The Issue of Too Big To Fail Banks - Essay Example

A Memo of Transmittal “Too Big to Fail” Describes the faith that if a leading and large organization fails. It will have a catastrophic ripple effect throughout an entire economy. The project report will contain the introduction, Roles of Banks in the development of an economy, “Too Big to Fail” Banks issues discussion. Finally the report will conclude an overall summary of the project. The recent global financial crisis has highlighted the issue of “too big to fail” banks. Table of Contents Executive Summary 4 Introduction 4 Roles of Banks in Economy 5 Role of Central Banks 6 Roles of Commercial Banks 7 The issue of “Too Big to Fail” Banks 8 Conclusion 10 References 12 Executive Summary The US has implemented their economy in the deepest and largest intervention history. In the year 2008, the leading investment bank, Lehman Brothers has collapsed due to in adequate mortgage plan and insolvency of the market. The study considers the roles of the banks in the economic development of the countries. Moreover, it will discuss the role of government for the “too big to fail” banks; whether they should be bailed out or not or how the banks can overcome these issues. The research has been done with several significant examples. Introduction Government around the globe took amazing procedures in order to deal with the failure of banks and large financial institutes during the financial crisis that was occurred in 2007-2009. The policymakers had clearly addressed too big to fail as one of those problems. The free market structure is fueled by the failure and success of firms in a crowd of industries. When government intervenes to keep the disastrous firms alive, it undermines the foundation of systems. However, banking has been treated differently. The sector has had the safety benefit that was provided by the Deposit Insurance and Federal Reserve, supplemented by extensive regulation and supervision. Across various countries at different times and various economic conditions government had protected uninsured and insured depositors, insured risky assets, guaranteed bank debts for the long period of time against depressed valued collateral. Moreover government has injected required public capital for the betterment of the shareholders of different leading banks in order to save them. Roles of Banks in Economy Banks around the globe used to play an important role in the economic development of various countries. Considering local community, banks provide access to financial services and funding to citizens and local businesses. Moreover, the money banks in a country provide business investments, taxes and employee pay role. On a large point of view, the national banks used to provide similar access financial services and credits to the large business units and local governments. Moreover, they also used to provide their services to the NRIs and international customers (Disyatat, 2001). Investments that are being made by the national banks are widely spread across specific nation. Therefore, it is feasible that, the banks play important roles in the economical development across an entire geographic region or country. Banks’ specific roles in the economical development of a nation vary. It depends upon the scopes. Generally the participation of the banks in country’s economical development focuses around offering financial services and credits in order to generate significant revenue. These are further invested back into an international or national or local community. The precise roles that banks play in the country’s economical development used to differ from the roles that banks play in international or national economical development. Few important roles are being underlined below in order to make the readers understand about the topic. Financial developmental projects. Transference of money. Development of agricultural and industrial sectors. Encouraging young and dynamic entrepreneurs. Overcome unemployment problem. Generally there are two types of banks, such as Central and Commercial banks. The roles of these two types of banks are being provided below. Role of Central Banks It is the foremost and important monetary institution in a country’s market economy. These institutions are usually government owned. Moreover, these central banks are highly responsible for the government interest. Major of the central banks act as the several banking systems’ bankers, serve as the banker of government, regulate the monetary system for both international and domestic policy goals and finally issues the currency of the nations. As it is the government’s bankers, the central banks collect and distribute the government receipts and income. These institutions manage the redemption and issues of government debt. It takes the responsibility to advise the government regarding all of matters that are linked with financial activities. Finally, these central banks help to make the loans to the government of a country. The central banks hold and transfer the deposit of other banks that operate within a nation. The central banks supervise other banks’ operation and acts as the lender. Finally it provides advisory and technical services to the other banks. Monetary policy for both international and domestic purpose is implemented by the central banks. In various countries, the central banks used to control other financial institutions directly or indirectly. The notes and coins that circulate within a country as the national currency are generally known as the liability of the central banks. Roles of Commercial Banks These are the most significant and important financial intermediaries. The commercial banks used to play valuable roles in the areas that are listed except encouraging the young and dynamic entrepreneurs and overcoming the unemployment problems. The role of these banks depends upon he programs and policies of the stakeholders. These commercial banks used to manage loan accounts for more than half of the total bank assets in the commercial banking system in US. They provide their key services in both domestic and international sector. The bankers lend to consumers, government and business both nationally and internationally. Investment is the second largest bank asset category. These are held by these commercial banks for both income and liquidity purpose. These investments include the guaranteed securities by the