Future Developments in the Global Financial - Term Paper Example

Impact of Global Financial Crisis on UK Economy Introduction The present global economic and financial crisis has been triggered by a combination of multiple factors such as the sudden increase in the U.S. financial crisis, the high price of commodities related to food products and oil including the U.S. and other countries’ economic turmoil on subprime mortgages which started back in 2006. (Wheatley, 2009; Stephanou, 2009; Lipsky, 2008) During the global financial crisis, many of the existing large-scale financial institutions and commercial banks suffered from massive financial losses such as in the case of the American Insurance Group (AIG). In worst cases, some of the well-established financial institution has to declare bankruptcy like in the case of Lehman Brothers (Stephanou, 2009; The Economist, 2009). (See Appendix I – High Commodity Prices, Oil Prices, Decline in the U.S. and Other Countries’ Housing on page 10 – 11) Global financial crisis triggers significant changes on the microfinance particularly on the sources of income and expenses. Since the economy of most developed countries are negatively affected by the global crisis, a large number of developing countries such as in the case of the Philippines, India, Rwanda, and Pakistan would experience a significant decline in their expected annual remittances. As predicted by the World Bank, “growth of remittance flows from developed countries to developing countries would reach the lowest point in 2009 but would bounce back to reach solid growth rates as early as 2010” (Littlefield & Kneiding, 2009). Considering that global financial crisis could cause millions of people in poverty, the International Monetary Fund (IMF) leader warns that failure to address the issue could lead to “social unrest and even war” (Walker, 2009). (See Appendix II – Predicted Growth of Remittance Flows on page 12) In times of global financial crisis, the external environment behind the UK financial sector will be analyzed using the PEST model. Upon analyzing the external environment of UK financial sector, a wide-range of sources and scenario planning model will be used in identifying the lessons and future developments that will enable UK financial sector to sustain the financial challenges associated with the global crisis. In line with discussing the future developments in UK financial sector, four different scenarios will be thoroughly discussed. As a way to promote a stronger, deeper, and more stable UK financial system in times of global crisis, recommendations will be provided as part of the conclusion. External Environment behind the Global Financial Sector Political Factors UK’s financial sector is the biggest contributor to UK government taxes. Considering the global economic crisis, UK’s financial sector’s contribution to government taxes is expected to decrease by up to 20% of its total contribution (City of London, 2009). As part of guarding the UK financial system from corruption, the Financial Services Authority (FSA) was established under the statutory powers of the Financial Services and Markets Act 2000 back on the 20th of May 1997 (FSA, 2009). Within the macroeconomic environment, there is a strong need to address the political stability within the global markets. As part of establishing a new ‘policeman’ for the global financial system (Telegraph, 2008), Australian Prime Minister Kevin Rudd has recently announced the strong need for the G20 members to unite in order to develop new set of strategies that could tackle the global crisis particularly the development of more concrete information regarding the future role of the International Monetary Fund (IMF) and the World Bank (WB) with regards to funding. In line with this matter, Rudd stated that “only the G20 has the global economic reach to provide the response necessary to begin to mend this global economic recession and support the restoration of jobs around the world” (BBC News, 2009). As part of the changes that will be considered during the G20 conference in London on April 2 (Financial Advice, 2009), the World Bank proposed the need to consider leverage ratio in banking as a way of limiting excessive leverage within the banking system. With the use of the leverage ratio, banks will be able to easily trace the difference between the dispersion of leverage ratios (LHS) and the average leverage ratio (RHS) (BBC News, 2009). (See Appendix III – Evolution of Leverage Ratio of Major UK Banks between 1990 – 2008 on page 13) Economic Factors Aiming to find solution for the credit loans within UK, the Bank of England (BoE) has recently cut the interest rate at 0.5% which is the lowest rate in the history. Basically, the decision made by BoE is to fight the lending drought. Although lowering down the interest rate to 0.5% is not beneficial on the part of the bank savers and creditors, the low interest rate would benefit approximately 4 million borrowers during the time of global financial crisis (Burridge, 2009; Metro, 2009). (See Appendix IV – UK Interest Rates on page 14) Aside from lowering the interest rate, BoE agreed to print another £75 billion worth of money which will be used in purchasing government bonds to support the economy (Metro, 2009). As a way to prevent the UK economy from experiencing a long-term economic recession and deflation, UK government strongly believes that the printing of additional money could temporarily aid the development in UK economy since it could increase the government spending within a short period of time. With regards to the creation of more cash, Mervyn King – the Bank Governor together with Alstair Darling – the Chancellor of the Exchequer explained that this strategic approach would “prevent Britain from sliding into a 1930-style depression” (Conway, 2009). Social Factors The number of unemployed people in UK has been increasing since January 2008. As of January 2009, the unemployment rate in UK has reached up to 6.5% (National Statistics Office, 2009). In the case of those individuals who are employed, their average earning and bonuses