Banking Regulation and Risk - Coursework Example

Number Word count Banking and Risks involved Banking is the process of banks offering services to the s satisfying and meeting their requirements. This depends on the kind of financial services that are being offered by the institutions in accordance to the type of services a customer needs. Most of the institutions are owned by the government and they provide the required financial services to the customers. Some of the services being offered can be the collection of the deposits from the customers and the lending of money to them. This will also depend with the ability and capability of the customer to have the required qualifications for the loan approval. The debit and credit cards are also offered to the customers depending on the kind of services they need from the institutions. Finance is a crucial sector in the field of financing which is the funding to the customers in order for them to be successful in life. It is also logic that the customers need techniques for them to manage their financial activities. Types of banking When I say about banking, it is the financial institutions that are working on different kinds of business. For one to understand the challenges and risks of banking, it is good to understand the types of business involved in the banking system. This depends on the type of banks running the business whereby some banks carry out different functions depending on the size of the bank. Some banks are large and offer a large number of services to the customers which have complex functions that are more specialized. It is not all the banks that have same financial activities and functions but they vary depending on the kind of services the customers need. Banking is usually divided in the following types; Central Banking It is a bank that deals with the maintenance of the country’s economy. Without the central bank the country can not have a stable economy. The banks normally deal with the circulation of the buying and selling currencies in the country and it controls the interest rates of the amounts. The bank also acts as the last resort lender to other banks when they face trouble. It is a bank that is separate from other banks in the country. Retail Banking Retail banks are the banks at the streets where many people in the country access the banks. The banks collect deposits from the customers and give saving facilities to them and they pay interests on the accounts. The banks also lend the customers with money and charge them a certain amount of interest depending on the rates. the banks also provide other services to the customers. Commercial Banking This are banks that have divisions of banks which offer services to businesses organizations varying from large to small companies. The banks help the business organizations with the financial support and it assists the businesses to expand and prosper. The banks also save the businesses by lending them money to maintain the cash flow of their businesses. The banks also provide a wide range of services to the business organizations. Investment Banking These banks are a bit different from other banks in that they advice the financial markets and they advice them. The banks provide a security to the financial markets and to the capital markets. These banks are normally in the United States and they are gradually spreading to other parts of the countries in the world. In the current research, the banks are also in the United Kingdom and they are normally owned by the merchant people. (Andenaes; chiu 2014) How Return-on-equity can be efficient Banks can face problems in the way they operate in terms of the financial earnings and investments. The efficiency of any bank can be known by the measure of the ratio of the return –on-equity which clearly explains the bank procedures of reinvesting on the investments of the customers in order to come up with the best profits for both the bank and the customers. There are several examples which describe numerically how the ROE (Return-on-equity) has majorly improved the banking process. In the financial crisis of the Asian economy the ROE proved to be the hero by the saving the economic from diminishing. In the year 1997 there was a drop of the ROE which was at 9.8 percent. After the right consolidation and protection over the ROE the percentage increased to 19.7 percent by the year 2007. The improvement of the ROE was force to undergo stages beginning from the recovery of the crisis that happened in that period (1997-1998). This is then followed by the expansion of the loans to the customers that are well maintained by the management system of the financial department. The growth of the ROE normally depends on the local banks in the country. As the local banks are highly capitalized, the capital adequacy ratio (CAR) will make the ROE metric to retard. The main reason for this is that, the capital that is excess in the local banks is not generally distributed to the stakeholders of the banks and the money is supposed to be retained in the banks for expansion of the future. In the current economy it is recommended that the CAR be at 4 percent. In Asia, statistics has proved that the CAR was at 10.5 percent on September the same year of the crisis. The ROE is also responsible for the hinges found in the banking system actions. If a local bank has the best active capital management then it is a probability that its ROE will be also good. All this is maintained by a local bank having obtained the best dividends that are consistent and have perfect programmers and mergers including the acquisitions. Higher payouts dividends at a local bank will reduce the reserves emerging at the bank and improve the ROE. On the other hand, banks with higher reserves with investments in the future will eventually diminish the percentage of the ROE (Bindemann 1999). The operating