Governing the Banking Industry: Banking Deregulation - Research Paper Example

Introduction Banking deregulation is the abolishment of regulations governing the banking industry, and financial institutions in the United Kingdom, covering the issues from interest rates to speculation. Bank deregulation is associated with the involvement of the government in the private sectors that result in settling of optimal competition in the banking sector. Levine & Norman (2000, p. 31-77) claims the deregulation cause stiff competition in the banking industry that initiate offering the best service to the prospective customers, and manage their dealings efficiently and effectively to rally competition. According to the views of bank regulators, monetary authorizes, and economists in the UK, bank deregulation enhance the competitive efficiency of the payments, expanding the scope of financial intermediation. The UK's over reliance on a deregulated banking industry is the key factor in the current economic downturn. Deregulation supposedly undermines Banking sector ability to control nominal magnitudes and increases the probability of catastrophic payments-system failure. The deregulation measures taken by UK are classified as deregulation of interest rates on the deposits, domestic financial markets and promotion of access for foreign financial institutions to UK markets. Changes in the interest rate in a drastic way resulted in difficulties for the banks due to deregulation of interest rate on the large sum deposits. The deregulation has posted a treat to both national and international financial sectors, and increased the trend towards more formal supervision of banking activities. The 1979 act is of particular interest control as it coincided with the end of exchange controls in the British financial structure and led to start of deregulation of UK banking sectors. It has been referred as a turning point in UK banking deregulation because it abolished the old systems of “gentlemen Agreements” that had long characterized the relationship between regulators and regulated in the British banking system. Indeed the act formalized the system of supervision and for the first time they required deposit taking institution be licensed by the bank of England that led to deregulated banking industry to facilitate the current economic downturn. Impact Of Over Reliance on a Deregulated Banking Industry Deregulation enabled immediate changes in the banking compensation structure that was due to the abolishment of the barriers to entry in the banking industry, allowing a large number of new specialized firms to enter the market. It also allowed banks to achieve a much larger scale of operation and shifted the distribution of large firms throughout the industry, resulting in the change of dimensions of bank composition. In the significant study, Doha (2003) demonstrates that banking employees attributed a large share of the narrowing gender wage discrepancy in banking to deregulation that affected the economic growth in UK. As mentioned above, deregulation may cause many firms to change compensation for reasons other than regulation erosion. James (2007, p. 568- 580) examines a range of banking sectors and finds out that increasing occupation inequality within the industry is due to deregulation. She argues that the pressures of increased product market competition raise the cost of employees, this reading to firms to reward competence and performance more highly and result into an increase of inequality among workers in a given occupation. This lead to reduction of production in a different sector; hence, causing the decrease of profits into the sectors. Expansion of efficient firms due to the deregulation led to drastic increase in measures of sector concentration at the economy level; however, the tendency of increased concentration was far from uniform of the banking industry. The appropriate governmental changes targeted a single sector; this identification strategy produces a huge difference of deregulation effect on the banking compensation structure. When the measures are compared with those in other sectors at different years it indicates that, the deregulation affects the innovation of the banking sectors that result into a downturn of the economy. Effect on Wages and Employment The deregulation led to decrease in the wage inequality between managers and non-managers within the same establishment. The effects are negativities that provide weak reaction toward improvement of wage distributions. Employment gains were of greatest interest among the managers and growth in managerial employment were in different rate between men and women. There was evidence that occupation in banking sectors became male-based institutions that was due to deregulation. Black & Philip (2001, 814-831) claims that strong absolute and relative employment growth among male banking employees, combined with evidence that changing characteristics of banking employees had a role in wage declines confirms that wage declines among gender in banking following deregulation were due to the abolishment of market wages under the regulatory regime. As it was with decreasing occupation inequality, various channels explain the increases in establishment inequality in the banking sector following the deregulation (Black & Elizabeth, 2004). One evidences that firm size compensation premiums shifted due to the deregulation was by disproportionate share of pre deregulation earnings by small firms. Meanwhile, the differential might also increased if the large sectors started hiring more capable people relative to small firms when faced with a more competitive product market. The deregulation caused the rate of overtime pay and severance packages to increase gradually for the banking employees. As a result, the bonus pay declined and the overall impact of deregulation on the coverage of the forms of compensation was not significant. The increase in the coverage of overtime pay was particularly accounted for by increasing overtime pay for non-manager, and increase in packages and decrease in bonus pay that led to low