Trends in Banking Regulations After the Crisis - Assignment Example

 Introduction: The global financial crisis of 2007-2010 has had a severe impact on the international baking activities. As a result of the crisis many banks were forced to change their strategies and policies that were followed for long years. There is no doubt that the banking sector is undergoing significant changes. It is expected that the banking industry will be less fashionable and heavily regulated with greater state involvement, Greater investor scrutiny and substantially higher capital levels. This would lead to low growth, lower profitability and lower volatility. The financial crisis has destroyed the confidence of all major banks. It has also effected its reputation. This may not have painful consequences in the short run as the demand for the banking services is relatively inelastic. But in the longer run, banks could feel strong negative repercussions (Global banking trends after the crisis. 2009). The literature in relation to changing trends in the banking industry is based on theoritcal as well as parctical case studies. For this purpose datas relating to both 2009 and 2010 are analysed. Extensive use of reports from the world bank, Federal reserve and opinions from financial experts are included. The literature not only includes details of regulations that are implemented by banks but also suggstions that if implemented can change the face of the entire banking sector. Moreover outcomes of the new regulations are alsdo discussed. Global financial crisis has affected the credibility of banks. As a result the banks were forced to change their policies to recover from the crisis. Some trends in policies have raised concerns about the competitive dynamics of the banking sector. The banking sector has become more concentrated after the onset of the financial crisis. In Australia, which has a well developed banking sector, all the major banks net interest margins increased over the crisis. All the major banks in Australia increased their market share for most of the products during the crisis. The share of owner occupier housing loan approvals of the last five years increased from 60% to 82%. A major driver for the consolidation of the market share was because of the firms exiting from the market or due to scale of operations (Henry.K, 2010). . Close of securitisation markets as well as constraints in other funding market5s have forced some of the smaller players in the sector to exit or scale back the lending process (Doan.C, Glanville.V,Russel.A,&White.D. 2006). Moreover withdrawal of some foreign banks form the Australian banking sector has added some dimensions to the changes. Increase in levels of impairment especially in lending portfolios has also forced some players to scale back their operations. Another significant change that occurred in the banking industry in Australia is the mergers undertaken in the banking sector (Banking regulation, 2010). The global financial crisis has affected the profitability of many banks world wide. In Australia, the fall has been greatest for some mid-tier banks. To overcome the adverse situation, these smaller banks started to tighten the interest margins than the major banks. By the end of the year 2009, all major banks in Australia had increased the net interest margins by about 20-25 points higher than the pre crisis period (Henry.K, 2010). The financial institutions in the US are thought to be responsible to be heart of the problem that resulted in the crisis. The crisis has affected all major US banks critically. Many banks have collapsed and others were on the verge of collapse. The crisis has also affected European banks. Banks in US and Europe has been affected by losses in sub prime mortgage investments, leveraged loans, failed financial hedges, and conventional credit losses. Governments around the globe were forced to intervene in the financial systems to prevent a massive collapse. More than 200 billion dollars was freshly introduced into 20 major banks alone (United States Banking Regulation, 2010). The crisis has forced the respective governments to establish new rules so that such crisis will have no effect in the future. The governments are working out measures to reduce weakness in the regulatory frame work of banks and the in the instruments and methods used by bank supervisors. The likely changes are, banks will be required to hold large capital buffers, banks would be required to follow extensive disclosure requirements and introduce simpler products than complex ones. Securitization will become less attractive. Traditional business models should be favored. One of the most significant changes triggered by the crisis is that involvement of the state in the banking sector that never before. After years of liberalization and privatization, the state is assuming a greater role in the banking sector. Even though in Europe there was government participation up to a limited extent before the crisis, government participation in US was boosted after the crisis. The government started to involve in banks operations. They increased their stake in some banks up to 50% and some banks were totally nationalized. All compensation mechanisms for employees were reviewed by major banks. These were according to policies and guidelines issued by the regulators. Compensatory packages were to be assessed in a differentiated manner. More importance was given in remunerating long term success rather than short term. Bonus payments to employees were to change. Bonus-malus system was introduced to get better profitability in the future (Global banking trends after the crisis. 