profits of a bank are another factor that can dictate the growth of the ROE trend. In the current position of most of the local banks the interest is on the non interest income whereby the net interest margins affects the income interest because of the increase of the competition in the market. If the local banks are able to manage their operating profits with no problem then maintaining the ROE is not a big problem. For the provision of higher operating profits the local banks need to give out loans to the customers that have higher returns. Securitization in banking This is a process in banking that enables a customer or bank to transform a illiquid asset to be a security measure. This is a quite an interesting idea in that a group of loans can be turned to be a debt security to guard the customer or the company. A security in business banking can be something that is very tradable and be more important than the other financial processes in the bank including the liquid assets in the loan process or the receivables being offered. In the current business sometimes it is even better that the assets are more important than the balance sheets that are produced because of the same assets. Ways of creating security assets There are many techniques that are used to create assets that act as security in the banking system. This can be a lender who gives loans to the customers or to the homeowner or the corporation agency. In this process, the securitization structure is then created where the bank sells its assets to the consumers including the receivables like the best purpose vehicle. In this process, the structure of the process is maintained and legalized by the management staff of the bank. This also includes the credit enhancement and the agency rating views from the bank customers and the external environment. The SPV in the bank gives out the debt and groups the risks to face the bank investors and it gives out the required pro data for documentation. In the structure of the process it is the sponsoring company that is accountable for the asset securitization. The accounts that have the ability to receive the security assets are then approved. The accounts normally have the sales or assignments that are promising. When the process begins the question is that whether the company or organization is ready for the business and whether the assets are suitable for the organization. This follows on what pool to be used in the business and the legal structure that is very suitable for both the bank and the organization or company. This will also have the fact that the credit enhancement will also be required and be analyzed. The kind of assets to be processed should be analyzed and be checked whether they are suitable for the process. This will be known from the pool of the assets which should meet the required qualities. The volume for the process should be large and homogenous in order to come up with the best statistical analysis. The bank should also have the best rates history including the defaults, delinquencies, prepayments and many more factors to prove the history trend. The diversification should also be sufficient in that vulnerability could be reducing because of the geographic and social economic factors. The last point is that the assets should also be transferable from one party to another and they should also be unencumbered. Generally the assets must be sufficiently strong to be in control incase of high credit rating without back affecting the original lender (Freixas 1997). Example A case study is on the finance company limited that has a growth which is constrained. The company has a pool of automobiles which are the receivables of the company. The company also has a tracked record history for the business. The company also has a number of plans that will provide the source of the financing problem that may arise. The company must securitize its assets by making up the right decisions. There is a hire purchase agreement of the company with the financial institution. Then there is a servicing agreement of the finance bank with the company in question. If the two parties agree then an act is implemented and written down for security purposes. The lending financial institution proceeds to have its investors in the business as it provides the asset backed securities to the company. In the special agreement of the two parties there is a trustee who becomes the witness to the agreement (Heffernan 2005). Security Risks in Securitization The risks that can involve in the process includes the credit risks, liquidity risk, the service performance risk, swap counterparty, guarantor risk, legal risk, sovereign risk, interest rates and the currency risk and the prepayment risk. The legal aspect of the securitization has a goal to ensure that there is quality on the assets and enhancing the obligations even without the giving a credit to the owner of the assets. Importance of securitization There is scant information as to why most of the banks securitize in the banking system. one of major reasons is to promote the economy of the country and the improvement of the capital markets. At the same time the company can go about giving its assets in order to gain the profitability. Companies like securitization because they consider several reasons for the process. 1. A company can improve the capital through the improvement of the return on capital because the process always needs a small capital start and support it instead of the old on balance sheet funding which has fewer benefits. 2. Incase there is no fiancé or other means that support the company, the process of securitization can be of help because many banks does not lend more so when there is a boom where banks are not able to keep up the demands of the companies. 3. The process also improves the return on asset because it proves to be the cheap source of the funds in the business depending on the cost of the funding which are the source. 