production in the economy. Banking share of employment in the large size sectors increase following the deregulation, while, its share in small institutions declined. In other works, banking employment at large firms grew faster following deregulation than employment at small firms that resulted into reliance on employment on larger firms; hence abandoning small firms resulting into low production in the economy. Competition Issues Robert (2011) notes that the number of banking firms in the UK dropped drastically, but the number of bank establishments continued to expand at a stable rate over the same period of deregulation. Indeed, the growth in various bank branches appears to have prevented any real decline in employment for bank tellers, who were largely being replaced by ATMs machine. The decline in the employment resulted into inefficiency effects in the banking industry that caused the reduction of banking services in the economy. To identify effects of increased competition with the change in the banking sector structure, the changes to laws regulating entry into the commercial banking sector play an extremely important role. The abolishment of these laws lowered barriers to entry and reduced restrictions on scale, leading to more competitive environments in the banking sectors. The deregulation had a huge effect on the real economy because it played an important change in the banking structures. To summarize the key changes as the result of relaxation of the restrictions on the expansion led to larger banks operating across a wider geographical area. The restrictions on the branching and interstate banking did not apply to local markets, with the exception of few sectors that did not permit branching in any form; thus, deregulation led to banks to enter new markets, but it did not consolidate the banks within a local market. Banks tended to expand by purchasing branches of existing banks during the reform rather than by acquiring all of the branches and other assets of the whole banks, so the acquisition rate of whole banks did not rise; hence causing the downturn of the economy. The deregulation of the banking industry help in gaining an understanding of what is happening in UK, as well as considering how the overreliance of the deregulation services affect the world economy. Deregulation in UK has induced greater global financial fragility in the economy, and promote the inefficiency and reduction of innovative markets that were expected to manage risks better. The downturn in the economy comes as the result of loan delinquency that rose rapidly and the standard rules on provisions can lead to the credit crunch, and enforcing of capital charges under deregulation would only serve to deepen the credit crunch and a recession. Overreliance Caused Debts Predicaments Braga & Vincelette (2011) indicate that debts predicaments are featured to pro-cyclical economic policy in the period preceding the economic crisis due to deregulation. This caused the UK to start managing large and untenable fiscal deficits for several years, largely funded through borrowing. The losses came about from poor expenditure of welfare as well as collegial factor markets. The Government of UK used deficit spending to increase extraordinarily, the people’s standard of living as the debt funded the joblessness societal benefits, raised the remuneration of public workers along with pensioners’ income, and sustained a mutually respectful labor market. The widespread fiscal crisis that started in the banking sector resulted to declination of the government profits. Some governments funded financial organizations that turned into failure subsequent to the rupture of their financial systems’ housing bubbles. For instance, prior to the deregulation reforms the UK banking system had developed considerably and received enormous proceeds through credit expansion as well as underlying government backing (Velandia, 2002). The increase of credit caused a housing trend that stimulated the fall of banks in the year of deregulation reforms. The UK government secured all the outstanding balances of the bank, in this period, and put in so much money in its banking department. In addition, the entire global depository section in banking sectors failed due to the international monetary crisis. As the economic crisis transformed to worldwide recession, there was the use of development financial policy in order to promote economic recovery. Velandia (2002) indicate that governments in a variety of financial systems of the world rise spending and decreases taxes to arouse comprehensive market and take out their economies from the recession. As a result, there is worsening of financial budgets since the financial plans of the government are declining due to UK's over reliance on a deregulated banking industry. Depreciation of Currency The overreliance of deregulated banking services has depressing repercussion for the financial system of the UK and the rest of World. The crisis severity measures may reduce UK growth and cause loss of trust in the pound, leading to lessening of the pound comparative to the US dollar. Mary & William (2010) indicate that all these issues slow down the United States exports’ demand to the UK as well as raise its imports from the pound area, resulting to the widening of the US trade shortfall. The reduced rates of development in UK possibly cause shareholders of the United States to consider increasingly, the upcoming markets for chances to invest. However, when the pound is weak, it make the stocks, as well as assets of UK; seem more economical and attractive, thus, drawing the capital of the United States towards the pound situation. The over reliance of deregulated banking services cause assets to have high systematic threats that contains a return which is high than of those assets containing a less systematic threat, and assets having similar systematic risk must provide equal returns. This argument is significant in that it permitted the banking industry to measure the portfolio’s risk of the deregulated indicators. Therefore, the UK should deal with the risk of