has gradually declined because of the tight economic crisis. (See Appendix V – UK Unemployment Rate on page 15) Because of the significant decrease in the average income and the high number of unemployed, a lot of people are relying much on their savings. Given that BoE has decided to lower down the interest rates at 0.5%, a lot of people are not in favour of BoE’s strategic decision since it could significantly affect the financial standing of those individuals who are highly dependent on their savings (BBC News, 2009b). Rather than spending more time on leisure, there are a lot of people who are searching for additional jobs to compensate their monthly expenses. Technological Factors Prime Minister Gordon Brown has publicly announced that science and technology should replace the financial services as the heart of the UK economy. According to Brown, “The success of our plan for building the knowledge economy as the best route to recovery hinges on continued investment in science today and on our ability to commercialize its applications - to turn scientific genius into successful technology-led economic growth for Britain. Because this is how Britain will invest our way into the future” (Glick, 2009). By gradually shifting UK’s dependency from financial institutions to science and technology, UK can easily protect the country from possible future global financial crisis. As part of promoting the importance of science and technology, UK government publicly announced the need for everyone in UK to have an access over broadband by year 2012. In line with the government support on encouraging more people to use the Internet, Brown pledged to extend £300 million over the next three years to increase the children’s access to free broadband and computers (Wray, 2009). Scenario Planning Model Used in Identifying the Lessons and Future Developments within the Financial Sector Managing the finances is essential in terms of mobilizing domestic savings and financial investment as the economic growth accelerates. Given that the financial sector plays an important role in terms of managing the financial system in each country, it remains a challenge for international banks and insurance companies to be able to develop and implement strategies that will enable them to achieve the following: (1) reduce the high level of non-performing loans (NPL) especially in times of global crisis; (2) strengthening the financial regulation based on the international standards for increased in transparency and accountability; (3) improve liquidity in the global market; (4) protect the rights of the creditors and investors; (5) promote new financial products as a way of tapping saving; and (6) exert extra effort in removing the presence of tax distortion (Smirnova, 2009; The Economist, 2009; Wheatley, 2009; Lipsky, 2008). Political Factor The absence of transparency and strong financial regulation is one of the main factors that caused the global financial crisis. During the past decades, banks and other financial institutions were very lenient in terms of dealing with loans and collateral/mortgages. Failure of the borrower to payback the principal loan would give banks the right to confiscate the collateral without having the borrower held liable for their inability to pay their debts. The problem with having too much mortgages is that failure of the banks or financial institutions to resell these properties could increase the chance of increasing their non-performing loans via sub-mortgage properties. (Shah, 2009) In times of financial crisis, banks and other financial institutions would have difficult time generating money out of the NPLs. As a result, some banks that had accumulated loans with other banks or financial institutions are unable to pay back a large amount of debts. To avoid such global financial crisis, there is a need to strengthen the financial regulation based on the international standards for increased transparency and accountability. (See Figure I – Impact of Strong Financial Regulation on page 7) Figure I – Impact of Strong Financial Regulation ££ Economic Factor The Bank of England has cut down the interest rate at 0.50%. (Metro, 2009) Basically, cutting down the interest rates can help the local banks and other financial institutions to reduce the number of its respective non-performing loans. For instance: With the low interest rate, banks can start making new deal with the borrowers concerning the number of years of payment. Since the interest rate is low, it would be easier on the part of the borrower to gradually payback the interest and principal of their loans. (See Figure II – Low Interest Rate vs. Decrease in Non-performing Loans below) Figure II – Low Interest Rate vs. Decrease in Non-performing Loans Social Factor Given that the unemployment rate in UK has reached 6.5% as of March 2008 (National Statistics Office, 2009), there is a strong need for the government to create new job opportunities for the people. Since BoE agreed to print £75 billion worth of money (Metro, 2009), the government should increase its expenditure as a way to increase business opportunities for the people. (See Figure III – Strategic Way to Reduce High Unemployment Rate below) Figure III – Strategic Way to Reduce High Unemployment Rate Technology Factor Considering that UK is currently dependent on the stability of its financial sector, the incidence of global financial crisis has signficantly affected UK economic activity. For this reason, the country is now experiencing economic recession. Given that UK could gradually shift its focused from being highly dependent on financial sector to establishing its science and technology (Glick, 2009), there is a strong possibility that UK economy would remain strong in times of global financial crisis. (See Figure IV – Importance of Shifting from Financial Sector to Establishing Science and Technology below) Figure IV – Importance of Shifting from Financial Sector to Establishing Science and Technology Conclusion and Recommendations Global financial crisis is a serious economic problem. Not only does it increase the number of