Universal Banking Challenges due to Regulatory Actions Adopted by the Government - Case Study Example

Finance and Accounting Introduction Global financial crisis of 2007-2008, had empowered the government to modify the financial regulations that are prevalent in the financial markets. The reforms were needed for ensuring greater transparency during transactions in the capital and financial market and thereby, reduce the risk associated with each trade (HSBC Bank plc, 2014). The regulations were required for building a stable financial system and protect the global financial market from any vulnerable activities related to cash transactions. Immediate actions were entailed for raising capital base by employing Basel III and also strengthening the supervision and oversight into financial system. The size, interconnectedness and complexity in the universal systemic banks have encouraged regulators, politicians and the broader community, to take appropriate measures that will modify the traditional regulatory approach. Hence, the potential measures in form of reforms are devised for the socio-economic transition (FTI Consulting Strategic Communications, 2014). The proposals of Vickers, Volcker, Liikanen and other regulatory approaches not only take into account reforms in the universal banking systems, but also included structural procedures pertaining to scope and sizes of activities. Nevertheless, these reforms are straightforward and ensure that, the universal banks are structured in such a way that it has the ability to encounter constraints in different activities and market realities. It has been proved that, the implementation of the reforms is highly complex and at the same time, there are a number of challenges associated with process. Consequently, financial sector encounter legislations that amends the structures of business models and existing markets. This essay lays emphasis on the different propositions of Vickers, Volcker and Liikanen with respect to implied costs that are relevant for international banking and highlights its advantage globally (FTI Consulting Strategic Communications, 2014). International banking system and structural measures There are smaller numbers of financial institutions that are responsible for majority of cross-border transactions; these institutions are benefitted from the diversification. Thus, they are encouraged to facilitate cross border transaction (capital flows) and distribution of savings globally. Nevertheless, as a result of the interconnectedness with the financial market and other institutions, there are several risks, which cause financial distress in the broader financial systems globally. This financial system has had complex operation and structure. These entities are quite challenging to supervise and regulate as far as resolutions are concerned. Hence, Basel Committee on Banking Supervision (BCBS) has been identified, which are basically financial institutions that are regarded as, too important to fail (TITF). BCBS summarized the two approaches that are relevant for limiting the challenges, which are developed by the financial institutions. The approaches are price-based regulations, which are accompanied by effective resolution and improved supervision and structural limits that are developed based on the scope and size of activities that are prevalent in the financial institutions. G20 have proposed few measures that are implemented in order to reduce risks that exist in the financial system globally. This takes into consideration the capital requirements mentioned in Basel III, which is a well managed regulatory framework; proactively and intensively supervised and additionally it provides lucidity and strength to the market infrastructure. There are several regulations that are supplemented with the measures, which are introduced for combating with the systemic risks that are occurring in the financial system globally such as in the United States, the United Kingdom and the European Union (Varriale, 2014). Impact of the structural reforms The financial crisis that followed the regulatory reforms indicated that, the financial institutions could not follow the business model that is structured for combating against all challenges. The structural measures are used as the complement for conventional prudential tools. International Monetary Fund (IMF) argued that, the structural measures reflect the form specific profiles that aim at increasing effectiveness when compared to one-sized approach. The restriction of the activities is regarded as useful tools for managing risks and it is difficult to address and measure when the price based tools are employed. Additionally, the regulators also shared their views pertaining to the business models that are formulated by the regulators. The business models are complex for accurately measuring risks and effectively supervising its importance. Volcker, Vickers, Liikanen – Design of the proposals The universal banking system reforms seeks to protect the payments and deposits functions from risks, which are generated in investment banking. These systems are associated with volatilities, which exist in financial market. Volcker, Vickers and Liikanen have given different proposals in order to explain the reforms that are needed in the global financial system. However, it is worthy to mention that the proposals of the above mentioned authors display significant differences. This difference pertains to geographic and institutional coverage and also scope and nature of separation of the businesses that are related to banks (HL, 2014). Volcker In the United States (US), there are significant international efforts for structuring reforms in banking sectors. During December 2013, Dodd-Frank Wall Street Reform and