the over reliance by simulating the service flows of cash upcoming liability. According to Mary & William (2010), the simulation will primarily give a projected pathway for future obligation service that is linked with the concept of price. It will as well recognize the prospective divergence of arrears servicing flows from that projected trail because of shocks in exchange along with charges of interest, or lack of loan able finances in the internal or else the global markets, presenting an appraisal of risk. This function let the banks to evaluate varied strategies, assess the cost-risk exchange, and then choose a policy that well again reflects the goals of the government as well as its ability to bear the risk of over reliance. Effect on Credit Control and Insurance The over reliance of deregulated banking services reduces the incentive for the bank institutions to play their duty of monitoring functions of vetting borrowers. Poor methods of operating credit controls and providing information on quality and performance of the assets that are repackaged originate to distribute process contributed to economic crisis in the UK and the rest of world. This is a downturn of the economy because the banks are the institutions that are trusted to carry out such vetting and monitoring of the borrowers, and since the regulations are not used the process lead to financial crisis. Justin & Boris (2011) claim that the deregulation of the banking sectors magnifies systemic risk and leads to systemic problems that cause banks to transfer the risk of a loan or mortgage defaults to the wider capital markets. Thus, it creates fear within entire economical system, because it is clear that the losses of mortgages and loans cause a downturn of the economy. The overreliance of deregulated banking sectors in UK allow banks to pass on their risk to others, while, at the same time reducing their responsibilities of monitoring their borrowers, and this make them a major source of systemic risk Kim (2010). This unbundling of credit risk is potentially problematic because it shifts risks away from the banks that are expected to understand the causes of such risks, and explain the prospective customers and institutions who might not understand the nature of the risks. In essence, the credit derivatives shift risks from deregulated banks to less regulated insurers thereby creating, rather than lowering, market instability, and create systemic financial crisis that led to the economic downturn in the economy. Justin & Boris (2011) indicate that UK the rationale of deposit insurance is the protection of unsophisticated depositors who are at an informational disadvantage in judging the soundness of the deregulated bank services. In deregulated banking sector, deposit insurance give rise to moral hazard because it undermines the incentives for depositors to monitor excessive risk taking by the banks due to over reliance. Kim (2010) argument is that deposit insurance and other safety nets for the banks have perverse effects, by giving rise to moral hazards and encouraging risk prone behavior, thereby imposing excessive costs on the financial system and, in worst cases, on the taxpayers as well causing the downturn of the economy. It is clear that deposit insurance does raise some issues regarding moral hazard, but the inability of regulation to eliminate the possibility of bank failures. Instability in the capital market The need to protect the depositor by the deregulated banking sector, cause economic instability that result into a reduction of GDP of the UK and the rest of the Countries. Jane & Scott( 2001) indicate that the significant effect of the over reliance of the banking industry by UK, affect the global financial markets, and UK authorities to allow over reliance of the deregulated banking services cause huge financial and economic implications not only in the UK, but across the globe. The UK regulator, the Financial Services Authority (FSA) failed to properly address the weakness in the deregulated bank’s funding model and did nothing to prevent the problems that came to fore from August 2007 onwards (Kim, 2010). This has been viewed as a significant regulatory failure and it brought serious weakness in the regulation of the liquidity of the banks, and brought shock in the economy that led to reduction of production in UK and the rest of globe (Jeff, 2009). The shortage of liquidity causes the closing up of the capital markets that have a significant impact on the global economy, not just on the financial markets but also on the wider community general(Kim, 2010). This triggers a credit crunch and subsequent financial crisis, the cost of that is in the region of $1 trillion in money terms, and even more impact on the global economy (Jane & Scott, 2001). Banks and insurance companies across the globe make huge losses and subsequently see their markets capitalization fall drastically as their share price shift. The drying up of funds in the capital markets due to the over reliance of the deregulated banking services led to specialization in providing residential mortgage in the UK (Kim, 2010). This was the first run on a bank in the UK since Victorian times, and it affected the drying up of funds in the wholesale markets because its business model was fundamentally flawed due to over relied on the deregulated banking sectors. The conditions in the global credit deteriorate gradually, and UK experience chronic difficulty in securing the deregulated banking services. The banks fail to diversify its funding sources adequately, and it has failed to take adequate insurance for the problem it is facing (Jeff, 2009). The over reliance on the deregulated banking services cause capital market to suffer liquidity problems when these markets dry up, and this liquidity crisis, rather than solvency issues, lead to run on the banks, and cause subsequent nationalization in the globe economy. The deregulatory measures on the banking institutions like opening the capital market, macroeconomic conditions, financial innovation, excessive liquidity and easy access of the credit led to a fundamental