4. The sources of the funding can also be increased depending on the type of the bank either be retail or commercial funds and on the size of the funds. 5. The process can help to make the credits of the company assets be exposed. This is when the lending bank become large in the relationship with the balance sheet. In such cases, the process can remove the assets from the balance sheet. 6. The process can also help the matching of the assets in their funding criteria. Example is the mortgage which is mostly around 25 years old. They need a promotion in which they need to be funded with a long term financing assessment. The process of securitization helps the assets to be funded the long term by raising a finance that is strong enough to be available in other finance markets. 7. The process of securitization can achieve the regulatory advantage because it is responsible for the risks removal by creating a good form of finance in the business. Financial Crisis in Banking For one to understand the financial crisis causes, one must understand the risks that are in the banking system and all the possible causes. This is a challenge that most of the financial organizations face depending on the profitability, complexity and the regulation of the business environment. Many of the financial banks are reconstructing their financial obligations by changing their business models to avoid the rules and regulations like Dodd-Frank, Basel three and Solvency two that increase the capital cost of the business and the costs of compliance. This also enables the business of the firms to even avoid some lines in order to avoid the rules and regulation that my affect the business financially. Most of the companies concentrate on the complexity of the business in order to meet the rapid growth where by the companies face the under investing of the technology sector by cost cutting the costs. Crisis of financial crisis can be felt in an organization and be of a deeper pain more so when there is no source of income. The courses of the crisis can be well explained from the fall of the Lehman Brothers, a sprawling global bank that fall on the month of September in the year 2008 which almost affected the world’s financial system. It took time for the tax payers and the victims to bring up their living standards. The GDP of many of the rich countries in the world is still low while in Europe the financial crisis arose to be the Euro crisis. The effects of the crash of the financial crisis are still affecting the world’s economy. This is proved when the wobbles of the American financial markets try to scale up and improve their growth by buying and selling of their goods (Gardener: Revell 1990). The crisis of the financial was caused by several reasons on which the major causes are the financers in the business. In the case above, example of the financers who led to the fall of the global bank is the irrational exuberant who came saying that they have a new way to stop and eliminate the risks in the business where by the lost track of the business. Even the central bank staff and the regulators of the bank also are the risk that led to the fall of the bank. This is because they are the main people who are blamed for not being serious by being tolerant to the fall victims. This also led to the fall of the macroeconomic which led to the backdrop. The research in Asia shows that in Asia there is a saving glut which affected the global rate of interest. Some of the European banks borrowed money from the American markets giving out the best to buy securities that are very dodgy. All this points come out to be the risks that contribute to the fall of the finance. The financers in the business had more of the problem because most of them had irresponsible loaning of the mortgage before the fall of the global bank. The bank also gave out loans to the borrowers who sometimes took time to return the money affecting the financial environment. The mortgages were put together as a pool that was taken to the financial engineers on which the security was into a risk. The pooling process had to work perfectly when the risks of the loans are taken to be uncorrelated. In the arguments, financial markets may fall and rise independently without any help. The financial crises occur when the housing market comes into question. Since the financial engineering does not help the global banks with the investment, the mortgage facilities prove to reduce in its value. It is very difficult for the bank to sell unsuspected assets to the market at a cheap price making it hard for the bank to settle the short term funding. Trust is another risk that the bank takes in the business whereby it develops a ultimate glue to the financial systems creating bankruptcy. This enables the banks to have questions over their customers and partners in the business. This also makes the bank and the sources to with hold the short term loans they lend to the customers. This is caused by the trust that the staff team develops which causes such causes in the financial crisis. Giving out loans and lending money to the customers can create a link of a pool of customers who can lead on the fall of the business. The credit swaps of the global bank can assist in the paying back of the buyer creating a compensation for the third party. Regulators are also blamed in the financial crisis where they also contribute to the failure and not only the people. The central bankers and the regulators carry the blame for the financial failure because they normally handle the crisis inappropriately by not keeping the imbalances and not keeping a look at the insight of the finance of the bank. In the case of the global bank, the regulators had made a mistake of leaving the Lehman brothers to be bankruptcy without checking on the