2009). . The financial crisis has led many banks to realize that there should be a prudent and long term and balanced view of their business. For growth as well as success banks has to concentrate on their core assets, staff, capital and customers. Management of these assets could prove beneficial to the banks in the future. More banks in Europe and US have concentrated on fundamental principles of the banking business like profitability, client relationship management and cross selling capabilities. Banks are concentrating on customer, staff and capital rather than unnecessary product innovations. When compared with the pre crisis period, banks are taking steps to reduce the operational risk through increase in transparency and complying with the traditional corporate governance and standards. Increase in staff efficiency is on the agenda now. Efficiency is planned to get increased through enhanced IT solutions. There was a significant shift made by the banks from product centered approach top customer centered approach this was a major change in the trend in the post crisis period. Client management was given importance to maintain and sustain good client relationships. Moreover client profitability analytics was developed by banks to enhance performance by analyzing profitability at multiple levels. The post crisis scenario also demonstrated the use of better leverage on the best infrastructures while adding new platforms for operational as well as cost efficiencies. Acceleration in the use of algorithmic approaches to solve complex back office tasks for increased automation and efficiency has been another significant development. More and more banks are looking to do more with less banking costs through process improvements using latest business management techniques (Ten Trends in Banking, 2010). A roundtable conference took place in Brussels on October 12 2009 to discuss about concrete proposals that would strengthen the banking industry after the crisis. The discussion aimed to find answers that would enable the industry to prevent such collapses in the future. It gave the opinion that the Basel11 norms has failed to prevent the collapse of banks during the crisis and there is a need of fresh regulations may be Basel 111 in the future. The crucial aspects of the new regulations should be counter cyclical measures and it should be comprehensive across all countries and institutions. All banks should increase their balance sheet capital during the upswing cycle and should draw on this capital buffer when the economic trends go down. Opinions suggested that regulations should not only focus on the capital structure and liquidity of the banks but should impose detailed restrictions in the field of risk taking that includes rules on incentives also. There should be a tax on transactions aimed for reducing the volume. In order to sustain growth; it should be ensured that SME’s and emerging markets should receive capital from less useful applications. Majority of the participants argued that regulations may not find its target but the dynamic regulation can constantly evolve to meet changing requirements. Regulations should also be robust that can apply to a multi pronged problem even in situations of complexity. The participants’ s of the meeting acknowledged that regulation is not one part of the solution, other elements are also required to overcome the crisis like returning to the old model of structure in banks where there was partnerships. These structures produced greater alignment of interests between the customers and the board members that cannot be found now. This would help to solve the problem which has grown proportionately large. It is desired that banking should serve and not control the economy. Moreover the problem of toxic derivatives is unlikely to be applied through the process of regulation. The growth of collateralized debt obligations as well as credit default swaps was seen as instruments that are negative to financial stability. There is a move currently in the US to force most over the counter derivatives onto exchanges. This idea reduces counterparty risk but systemic risk may remain unless all the relevant exchanges are capitalized with trillions of dollars. Last but not the least, lasting reforms is possible only through the support of the public. Politicians and a handful of supporters cannot enforce regulations. A new cost benefit approach should be followed to reduce the impact of the crisis and thereby helping the effected public (Towards Basel III? 2010). The policies of the Federal Reserve in regulating the banking sector in US were explained by its chairman, Mr. Ben Bernanke on October 23, 2009. There was a revaluation of regulatory, supervisory and central banking policies in the country after the crisis. Forceful and coordinated policy actions along with wide range of government programs have stalled the crisis from deepening further. Important steps like encouragement to hold more capital, improvement of risk management practices, more robust liquidity management, employment of compensatory structures that provides appropriate performance and risk taking incentives and fair dealings with customers (Obama pushes new bank regulation , 2010). In the supervisory front, steps like strengthening oversight and enforcement at the firmwide level, augmentation of the traditional micro prudential methods of oversight with macro prudential approaches to mitigate broader threats to financial stability etc. Under the influence of the Federal Reserve, the US banking sector followed the following regulations to strengthen their financial stability. These includes, increasing the capital base of banks and securitizations, conducting supervisory capital assessment program which is popularly known as the stress test that enabled the supervisors to ensure that all banks holds adequate amounts of high quality capital, reducing the requirements of current capitals to promote growth in booms and restrictions during downturns, following countercyclical capital standards, assessment of capital surcharges on institutions whose failure poses a significant threat to the banking sector, addition protection to banks through the issue of contingent capitals etc(Regulations, 2010). Other regulations include adoption of sound liquidity risk management principles into the banking sector. Review of the compensatory packages and protection of consumers from unfair and deceptive practices. It was considered that strong consumer protection measures would enable to safeguard the interests of the small consumers whose savings will be protected (Bernanke, others working