Consumer protection Act was implemented that included the Volcker Rule. The rule highlights the following points that are discussed henceforth. Firstly, the rule bans the use of proprietary trading by banking system. This means that, the use of short term proprietary trading of commodity futures, options and securities are prohibited. However, there are exemptions that include, activities related to market marking, underwriting market and risk mitigation through hedging. Secondly, the rule does not prohibit trading that is encouraged by foreign banking systems. However, this is applicable only when the trading decisions and the risk associated with foreign banking system arise outside the United States. Likewise, trade occurring on behalf of a specific customer in riskless principal trading or related activities of insurance company is not prohibited. Thirdly, the rule highlights few clarifying exclusions such as activities pertaining to proprietary trading on a condition that the particular requirements are met that includes trading by broker, agent or custodian. There are several conditions too, which are associated with trading that takes place along with the deferred compensation plan; trading activities that satisfy debt that are previously contracted, trade for repurchase activities and securities that have lending agreements. The trading activities are also associated with liquidity management, which has specific documented liquidity plans and trade takes place in association with particular payment activities and satisfy existing legal commitments (Froot and Stein, 1998). Fourthly, Dodd-Frank Wall Street Reform and Consumer Protection Act prohibits banking individuals from sponsoring, owning or developing particular relations with the private equity funds or hedge funds that are referred as covered funds. However, there are exclusions pertaining to certain individuals, who are related to corporate purposes such as joint ventures, wholly-owned subsidiaries and acquisition vehicles (Garvey and Murphy, 2004). Additionally, the registered investment companies under Security Exchange Commission and other business development companies are also bind by the same rule. It is noteworthy to mention in this regard, that the rule permit banking entities that are subject to particular conditions related to sponsor or investment in covered funds, which is associated with offering and organizing these funds. However, it also includes market making-related or underwriting activities and certain risk mitigation procedures that arise exclusively outside the US. The clarifying exclusions are also included and the banking entities are not allowed to engage in investing in covered fund activities. The customers act as broker, agent, trustee, custodian or similar entities according to similar plan or deferred compensation in ordinary way of gathering debt that are previously contracted. Fifthly, the rule states that the compliance requirements vary on the basis of size of banking system and activities that are conducted within the system. Universal banks have to establish internal compliance program, which are rationally designed for ensuring and monitoring compliance and documents are needed to be maintained. The banking individuals that have trading operations are bound to report particular quantitative measurements that are considered for monitoring few trading activities. Sixthly, it is stated that the rule has become effective from 1st April 2014; however, Federal Reserve Board has extended conformance period till 21st July 2015 (Fecth, 2013). A particular phase-in is scheduled, which is discussed henceforth. At the beginning of June 30, 2014, the banking entities, which have $50 billion or more as their trading liabilities and assets are required to report the quantitative measurements; however, the entities with not more than $25 billion trading assets and liabilities are subject to the compliance dated on 30 April 2016. Lastly, those entities, which have more than $10 billion and less than $25 billion as on 31 Dec 2016 are also subject to reporting (Haushalter and Lowry, 2011). Vickers In the United Kingdom (UK), there are particular regulatory efforts that are prevalent among the financial institutions. Financial Services (Banking Reform) Act 2013 has received Royal Assent during December 2013. This is implemented as the recommendations pertaining to Independent Commission on Banking (i.e. Vickers Report) and Parliamentary Commission on Banking Standards. Banking Reform Act takes into account prohibition on the ring-fenced banking entities for conducting regulatory activities that are related to investments in the UK. This prohibition is subject to few exceptions, which are still agreed on secondary legislations. This legislation has to follow recommendations of Vickers Report. This includes exemptions for the payment services, underwriting activities and the institutions that have less than £25 billion as their retail deposits. However, Vickers Report has suggested that, many activities are permitted within ring-fenced banking systems and are appropriate safeguards. This includes activities such as commercial lending, debt-equity swaps, derivatives trading, securitization of the assets and ancillary activities. Nevertheless, the elements are left to the secondary legislation (Kregel, 2011). Under Vickers’ rule, secondary legislation is prohibited and the ring-fenced banks are banned from entering different types of transactions that are contracted among particular classes of people. This establishes and maintains bunch of entities that are prevalent in a particular country and hold shares or even the voting powers in some of the companies. The exemptions are evaluated on the basis of assessment that identifies