Deregulated Banking Industry in the UK - Case Study Example

Name: Task: Instructor: Date: Deregulated Banking Industry in the UK Introduction Britain has had a crisis with regard to its big debt that has threatened to lead the economy to a double dip recession. A number of economic experts have claimed that the deregulated banking industry is responsible for the current economic downturn in the UK. The debt problem which has affected the country has close links with the banking sector due to the policies in the industry that affects how the country borrows money from foreign governments. As at last year, the United Kingdom was faced by the worst budget deficit among the European Union (EU) countries, this was because that value was in excess of 10% of its GDP. A figure that was high, for the British Government was said to have spent more than rose from its revenue at estimated 146 billion pounds. While the Government tries to reduce the amounts of money overspent, the debt has kept on increasing with the deregulated bank industry being blamed for the economic crisis that has befell UK. The UK owed £967bn in October, 2010, a figure that was up from £837bn debt recorded the previous year earlier. This even is made worse by the predictions that the figure will hit £1 trillion in 2012/13 fiscal year. I agree to the suggestion that the deregulated UK banking industry has significantly contributed to its current economic crisis (Sharma, 43). a. Historical background of the UKs deregulated banking industry The case of the deregulation of the banking industry in the UK is not a new concept for it first may be dated back to 1987, after the banks and the building societies were engaged in competition with each other with regard to provision of financial services. Many of the building societies that were in UK were converted into banks owned by shareholders (the societies included Halifax & Abbey National). The mergers led the long established banks to benefit from the customer base, services, as well as specialized programs that were provided by the former building societies. The demutualized insurance companies were additionally bought by the large existent banks in the UK though they retained their identity (Shull & Hanweck 54). This happened after the banking regulation rule of the 1930s were reversed, and the changes that happened in the industry as mentioned above were effected after the removal of regulations governing the banking system in the UK (Banking industry deregulation). Deregulation of the banking industry resulted into the financial companies taking over the small companies, increase mergers and take over’s among banks, building societies, and insurance firms. The big banks in the United Kingdom went on to buy the small banks. This turned the financial institutions in the United Kingdom to perform multiple roles which covered the areas of investing, housing mortgages, insurance, private banking, and offering deposit services among others. At this time, many of the people also rushed for credit services, with a number of people taking mortgages, this affected the lending rates due to the increased demand from the financial institutions which offered more than one financial service at around the year 2007. Actually, this led to the start to the economic crisis in UK which was characterized by the house prices going up, leading to the problem of repaying the subprime mortgages. Companies such as the Northern Rock faced a continued downfall around September 2007and was nationalized in February 2008. This period was also characterized by economic crisis of the consumers who felt the burden of the prize squeeze. The prices for the commodities rose rapidly in 2007. This situation was made worse by the increased demand from India and China, which made the prices for food, and petrol to rise. The surging inflation that befell UKs economy prevented the central bank from cutting down the interest rates in a bid to ease the credit crunch. There was fear in the UK economy, after Bear Steams collapsed in March, 2008, however severe crisis began when Lehman Brothers collapsed. This was followed by a merger between Lloyds and HBOS. The UK base rate also was affected after being slashed. Regardless of these measures, and bank bailout II which happened in January 2009 the impact of recession in UK became inevitable. UK Banking deregulation may be said to be a complex issue that brings forth a cut point between the impacts of government involvement and that of UKs government interference. Impact of the deregulated banking industry of UK to the current economic downturn in the United Kingdom The financial crisis in the United Kingdom comes as a result of the accumulation of debts, which was brought about by the growing recognition of the bad debts in the UK financial system not to be as much amplified as the case was. The financial crisis in the United Kingdom had a number of impacts to its economy. This came as a result of the UK overreliance on the banking industry which had been deregulated. The deregulated banking industry in the United Kingdom played a role to the economic downturn in the following ways: a. Employment Crisis Deregulation of the banking industry which led to increased mergers and take-over’s in the financial institutions led to loss of so many jobs, which increased the problem of unemployment in the United Kingdom. The many small financial institutions which were bought by the big banks and financial institutions made many people to lose jobs. The increased amounts of the debt deficits that shot because of the increased Government borrowing to deal with the inflation of prices also increased unemployment because of increased Government obligations. It is projected that unemployment will shoot up in the United Kingdom, and this will create a weak demand for the exports and this consequently would harm the economy. b. GDP Increased national debt in the UK has been a major area of concern. The Government obligation to repay its loans has affected the country’s GDP. This is because the Government has been obligated to increase its taxes on the people so that it can boost its revenue and thus have the capacity to pay back the debts. Reduced UKs GDP has very significant impacts on the UK economic stability since, in the case where the GDP has reduced the country’s economic stability is threatened. Often the Government taxes would rise to boost the GDP and this rise would affect the economy of UK. c. Other economic impact The other economic impact of the UK deregulated banking industry is the impact that it has on the companies and the state, where the actions that the big financial institutions to buy or merge the small companies leads to companies being locked in dilemma, with regard to the strategies that they are to embrace to straighten their finances. It just implies that the companies will pay down debts, and this means that the economy would be strained in the short-term. The crisis that had befallen the economy led the Bank of England to go back and print money in October, 2011. This was through the quantitative easing programme which led 200 billion to be created in 2009/10, and a further 75 billion is being deployed to increase lending. The increased lending affects the national balance of payment, because increased lending will destabilize the BOP, for more resources would be required to fix up the balances. OECD