US government, private security and the bonds of municipalities and states. The commercial banks also used to hold the cash assets, specifically for the liquidity purpose. In terms of the liability of the banking systems, three-fourth part is the form of deposits, generally for the companies and the individuals. The non-deposit liabilities of bank include federal fund market borrowings. Although the roles of banks can vary, but several factors, such as access to bank investment practices or policies and credits used to remain constant in the unfavorable scope of economical development. The issue of “Too Big to Fail” Banks From 1991 to 2008, the systematic risk omission was cited by the regulatory authorities. The first-ever implementation of systematic risk exception was to symbolize the floodgate opening. However, the things have changed in the fall of 2008 (Wolgast, 2001). The economic reform pillar is competitive neutrality. The framework that is mandate by the leading countries of the world with reorganizing the global financial system, has agreed on strict standard framework. Moreover, they have supervised the large banks and other financial institutions whose collapse can cause extensive economic disruption. The breakdown of leading investment bank of US that is known as Lehman Brothers Holdings has focused awareness on the threats related to the global financial systems by large insurance companies and banks that go bankrupt. The FSB has agreed on this policy framework in order to symbolize how to pact with the “too big to fail” banks and financial institutions. A group of 20 leading emerging nations has decided to co-ordinate with the financial and economic policies, after the financial crisis era. Large banks always enjoy a couched guarantee of the solvency as, being “too big to fail” the banks can be bailed out in the crisis situation. Nan-banking institutions and smaller banks are not that big to fail as they used to pay more wholesale funders. Securitization market snatch up and turn them into liquid would need some emergency and tricky actions. Two banking regulators, such AS Reserve Bank of Australia and Australian Prudential Regulation Authority has usually focused on the critical financial system stability within the banks’ official family. Competitive neutrality with the help of shadow banking from the securitization gets short shrift. The major purpose of the regulation came out in order to stabilize the financial institution’s existing structure. Specifically, the particular objective is a guarantee for the future and has potentiality more than the crisis (Guren, 2013). There was not a single investor from the Australian AAA rated MBS, who has lost the principle during or after the financial crisis era. The liquidity within the Australian market has drastically collapsed. Financial management office in Australia has critically provided the important and required life-support for the institutions. But, still they have allowed their security home lending market share to fall within three quarters. On the other hand, the leading banks in Australia snapped up Aussies, RAMS, Challengers and Wizard’s lending arm. However, the Bank of England has calculated the yearly “too big to fail” taxpayer financial support. The value was 70 billion US dollar before the financial crisis for the 29 large banks around the globe. The global banking regulators, such as Basel Committee are trying to minimize the future crisis possibilities. The regulators, have recommended that, basic level liquid assets’ buffer need to be hold. But, the debt of the Australia’s government is quite low. Therefore, it is difficult to provide the banks sufficient level one asset. Moreover, it is assumed by them that, the similar thing may be happened in case of level two assets (Stern & Feldman, 2004). This includes MBS. Therefore, Reserve Bank of Australia will provide them sufficient loan amount through the committed liquidity facility. The number of MBS is quite low in the Australian market because, enjoying such mortgages and exorbitant privileges can cause securitized recline. The Reserve Bank of Australia ramps up the support for other banks within the country, with several policies that can increase the moral hazard (Kolb, 2010). The latest annual report of AOFM’s has stated that, growing concentration on the needs that will help to encourage the switching towards the securitization market is not quite reliant enough on the financial support of government. Conclusion The banking sector has had the safety advantage that was committed by the Deposit Insurance and Federal Reserve, complemented by widespread regulation and supervision. Considering national community, banks used to provide the access to several financial services and funding to the citizens and local businesses units. Moreover, the money banks within a nation provide business investments, taxes and employee pay role. On a large scale, the national or the central banks used to provide similar access financial services and credits to the large business units and governments. The economic reform pillar is competitive impartiality. The structure that is consent by the leading countries of the world with reorganizing the global financial structure, has agreed on strict regular framework. The global banking regulators, such as Basel Committee in Australia are trying to minimize the future crisis chances. The global regulators, have suggested that, basic level liquid assets’ buffer need to be hold. Therefore, it is difficult to provide the banks sufficient level one and level two assets. “Too big to fail” generally delivers more to the certain readers comparing to the other, but used to preserve some interest for everyone (Gup, 2004). References Wolgast, M. (2001). “Too big to fail” : Effects on Competition and Implications for Banking Supervision. Journal of Financial Regulation and Compliance, 9, 361-372. Stern, G., & Feldman, R. (2004). Too Big to Fail: The hazards of Bank Bailouts. Washington D.C.: Brookings Institution Press. Gup, B. (2004). Too Big to Fail: policies and practices in Government Bailouts. Westport: Greenwood Publishing. Kolb, R. (2010). The Financial Crisis of Our Time. Oxford: Oxford University Press. Disyatat, P. (2001). Currency Crisis and the Real Economy: The Role of Banks. Washington: IMF. Guren, N. (2013, February 6). Too-Big-t0-Fail Banks Warp the Playing Field. The Age, pp. 1. Read More