together on overhaul, 2010). Rules regarding disclosure of information’s to the consumers regarding investment were modified. New rules were introduced so that it would benefit the well informed customers and prompt them to make appropriate decisions. Moreover deceptive advertisements on investments that was followed by many banks before was prohibited. The concept of effective consolidated supervisions was introduced which would enable the supervisors to understand risks and exposures of complex organizations very easily. Moreover the development of more comprehensive information reporting requirements was to be followed by banks during the post crisis periods. Last but not the least, the Congress should take necessary steps to support the reforms in the banking sector as proposed by the Federal Reserve (Bernanke,B.S, 2009). The current economic crisis has not only created challenges for the US banking industry but to all sectors across the world. It has changed the dimensions of banking risks and the policies that were used before to implement banking regulations. Mispricing of the risks was the outcome of the crisis along with instability and fragility of financial institutions. The crisis has changed the already established bankruptcy rules of banks. New rules allow the increase in the value of the banking firms by decreasing the uncertainty and bargaining costs. The new bankruptcy rules framed by banks are in such a way that the chance of conflicts between different stake holders is minimized. Moreover it is also cost effective and reduces burden on the tax payers. These principles were incorporated by the banks as part of the post crisis strategy on the basis of outcomes from the Swedish experience in the nineties. The Swedish banking crisis was considered as an exemplary example in terms of low cost implications as well as good practices that were implemented. The general principle that was used was to get uncertainty out of the system through ring fencing of the bad assets. The good bank/bad bank scheme was used in combination with extensive use of asset management corporations. The ‘bad bank’ part of the bank was transferred to asset management corporations on the basis of carefully assessed market values. In the next step, the asset management companies proceeded to regroup the assets and offer them to the potential buyers. Because of the pressure that was associated with preservation of stability of the bank along with a well functioning payment system had vanished, all the first sale of the assets were avoided. Moreover the government issued an unlimited guarantee to all the depositors and counterparties that came at the cost of the tax payers. The shareholders were excluded from this guarantee and avoided any type of delay in the process of renegotiating with the other stakeholders. The bank support authority who were in charge of deciding which types of banks have to be reconstructed and which should be liquidated, disclosed its mission to the general public. The measures were designed in such a way that it could minimize the costs of the government and reduce the risks. The credibility as well as political support of the bank authority was thought as an essential element in the success of this plan. The procedure sometimes referred as the “hammock” procedure consists of writing down the bad loans of the bank , testing the banks in a model of micro as well as macroeconomics, and giving support to the banks that pass the test and to close, merge or restructure banks in an orderly manner to those that fail. The procedure that followed was undertaken in a case to case basis but with clear and transparent rules that could avoid delays and renegotiations. If the crisis has higher levels of uncertainty, the bad bank or the asset management company has to hold the assets for a longer period of time. But still the flexibility of the good/bad bank separation and the closest possibility to make a case by case approach makes this a powerful tool to be used in times of crisis (Freixas.X, 2010). Conclusion: After the financial crisis, all the financial institutions, regulators and customers have become cautious. Tighter and stricter rules and regulations are making it hard for banks to obtain the growth rates of yester years. There is a common belief that there will be a new normal financial atmosphere. As a result of this more and more financial institutions are returning to a client-centric approach rather than focusing on innovating with more products that adds operational cost and complexity. Banks are looking to drive operational efficiencies and better manage their exposure to risk factors in the industry. This return to general fundamentals approach is the overarching change for banks as they ressurect from the crisis (Ten Trends in Banking,2010). Reference: Bernanke,B.S, 2009, Financial Regulation and Supervision after the Crisis: The Role of the Federal Reserve, Retrieved 10 December, 2010, Banking regulation, 2010, Retrieved 10 December, 2010, < http://knowledge.asb.unsw.edu.au/article.cfm?articleid=1105> Bernanke, others working together on overhaul, 2010, Retrieved 10 December, 2010,< http://news.yahoo.com/s/ap/us_financial_overhaul> Doan.C, Glanville.V,Russel.A,&White.D. 2006, Greater international links in banking- challenges for banking regulation. Retrieved 10 December, 2010, < http://www.treasury.gov.au/documents/1190/PDF/09_banking.pdf> Freixas.X, 2010, Post crisis challenges to banking regulation, Retrieved 10 December, 2010, Global banking trends after the crisis. 2009. Retrieved 10 December, 2010, Henry.K, 2010, Emerging from the Global Financial Crisis, Retrieved 10 December, 2010, Obama pushes new bank regulation , 2010, Retrieved 10 December, 2010,< http://news.bbc.co.uk/2/hi/8473294.stm> Regulations, 2010, Retrieved 10 December, 2010, SunGard Identifies Ten Trends in Banking,2010, Retrieved 10 December, 2010, Towards Basel III? Regulating the banking sector after the crisis, 2010, Retrieved 10 December, 2010, United States Banking Regulation, 2010, Retrieved 10 December, 2010,< https://www.10ainvestigation.com/sites/detail.asp?market=91&id=42> Read More