The Long Term Nature of a Number of Financial Products in the UK Commercial Banks - Book Report/Review Example

 Introduction: This report, as the title suggests, is a study of the trust of the consumers in the UK Commercial Banks. It starts with the major banking crisis which affected customer trust and confidence in the UK banking system (BBC, 2007). This report will firstly start with a brief about the major reason behind the entire crisis, i.e. Northern Rock. A brief introduction of the bank will be discussed following which a review of the crisis will be discussed. This is a very essential issue that requires to be discussed simply because the crisis that was faced by Northern Rock affected the entire UK financial system in a very drastic manner leaving the financial sector with a very big damage. This crisis has led to the decline of consumer trust in the banks and the financial industry as a whole. Also apart from this a brief discussion of the media’s affects on the consumer mind will also be discussed. In order to gain a clear idea of the entire situation a secondary research has been undertaken. This involves a deep study of the various reports that have been published in the past regarding the issue. To go on further and analyse the issue and the crisis of the bank, firstly let us begin with a review of Northern Rock bank. Northern Rock Bank: The idea of Northern Rock bank was first established in 1990s. Robert Dickenson the chairman of the Northern Rock Building Society announced the formation of a Foundation. This was established in 1997, where the Bank as well as the Foundation came into existence. The Foundation kept growing and by 2000 the Foundation grew to become funders to high profile culture schemes (Northern Rock, 2008). In the following years the foundation worked hard and had achieved a status where the foundation was in a position to fund large scale initiatives. Between the periods of 2003 – 2006, they launched three; a) region – wide programme of training for the voluntary sector, in partnership with Project North East, b) A demonstration scheme and also evaluations for better ways of supporting people facing domestic violence, and c) a number of projects testing out different ways to tackle the re-offending. Over the years alongside the Foundation the bank has also been growing and had become one of the trusted commercial banks in the UK (NR Foundation, 2008). Introduction of Formal Loans scheme was in 2003, after a number of testing. By 2005, the trustees decided it was a time for reconsideration and look for further expansions of the grant – making (Walters, 2008). The foundation has grown to be one of the leading financial and commercial banks in the UK (Williamson, 2008). The Crisis: 13 September 2007, proved to be one of the worse days in the history of Northern Rock. It was on this day that the news of Northern Rock emerged. Northern Rock has been one of the five largest British mortgage lenders. It was on 14 of September 2007 that the Chief Executive – Adam Applegarth, confessed that the problems started off on 9 August 2007, where the banks watched its liquidity disappear on a global basis and the intensity with which this happened was very high. This crisis rocked the entire British economy in a very alarming manner and was threatening not only for the other banks of the country but also the economy on the whole (Business Week - Crisis, 2007) Northern Rock which was a former Newcastle building society was brought down by its innovative business model. It grew to almost 19% of the British mortgage market by the first half of the year 2007. Within a span of one day, Northern Rock has been reported to have paid out a total of almost $2 billion to the customers. This was due to the rising fear among the people related to the bank who wanted to ensure that all their savings were safe. This led all the depositors of the bank to try and withdraw all their savings at the earliest from the bank. This was never expected as Northern Rock was backed by the Bank of England and it was almost impossible for a bank to go out of order like this (Walters, 2008). It is important to note that Northern Rock Bank is to a small niche institution and it stands in the top five mortgage lenders in the country. The Bank of England has taken a number of steps like dropping the rates of the London Interbank Offered Rate (LIBOR) to 6.82% from as a record high of as much as 6.90%. This however has prompted worries about the credit (Brummer, 2009). Adamson and a number of other analysts have also commented that Northern Rock disaster has put forth the question about the health of the banks in both Britain as well as Europe and has brought in the element of doubt in the minds of the customers about the safety and security of their monies. Almost 77% of the financing for its $230 billion in assets is got from the bonds and other securities and only about 23% i.e. merely a small sum of almost $46 billion, of the funding is from the deposit base (Deccan Herald, 2008). This crisis has not only affected the Northern Rock business but has also caused a large threat to the other lenders as well. Further Adamson has also noted that other banks in the country would also require support for liquidity and that the midsize banks that rely majorly on the wholesale funding would also face difficulties as these could be highly vulnerable (BBC – Timeline, 2008). Media and Consumers: According to Solomon (1992) media reporting and coverage has an effect on people’s behaviour (p. 573). Indeed, people were not aware of Northern Rock’s crisis until the media made an announcement, and it was then that people made a run on the bank to withdraw their moneyAs Solomon tells us (1992) “consumers increasingly rely on mass-produced imagery as a window onto the “real world,” they come to accept what they are seeing as real” (p. 575). People