Property Finance - Current Economic Climate and Main Issues Related to the Financial System in the UK - Essay Example

Property Finance Table of Contents Table of Contents 2 Introduction 3 Current Economic Climate and Main Issues Related To the Financial System in theUK from an International Perspective 4 Turner’s Recommendations for Reforming of Financial Regulation 6 Potential Impact of the Changes in Regulation on Real Estate Funding Mechanisms 8 Conclusion 10 References 12 Introduction The United Kingdom economy was facing a period of recession that started in the year 2007 and ended in early 2009. The recession that started in the UK deteriorated the overall economy of Britain and adversely affected various sectors along with banking institutions that resulted in economic downturn of the entire nation. The main effect of this recession was banking crisis wherein the banks stopped lending funds to each other as the banks had a risk of getting exposed to potential risks of losses. Numerous banks had to rely on Bank of England as a lender of last resort which means it had the authority and provision of providing liquidity to banking institutions across the UK. Moreover, as the government was pressurised due to the recession being faced by the economy, it was viewed that various banks were getting nationalised for a temporary period due to recession (Positive Money, n.d.). In addition, the financial authorities in the UK took support from various American lending institutions such as Fannie Mae and Freddie Mac that were regarded as the topmost lending institutions in the United States. It was revealed that UK had collapsed deeper due to recession and thus the economy had to make significant efforts in order to recover from this problem (Telegraph Media Group Limited, 2009). With these considerations, the essay intends to discuss the present economic condition and the financial system in the UK and analyse the potential impact of the regulatory changes as propounded by Lord Adair Turner on the real estate funding mechanisms of the UK. Moreover, the essay also highlights the recommendations provided by Lord Adair Turner on the reformation of the financial regulation in the UK. Current Economic Climate and Main Issues Related To the Financial System in the UK from an International Perspective The UK economy declined in the year 2012, wherein it was observed that the nation had a poor performance in its export and import activities. However, it was predicted that there is a possibility that the export related activities of the country is going to improve in the year 2014 through the progress in its net trade (UK Parliament, 2010). Moreover, the domestic economy is likely to build up and it is forecasted that in the year 2014 there would be a 1% growth in the Gross Domestic Product (GDP) of the UK. It has been witnessed that GDP of the nation had a significant growth in the later phase of 2013 and it was forecasted that in the year 2014 there would be an average growth in GDP at 2.1%. The main reason for this growth is that there has been a considerable decline in the inflation rate which has resulted in increasing the purchasing power of customers. Additionally, the strong financial position of companies in the UK is expected to attract a pool of business investments which in turn would contribute in improving the overall economy of the nation. It is estimated that there has been a huge gap in the output production of the nation and the main cause for this gap has been the financial crisis which has caused a significant damage to the potential production of output. Although, it is expected that within the period of 2013 to 2017 there would be an average growth of 1.9% in the average output growth of the country. Besides, it is expected that the GDP would raise from 1% in the year 2013 to 2.9% in the year 2017 (Goodwin, 2013). The figure below provides a clear idea regarding the economic situation of the UK until 2012. Figure 1: Comparison of UK’s Exports With World Trade (Goodwin, 2013) Figure 2: Contribution of Net Trade To GDP Growth in the UK (Goodwin, 2013) On the other hand, the issues being faced by the financial system in the UK include that the economy has been facing problems related to the financial stability along with resiliency in the financial system of the nation. The UK economy had to go through a phase of financial crisis which in turn affected the overall financial system in the UK. It has been revealed that the financial system in the UK lacks the capability of reducing the extent of risks as the system has the tendency of transferring the risks to financial institutions’ balance sheets which in turn makes the system more vulnerable to ‘counter-party risk’ and market liquidity (The University of Warwick, n.d.). Moreover, due to prompt innovation of financial instruments in the UK there has been a huge threat being posed to the financial system through structured credit derivatives. On the whole, the financial innovation and stability have strengthened the financial system in the UK but it also has increased the battle for gaining more market share that has resulted in increasing vulnerabilities in the financial system (Bank of England, 2006). UK’s financial system also has been subjected to concerns regarding independent debt that includes the rise in government