bank’s activities; placing the responsibility of the prudential operation of each bank on its directors and management, with penalties and financial liability for false statements; and avoiding putting taxpayer funds at risk, by making it clear that no bank is too big to fail and focusing the role of supervisors on ensuring that they have the power to step in and prevent adverse consequences to the system as a whole when a bank gets into difficulty. (Mayes, 2000) References Avgouleas, Emilios, (2008) Financial Regulation, Behavioural Finance, and the Global Credit Crisis: In Search of a New Regulatory Model" . 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