whether ring-fenced bank is prone to risks, which result from a group of allowed activities. Additionally, focus is on continuation of core activities, which can lead to failure when deposit is endangered (IIF Research Note, 2014). The regulators have the ability to formulate rules for the licensed firms, which forms part of the groups that are associated with ring-fenced banks. These regulators can impose reformation requirements that include the regulated member of ring-fenced bank group in the UK and any corporation, which forms an integral part of the group. The measures take into account, the power to entail disposal of property and transfer of ring-fenced banks to other entity outlook of the shares or securities. The Government dedicated itself to enact on the secondary legislation that are required for implementing reforms by May 2015. It is predicted that, secondary legislation contains exemption for banks, whose retail deposit amounts does not exceed £25 billion. The execution of necessary measures is predicted to be effective from 2019. Liikanen The European Union published structural reforms that measured the proposals that were executed in late January and early February 2014. The proposals were based on recommendations that were made in 2012 by High-Level Expert Groups, chaired by Erkki Liikanen, as well as the responses to the Commissions consultation in May 2013. The draft regulation of EU’s is applied to the European banks, which will be finally designated as global significance. This is also relevant for the banks that have operated for three consecutive years; it owns total assets that amount to €30 billion or trading books that is less than €70 billion or trading assets more than10% of the balance-sheet. This also implies that, about 30 institutions fall under the scope that mirrors the concerns around the compliance costs and high supervisory. However, the EU reserved the right of the regulators to have scope in smaller institutions, which are deemed necessary in perspective of the financial stability. Significantly, the regulators are reserved for the right to reach certain institutions, where the national legislation has equivalent effect to Liikanen. The proposal has introduced ban on proprietary trading, thus, it is significant to note that, it narrowly allowed the credit institutions, operating within the dedicated banking structures, for selling and buying the money market instruments for cash management. The lending in venture capital, market-making, private equity funds and investment and sponsorship of risky securitization are allowed for going forward. However, it is predicted that certain metrics are excluded. For, avoiding circumvention, the banks will accept data on the market-making “lending to venture capital and private equity funds, investment and sponsorship of risky securitization, as well as sales and trading of derivatives” (Varriale, 2014). The proposals of Liikanen are prohibited for the banks, to invest in hedge funds or other entities, which are engaged in proprietary trading or sponsorship of hedge funds. Additionally, the closed-ended and unleveraged funds have been established in EU, which are exempted. Conclusion Universal banking has encountered a lot of challenges due to a number of regulatory actions that are adopted by the government worldwide in order to regulate their actions. However, primarily, banks have succeeded in adopting the rules and regulation, but in the long run the regulations failed to produce any positive impact on the overall banking system and protect it from vulnerable activities. The rules failed to prevent the financial crisis that occurred during 2007-2008 when the universal banking system was affected severely. Nevertheless, it can be stated that, the proposals of Vickers, Volcker and Liikanen have made an attempt to review the situation and develop plans for prohibiting financial activities those are vulnerable to the banking systems. These proposals are successful enough to prevent illegal trading and hedge risk of the securities that are traded in the financial market. Reference List Fecth, F., 2013. Is proprietary trading detrimental to retail investors? [pdf] n.p. Available at: [Accessed 22 October 2014]. Froot, K. A. and Stein, J. C., 1998. Risk management, capital budgeting, and capital structure policy for financial institutions: an integrated approach. Journal of Financial Economics, 47(1), pp. 55-82. FTI Consulting Strategic Communications, 2014. Volcker, Vickers, Liikanen: Structural Reforms Of The Banking Sector – Quo Vadit Europe? [online] Available at: [Accessed 22 October 2014]. Garvey, R. and Murphy, A., 2004. Are professional traders too slow to realize their losses? Financial Analysts Journal, pp. 35-43. Haushalter, D. and Lowry, M., 2011. When do banks listen to their analysts? Evidence from mergers and acquisitions. Review of Financial Studies, 24(2), pp. 321–357 HL, 2014. Proprietary trading. [pdf] n.p. Available at: [Accessed 22 October 2014]. HSBC Bank plc, 2014. Financial Regulation. [online] Available at: < http://www.hsbcnet.com/gbm/about-us/financial-regulation > [Accessed 22 October 2014]. IIF Research Note, 2014. Volkers Rule Approved. [online] Available at: < https://www.google.co.in/url?sa=t&rct=j&q=&esrc=s&source=web&cd=2&cad=rja&uact=8&ved=0CCIQFjAB&url=http%3A%2F%2Fwww.iif.com%2Fcem201402_4.pdf&ei=3P_-U5P0Cc2XuATs64DoDA&usg=AFQjCNGtRQS4Y551hmMDufk-fRKmy-hYAg&bvm=bv.74035653,d.c2E > [Accessed 22 October 2014]. Kregel, J., 2011. Will restricting proprietary trading and stricter derivatives regulation make the US financial system more stable? PSL Quarterly Review, 64(258). Varriale, G., 2014. EU Bank Reforms Plan Points To Global Volcker. [online] Available at: [Accessed 22 October 2014]. Read More