debts that has acted as a restraining factor for the governmental balance sheets and financial system. Furthermore, interest rate risks have also been viewed as a major issue in the nation’s financial system along with operational risks that cause huge losses to the banks and financial system. Additionally, cyber-attacks have also continued to interrupt the financial system which has resulted in increasing the vulnerabilities in the system (Bank of England, 2013). Turner’s Recommendations for Reforming of Financial Regulation In order to effectively respond to the financial crisis being faced by British economy, Adair Turner the former Chairman of the Financial Services Authority provided certain recommendations to reform the financial system in the UK. These recommendations were focused to create stability and effectiveness in the banking system of UK (Wearden, 2009). It was recommended that the overall quantity and the quality of capital must be increased in the international banking system that would result in minimum requirement in the regulatory measures of the banking system. Turner also recommended that the requirement of capital against the activities related to trading books should be augmented and the regime for market risk capital must be introduced. Moreover, the regulators must take prompt actions to implement the present Basel II capital regime and regime of counter-cyclical capital along with capital buffers that would upsurge the economic improvements and decrease recessions. It was recommended that capital regulation must provide emphasis to both supervision and liquidity regulation (Wearden, 2009). The provision of supervision must be introduced for monitoring the liquidity positions of banks and core funding ratio should be introduced that would ensure sustainable growth regarding the funding of balance sheets. Offshore financial centres should fall under the global contracts of regulatory principles and there must be authority initiated within certain officials to gather the information of financial institutions which would help them in assessing the risk associated to the financial and banking system. Turner also recommended that rating agencies should guarantee that apposite communication is done to the investors which make them clear that the agency has been designed to provide suggestion for credit risk. Moreover, remuneration policies must be created that would avoid incentives for unnecessary risk taking and risk management must be considered as an important aspect that must be included in the remuneration decisions. Turner recommended that The Bank of England and Financial Services Authority (FSA) must be involved in the macro-prudential analysis along with policy steps identification. International Monetary Fund must have the authority and resources to undertake macro-prudential analysis and if required the institution must also have the authority to challenge orthodox intellectual insights and national policies (Wearden, 2009). According to the Turner report, major emphasis should be given to capital appropriateness and liquidity requisite that would create a better banking system. Turner recommended that supervision and liquidity regulation must include liquidity risks because it would stabilise the entire banking system in the UK. He further recommended that G20 leaders must increase their commitment to improve system of early warning and surveillance in the global banking system. Additionally, he recommended that requirements for liquidity and new capital must be introduced that would restrain the commercial banks’ role of activities related to risky proprietary trading. He emphasised the point that international coordination of bank supervision must be improved by creating supervisors that would supervise cross border and composite financial institutions. It was further recommended that FSA must be actively prepared to use its authority in order to improve financial activities and global coordination among financial institutions (Telegraph Media Group Limited, 2011). Potential Impact of the Changes in Regulation on Real Estate Funding Mechanisms The UK economy was suffering a phase of financial crisis due to which there was changes in the regulation of the country. These changes in regulation had a significant impact on the real estate funding mechanism wherein it has been viewed that there was a funding gap on real estates of UK in the year 2012. However, there was a positive response from the policy regulators wherein they have actively taken the initiative of tackling the problem of funding gap in the nation. During the phase of regulatory changes there was a reformation in the structures of market conditions that attracted a new range of players in the debt markets of real estate (Turner & et. al., 2010). Moreover, there has been a significant change in the real estate market due to the changes in regulation wherein it has been viewed that the construction activity being carried out in the UK has reduced to certain extent and the pool of funds received for the real estate mechanism has also reduced. In addition, due to these changes, it has been witnessed that there has been a huge incursion of foreign capital into the UK economy. There has been a further rise in the number of overseas investors buying real estates in the UK (Deloitte LLP, 