unemployed individuals but also the possibility of developing social unrest and war. Aiming to protect UK economy from the adverse effects of global financial crisis, the government should exert effort in increasing financial transparency aside from implementing a strong financial regulation when it comes to granting loan to borrowers. It is also a good strategy to lower the interest rate down to 0.5% to enhance liquidation of the NPLs. With regards to high unemployment rate, the government should use borrowed money to create new business opportunity. To avoid future economic problem, UK should gradually shift to establishing its science and technology rather than heavily relying on its financial sector. Appendix I – High Commodity Prices, Oil Prices, Decline in the U.S. and Other Countries’ Housing Source: International Monetary Fund, 2008 Appendix II – Predicted Growth of Remittance Flows Source: Littlefield & Kneiding, 2009 Appendix III – Evolution of Leverage Ratio of Major UK Banks between 1990 – 2008 Source: World Bank, 2009 Appendix IV – UK Interest Rates Source: Bank of England, 2009 Appendix V – UK Unemployment Rate Source: National Statistics Office, 2009 Appendix VI – Summary of PEST Analysis Political Economic Social Technology UK’s financial sector’s contribution to government taxes is expected to decrease by up to 20%. (City of London, 2009) G20 conference: consider leverage ratio in banking as a way of limiting excessive leverage within the banking system. (BBC News, 2009) Bank of England (BoE) has recently cut the interest rate at 0.5%. (Metro, 2009) BoE agreed to print another £75 billion worth of money which will be used in purchasing government bonds to support the economy (Metro, 2009) Unemployment rate in UK has reached up to 6.5%. (National Statistics Office, 2009) Many people are not in favour of BoE’s decision to cut down the interest rate. (BBC News, 2009b) Many people who are searching for additional jobs to compensate their monthly expenses Science and technology should replace the financial services as the heart of the UK economy. (Glick, 2009) Goal: Everyone in UK to have an access over broadband by year 2012. (Wray, 2009) References: BBC News. (2009, March 29). Retrieved March 29, 2009, from Leaders stress need for G20 unity. Key politicians from around the world have underlined the need for unity in addressing the world economic crisis when leaders meet at the G20 summit. : http://news.bbc.co.uk/2/hi/business/7970660.stm BBC News. (2009b, March 5). Retrieved March 29, 2009, from UK interest rates lowered to 0.5%. The Bank of England has cut interest rates to 0.5% - a fresh all-time low - and says it will now boost the money supply to help revive the economy. : http://news.bbc.co.uk/2/hi/business/7925620.stm Burridge, N. (2009, January 7). The Independent. Retrieved March 29, 2009, from Borrowers unlikely to benefit fully from rate cut: http://www.independent.co.uk/money/mortgages/borrowers-unlikely-to-benefit-fully-from-rate-cut-1230550.html City of London. (2009, February 13). Retrieved March 29, 2009, from City of London Corporation Research Report: New data on Financial Services contribution to UK tax: http://www.cityoflondon.gov.uk/Corporation/media_centre/files2009/FS_tax.htm Conway, E. (2009, March 6). Telegraph. Retrieved March 29, 2009, from Printing money: £150 billion leap in the dark for Bank of England. The Bank of England has taken an historic "step into the unknown" by pledging to create £150 billion of cash and pour it into Britains stricken financial system: http://www.telegraph.co.uk/finance/financetopics/recession/4945989/Printing-money-150-billion-leap-in-the-dark-for-Bank-of-England.html Financial Advice. (2009, March 27). Retrieved March 29, 2009, from G20 leaders warned of potentially violent demonstrations: http://www.financialadvice.co.uk/news/11/tax/10088/G20-leaders-warned-of-potentially-violent-demonstrations.html FSA. (2009). Retrieved March 29, 2009, from History: http://www.fsa.gov.uk/Pages/About/Who/History/index.shtml Glick, B. (2009, February 28). Computing. Retrieved March 29, 2009, from Brown wants science and technology to surpass financial services. Prime minister says knowledge economy is the best route to economic recovery : http://www.computing.co.uk/computing/news/2237516/brown-wants-science-technology Lipsky, J. (2008, September 24). 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Retrieved March 29, 2009, from Russian Stimulus Spending Debate: Opportunities for Greater Transparency: http://crisistalk.worldbank.org/2009/03/russian-stimulus-spending-debate-opportunities-for-greater-transparency.html Stephanou, C. (2009, March 17). World Bank. Retrieved March 29, 2009, from Interventions in the Financial Institutions in the US and UK: http://crisistalk.worldbank.org/2009/03/interventions-of-financial-institutions-in-the-us-and-uk.html Telegraph. (2008, October 8). Retrieved March 29, 2009, from Global financial crisis: does the world need a new banking policeman’? The global economy is regulated by rules agreed at Bretton Woods in 1944. Now we must tear them up and start again, writes Gordon Rayner : http://www.telegraph.co.uk/finance/comment/3155122/Global-financial-crisis-does-the-world-need-a-new-banking-policeman.html The Economist. (2009, January 22). Retrieved March 28, 2009, from The future of finance. Blank cheques, bankruptcy, nationalisation: the options are dire, but governments must choose between them: http://www.economist.com/opinion/displaystory.cfm?story_id=12987495 Walker, K. (2009, March 24). Mail Online. Retrieved March 29, 2009, from Finance crisis could lead to war, IMF warns: http://www.dailymail.co.uk/news/worldnews/article-1164273/Finance-crisis-lead-war-IMF-warns.html Wheatley, J. (2009, March 27). Financial Times. Retrieved March 29, 2009, from Brazil’s leader blames white people for crisis: http://www.ft.com/cms/s/0/ae4957e8-1a5f-11de-9f91-0000779fd2ac.html Wray, R. (2009, January 15). Guardian. Retrieved March 29, 2009, from Broadband for all to be funded by the industry: http://www.guardian.co.uk/technology/2009/jan/15/broadband-for-all-in-uk Read More