are affected to a great extent by what they see on TV. It was only when Alastair Darling, the Chancellor of the Exchequer, announced that all savings deposited at Northern Rock will be 100% protected and returned that people stopped withdrawing their money. In the UK and the US there has been a “large increase in bank lending, a reduction in cash reserves, a decline in demand and current deposits, and an increased reliance by banks upon markets” (Lewis & Davis, 1987, p. 9). Banks are taking greater risks by placing over 70 per cent of deposits in loans and advances and therefore the “risks are much higher than in the years when deposits were invested predominantly in government securities and, moreover, yields on those assets changed little” (Lewis & Davis, 1987, p. 9). There is an increased risk of bank failure because “over three quarters of deposits now bear interest, and increasingly those interest rates fluctuate with market rates of interest, increasing the chance of a sudden loss of earnings should market rates rise and loan rates not follow” (Lewis & Davis, 1987, p. 9). Teck Foo (2008) states that the ““Rock” was under a severe threat.” Northern Rock was relying on market loans to fund its borrowers’ demands, and when this was no longer available, it experienced liquidity problems and the threat of bankruptcy. Customers got aware of this situation only once the media threw the story open about the bank. With the various news papers and websites have opened up the issue of the bank to the public. This caused a major panic among the customers of the bank, who took immediate action of withdrawing all their monies from the bank (Engel, et.al. 1990). Both the media as well as the Treasury Select Committee chairman – John McFall urged the customers not to panic, and assured that this was a temporary issue and would be sorted out shortly. He emphasised on the fact that the bank was willing to act on this situation and this should be treated as a sure sign that the current accounts and the mortgages would be safe with Northern Rock and it was just a matter of time for the bank to recover from the temporary market conditions (BBC – Northern Rock, 2007). Banks and Consumer Trust: Post the issues that have been faced by the economy and the crisis of the various commercial banks, the consumer trust has been noted to be deteriorating. A research that was published by the Financial Services Consumer Panel in January 2008, displayed the general consumer trend towards cynicism and the growing distrust in the recent times (Clayton, 1992). They also said that there have been confusions between trust and familiarity. In a number of cases the public trust financial institutions based on the brand image and the levels of brand positioning. The report also highlighted that the consumer trust in traditional institutions has been constantly declining as the society which was known for one which is made up of consumers and the review has shown that it has lost its traditional respect to authority. It has been noted that the financial institutions give more importance to the profits rather than the consumers (Clayton, 1992). This has also had a major influence on the consumer distrust on financial service providers mainly commercial banks. This has been reinforced even more strongly with the recent experience that was faced and the media exposures on things like the credit card and overdraft facilities and most of all the problems faced by Northern Rock (Beesley & Evans, 1978). Reports from the BBC highlight that the Bank of England acts as a lender at the last resort. The Bank of England normally intervenes into the business of commercial banks only rarely, and it is after a lot of consultations with the treasury and the Financial Services Authority (FSA), that the Bank of England would consider acting as a lender of last resort. The Governor of the Bank of England however did also mention in his letter to the Treasury Select Committee, that the Bank of England would be willing to finance a bank in trouble as long as the difficulties are a temporary phase and due to temporary market conditions. This according to Peston symbolizes that the issues are temporary as the Bank of England has agreed to act as a lender of the last resort for Northern Rock (BBC – Northern Rock, 2007). In 2007, the survey showed that 48% of the respondent had trust in the banks, financial institutions and the stock brokers however in 2008 this has fallen to 42%. The total percentage change between the two surveys has been up to -12%. This is a clear indication that the trust levels of customers is now falling to great levels. This change has been seen in a matter of just eight months (Survey 1 – 09/2007 and Survey 2 – 04/2008) (See Table 1). Table 1: Survey for consumer trust in the various Sectors (Seeking Alpha, 2008) Conclusion: Banks rely on consumers deposits for their day to day working. If consumer trust is not prevalent, then customers will stop investing or depositing their monies in the bank (Webster, 2007). This is simply because customers deposit their monies in banks to ensure complete safety and security of the funds. In the long term nature of a number of financial products, the complexities of these are very high and the importance of these are very important as well and it signifies that customers perceive high levels of risks while making decisions regarding purchases (Coulson, 1998). Post every issue the affects on consumer trust is always felt. One of the crises that changed the levels of consumer trust to a great extent was the issue faced by the Northern Rock Bank crisis. It has been seen very clearly from the different comments of customers and the general public that the crisis has left a very huge impact on minds of the customers and the levels of trust have decreased to great extents. 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