deterioration of the risks controls for the existence of the credit and subsequently of creation of an asset price bubble in the UK housing Markets (Kim, 2010) Investment Issues This deterioration in risk controls for the extension of the credit led to excessive lowering of underwriting standards for the mortgages. When the asset price changes and sub-prime borrowers saw the values of their investment begin to fall, due to increase in their mortgage repayments caused increase of living standards of people to increase, which led to the increase in consumption and reduction in the investment. Cetorelli & Michele (2001, p.617-48) indicates the globe cost of the crisis is significant and it can be witnessed by the global economic recession that occurred that includes reduction of production in most sectors of the economy, significant job losses and an increase in unemployment, as well as the closure of several businesses. The UK bank bailouts cost pound 131 billion, while, sum of public institutions support for the UK banking services industry including the guarantees and liquidity support from the bank of England, as well as saving depositor protection to cause UK taxpayer pound 850 billion to date ( Kim, 2010). According to Lawrence & Lawrence (2003) the constant increase of taxation in UK is due to the over reliance of the deregulated services lead to an increases of living cost due to the increase of prices of the commodities. The over reliance of the deregulated banking industry impose additional burdens on the individual agency employees and force them to make difficult and often politically costly decision that affect the growth of the economy(Kim, 2010). This caused bank not to make loans, they had no trouble finding the alternative investments for their increase funds due to the competition; therefore, there was no trouble in investing in corporate stock that lead to lowering the commercial loans and deposit interest fluctuated that lead to interest rate risks (Bergstresser, 2001). The over reliance of the deregulated banking sector affect the investors in both UK and entire globe because they depend on the banks and other financial markets to generate the cash flow that can support the investment. The increase of the interest rate in the deregulated service due to the stiff competition in the bank industry caused the price of investment to increase in UK and in the rest world affecting the production of the economy. According to Caldentey &Vernengo (2011), deregulated banking industry faces multi-functional services due to the stiff competition of the service in the banking market that lead to riskier activities like dealing, underwriting and investing in the securities. The deregulated bank performs multiple types of economic activities that lead to economic inefficiency due to greater production of services of poor quality that leads to the downturn of the economy. The over reliance of the deregulated banking industry cause the shareholders of various firms to enjoy limited liability, the taxpayers face potentially unlimited liability with regard to the failures of the systemically important banks and financial institutions. Conclusion The consequences of the over reliance of the deregulated banking industry in UK are that the banks are expected to pursue more aggressive marketing and take higher risks and significant response to the downturn of the economy by trying to impose to see if the problem will be solved. The fact that there has been so much problem of the deregulatory service in the globe economy, the regulatory measures should be implemented to address the problem caused by the over reliance of the deregulated banking sectors. According to Peter & Keith (2007) such regulatory cannot be necessarily involve creating more deregulatory rules, but can be achieved by improved supervision of the financial services industry, as well as the acceptance that market fundamentalism has its shortcomings. To improve the image of the economy, the UK government needs to address the various issues that we have discussed in this paper. The increase of interest rate due to the high demand of the deregulated services in the bank cause the lowering of the investment in the economy, and the banking industry should emphasis on the financial innovation rather than competition in the capital market (Suresh, 2011). The cause of debt deficit in the UK economy and the rest of the world due to unhealthy borrowing of the loan to purchase mortgage should be discouraged and regulated in order to recover the downturn economy. According to Bernard (2001), overreliance of the deregulated banking industry cause lowering of wages and unemployment in the UK and the rest of the globe and should be addressed by trying to promote both large and small industry in the economy. Meanwhile, the issue of increase of living standard of the taxpayers should be done with by trying to impose regulatory measures that will reduce the tax, as well as cost of living. Addressing these issues will help regulators to better monitor the way in which banks and other financial firms structure themselves, what they do, how they do it and their financial healthy. Improved supervision in all of these areas will go a long way towards preventing the down turning of the economy in UK and the rest of World due to the overreliance of the deregulated banking industry in the future. References Bergstresser, D., 2001, “Market Concentration and Loan Portfolios in Commercial Banking,” PhD Dissertation, MIT University, Bernard, SG 2001, Bank Mergers in a Deregulated Environment: Promise and Peril, Greenwood Publishing Group, New York. Black, SE & Philip, ES 2001, “The Division of spoils: Rent-sharing and Discrimination in a Regulated Industry,” Quarterly Journal of Economics, vol.91, pp 814-831. 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Robert, WK 2011, Financial Crisis of Our Time, Oxford University Press, New York. Suresh, P 2011, Management of Banking and Financial Services, Pearson Press, New Delhi. Velandia, A 2002, Risk Quantification Model for Public Debt Management, Accessed at Read More