case. In the process, it caused panic in the market at the last minute. It is also a big challenge that in the business nobody trusted anybody complicating the issue by not lending to each other. The economy of the country also is affected because the non financial organizations suffered because they were not able to lend money and not being able to pay for the workers in the country. It is also very ironic to the government that it allowed the global bank to be bankrupt despite of the suffering of the economy of the country. With this, the government is also blamed for not taking care of the country’s economy and instead it is always happy when such financial institutions fall. It is at the end after the fall of the global bank that the regulators begun to rescue the behavior of other financial institution which was caused by the panic they developed. They even made more mistakes by letting the imbalances of the global and the housing bubble to inflate. The central bank pointed the issue when they saw the deficit of America and the capital in flaws increasing and becoming excess. This brought a spot that was permanent in the global bank when there emerged large inflow of the capital from Asia (Saunders; Cornett 2011). Regulatory system of the Basel II The central banks try the best to work on such financial institutions but they can not tackle all the short comings. They have the power to lower the loan to value to a specific ratio specified for the mortgages and they insist that financial institutions should have the required capital in order to avoid bankruptcy. A lax capital ratio is one of the first short coming whenever there is a financial crisis. In the year 1988, the central bank and the top staff members sat down and came up with the specific rules of the banks to have a reliable amount of capital that should represent some number of assets. While at Basel, the rules never followed all the required doctrines of the bank capitals. This gave the banks the ability to smuggle the debt making the companies not to have a loss in the absorption of the capacity as equity. Most of the companies get pressure from the share holders because they need to increase their returns making them to operate on minimum equity. In this state the companies can be left vulnerable in case problems emerge. The Basel committee never had a rule on the asset share with the liquid assets. They failed to come up with the best international bank that could be large to make other banks seize up. There is a lot in the response of the Basel to the recent financial crisis in order to come up with the best capital for the banks and the quality that is increased in the absorption of the capital. From the lesson of the fall of the global bank which lead to the financial crisis, reforms were also made to stop the scenario from happening again by imposing the legislation of matters concerning large capital in the companies. Since they discovered that the financial crisis occurred because of the low capital that was insufficient and insufficient land quality, the committee found it better to concentrate on the capital to diminish the losses incurred. They raised the capital cost and the level of different banks. In the current Basel it ensured that there was a definition of the common equity which was accompanied by a tight regulation. The committee also ensures that the banks should have the limitation over to which bank to have the Tier 1 capital. Filters are also introduced on the rules in the harmonized way. The major goal of the current Basel is to ensure that there is transparency in the banks finance and total discipline in the business. The reforms formed by the committee of the Basel strengthen the bank levels making them to be strong. The regulation improves the banking institutions whenever they have problems having a focus that is macro prudent. The new team focuses on the system’s risks undertaken in the banking. The system banking is maintained by the Basel committee in order to raise the quality of the capital to make banks to be the best in absorbing the losses whenever they occur and be able to adapt the new improvements on how to overcome the problem. This will also make the banks to increase the risks coverage depending on the lifespan of the capital of the banks. This lifespan can be the activities that happen when trading, securitization and the availability of the off balance sheets vehicles including the credits and the derivatives. References ANDENÆS, M. T., & CHIU, I. H.-Y. (2014). The foundations and future of financial regulation: governance for responsibility. BINDEMANN, K. (1999). The future of European financial centres. London, Routledge. http://search.ebscohost.com/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&A N=60655. FREIXAS, X. (1997). Microeconomics of banking. Cambridge, Mass, MIT Press. http://search.ebscohost.com/login.aspx?direct=true&scope=site&db=nlebk&db=nlabk&A N=11351. GARDENER, E. P. M., & REVELL, J. (1990). The Future of financial systems and services: essays in honour of Jack Revell. New York, St. Martins. MACNEIL, I., & OBRIEN, J. (2010). The future of financial regulation. Oxford, Hart. MATTHEWS, K., & THOMPSON, J. L. (2005). The economics of banking. Chichester, West Sussex, England, J. Wiley. HEFFERNAN, S. A. (2005). Modern banking. Chichester, West Sussex, England, John Wiley & Sons. SAUNDERS, A., & CORNETT, M. M. (2011). Financial institutions management: a risk management approach. New York, McGraw-Hill. SIRONI, A., & RESTI, A. (2007). Risk management and shareholders value in banking: from risk measurement models to capital allocation policies. Chichester, West Sussex [England], Wiley. TARULLO, D. K. (2008). Banking on Basel the future of international financial regulation. Washington, DC, Peterson Institute for International Economics. http://site.ebrary.com/id/10257394. Read More