2013). Likewise, the insurance companies have also provided a significant support for bridging the funding gap for real estate mechanisms in the economy. Since the change of regulation from the past few years, it has been evident that purchase of real estates has significantly increased that includes both residential property and commercial property and the major part of this purchasing activity has been done by overseas investors. In accordance with the statistics, the overseas investors had spent more than 20 million euros for purchasing real estate property in the UK during the year 2012 and it is expected that this investment would further increase. After the new regulation was introduced in the UK there were both positive and negative impacts on the real estate funding mechanism wherein positive impacts include that a simple and flexible structure for real estate funding was introduced which provided a good understanding to the investors in real estate industry. Moreover, the industry was not subjected to regulatory supervision regarding real estate funding and tax transparency was initiated in the economy which provided the opportunity to overseas investors of benefitting more from the lower tax rates that could be availed by non-resident landlords in the UK (PWC, 2012). Property Authorised Investment Fund (PAIF) was initiated into the UK economy which provided a huge advantage to the investors wherein the investment and its return was exempted from tax and there was no charge of entry to these investors. Conversely, negative impacts on real estate’s funding mechanism were that the regulation was not much suitable to open-end funds. The Property Authorised Investment Fund that was started in the year 2008 resulted to a slow start of investment coming into the UK market. Furthermore, the funding mechanism was decidedly regulated, due to which, there was a considerable extent of restriction posed to the real estate investors (PWC, 2012). Conclusion The UK economy was continuously declining as the nation was going through a period of recession that weakened the entire economy and negatively impacted various other business sectors along with banking and financial institutions which in turn resulted in the economic downturn of the UK. Therefore, in this period of recession, several banks depended on Bank of England who performed the function as a lender which provided liquidity to these banks. Moreover, the economy faced certain issues wherein the financial system in the UK lacked financial stability, there was a rise in interest rate risks and due to cyber-attacks the financial system had become more vulnerable. Therefore, Lord Turner provided certain recommendations in order to respond to the challenges of financial crisis and these recommendations were provided with a motive to bring financial stability and efficiency in the banking system. As the UK economy declined due to financial crisis, it was viewed that there were changes in the regulatory framework of the nation regarding the real estate funding mechanism which was viewed to have a funding gap and these changes had both negative and positive impacts on the real estate funding mechanism. Consequently, it was observed that insurance companies in the UK provided assistance in bridging the funding gap for this mechanism. References Bank of England, 2013. Financial Stability Report. Publications, No. 34, pp. 1-78. Bank of England, 2006. Financial System Risks in the United Kingdom. Quarterly Bulletin, pp. 337-341. Deloitte LLP, 2013. UK Real Estate Predictions 2013. The Evolving Market. pp. 1-14. Goodwin, A., 2013. The UK Economic Outlook. Institute for Fiscal Studies, pp. 23-52. Positive Money, No Date. Financial Crisis & Recessions. The Issues. [Online] Available at: http://www.positivemoney.org/issues/recessions-crisis/ [Accessed March 26, 2014]. PWC, 2012. Choosing an Investment Vehicle European Real Estate Fund Regimes. Real Estate, pp. 1-52. Telegraph Media Group Limited, 2011. Lord Turner: Reform UK Regulatory Framework and End Light Touch Regulation London. Embassy London. [Online] Available at: http://www.telegraph.co.uk/news/wikileaks-files/london-wikileaks/8305200/LORD-TURNER-REFORM-UK-REGULATORY-FRAMEWORK-AND-END-LIGHT-TOUCH-REGULATION-LONDON-00000723-001.2-OF-003.html [Accessed March 26, 2014]. Telegraph Media Group Limited, 2009. UK Recession: Timeline of How the British Economy Has Been Hit. Recession. [Online] Available at: http://www.telegraph.co.uk/finance/recession/4320827/UK-Recession-Timeline-of-how-the-British-economy-has-been-hit.html [Accessed March 26, 2014]. The University of Warwick, No Date. The Warwick Commission on International Financial Reform: In Praise of Unlevel Playing Fields. The Report of the Second Warwick Commission, pp. 1-62. Turner, A. & et. al., 2010. The Future of Finance. London School of Economics and Political Science, pp. 1-87. UK Parliament, 2010. Recession and Recovery. Economic Recovery. [Online] Available at: http://www.parliament.uk/business/publications/research/key-issues-for-the-new-parliament/economic-recovery/recovery-from-recession/ [Accessed March 26, 2014]. Wearden, G., 2009. Turner Review: The Key Recommendations. Guardian News and Media Limited. [Online] Available at: http://www.theguardian.com/business/2009/mar/18/banking-regulators [Accessed March 26, 2014]. Read More