forecast that UK may fall back to recession if the Government doesn’t come up with regulatory measures to deal with the issue of deregulation of its banking industry. The decline in manufacturing, as well as the rise in services greatly affected the economy (Roussakis 44). Causes of banking crisis in UK A number of suggestions have been fronted in a bid to explain what really caused the economic crisis in the United Kingdom. UKs Recession began in 2008 and ended in the summer of 2009, though the country has continued to experience economic crisis. The banking crisis was said to have began due to the following reasons: Lack of tough control measures by the UK Government to the banking Industry. The Government in a bid to avoid interference with the economy which is considered an open economy, made it to avoid taking tough measures on the banking industry. A number of players in the banking industry are said to have taken advantage of this loophole. This were particularly the big banks which went on to buy small financial institutions, and this is said to have led to a crisis. A spill of the global recession. The global recession which had already caught up with big economies such as the United States which is among the huge lenders of UK alongside other countries in the Europe, also spilled its impact to UKs economy. This really affected particularly the banking industry whose lending rates were affected by the increase in the prices of houses, making it difficult for people to pay back their mortgages. Increased Government borrowing from foreign countries. This through may have come as a consequence of the downturn that the economy had began facing; it may be said to have significantly contributed towards the crisis in the banking industry, for the increased Government debt deficit had implications on the amount of money that the Government was willing to lend to the commercial banks in UK, consequently this contributed to the crisis through pushing up the interest rates for the bank loans and the mortgages. Effect of banking crisis on UK economy The banking crisis significantly affected the UK economy. This is because the UK economy just like other economies is heavily dependent on the economic activities that are dictated by the money flow within the economy. In the UK, the banking crisis affected diverse economic sectors, and players even as efforts were made by both the Government, and the private sector to reverse the crisis. The crisis was severe since it affected the prices of commodities, the demand for the exports, the lending interest rates, the country’s GDP, as well as it led to a number of business closures, as well as mergers and closures of large financial institutions. The banking crisis in the UK had the following effects: a. Stock markets UKs stock market was significantly affected by the banking crisis, after the lending interests of banks went up making many of the lenders at the time to have problems in repaying bank the loans, and mortgages. Most of the individuals who had taken mortgages from the building societies also were affected, after the societies were merged with the large banks, and the crisis led to a problem in meeting the obligation of paying the loans. The economic strain led an increased number of people to sell their shares. On the contrary, there was speculation of the collapse of a number of financial institutions, and this led to potential investors to shun from purchasing the shares, and this affected the stock market significantly. b. Bank shares The bank shares were also affected by the crisis due to the strained revenues that the financial institutions raised at the period of the crisis. The Government also in a bid to minimize over dependence of the foreign reserves, had to borrow money internally and this affected the productivity of the banks. Many of the share holders of small banks pulled their shares off, and this led to bank shares reducing. A number of large banks bought shares from the small banks, ultimately buying them off. c. Inflation This was one of the impacts that was explicit due to the banking crisis. This was for the reason of the large banks being faced with pressure by the increased prices of houses to increase their interest rates, as well as lending rates. The consequence of this action was that inflation rose in the country. The prices of commodities in the country also shot up significantly due to the increased demand of the exports. Increased lending rates lowered the supply of the British pounds in the market, and this led to increased commodity prices in the market. This was one of the factors that characterized the banking crisis. Scarcity of money and controlled money flow that was a consequence of the increased lending rate, as well as the Governments increased fiscal regulation through increased taxes led to inflation. d. Interest Rates & Borrowing The banking crisis also significantly affected the interest rates and the borrowing ability of many of the people in the UK. This is because at this time, many of the large financial institutions due to deregulation of the banking industry had bought the small financial institutions, and had an umbrella of services they offered which included mortgages, insurance, loans and others which made them to have oligopolistic tendencies with regard to making their decisions on the interest rates for the loans and mortgages. The fact that the prices of the houses had shot up, had implications on the interest rates for the mortgages that were being paid (Bie 34). The lending rates also increased after the mergers of the bigger financial institutions such as that of Lloyds-HBOS. This is because these mergers reduced the competition between the financial institutions with regard to the lending rates that they offered to the lenders. The consequence of this was increased dependence on a smaller number of large financial institutions which led them to increase their lending rates. e. Taxation Effect The Government’s response to the banking crisis was aimed at curbing the situation since the crisis was already being faced by the economy. The Government of the United Kingdom opted to employ its fiscal policies to deal with the challenge. At the period of the banking crisis, the Government had to tackle two great challenges working out the measures to control the excavated interest rates, as well as work out a strategy to deal with the increased foreign debt deficit that had affected its operation. The Government in United Kingdom opted to also employ tax strategy to deal with the crisis. The first step that was taken was to increase taxes so as to boost its revenue, in a bid to offset the huge debt that they had taken over time. The second measure they took was to seek alternative sources of money through the internal large financial institutions. This had a counter impact on the lenders, for the banks remained with limited reserves of money for lending. Policy on Reducing Budget Deficit; the best policy on reducing budget deficit is the interest rate policy. This is because unlike the Keynesian and quantitative policies, the interest policy has a long terms benefit to the economy, in addition to being an internal solution that doesn’t depend on the foreign policy. A high budget deficit such as the case is with UK, requires a local solution, where the central bank may lower its lending rates, thus increasing money supply and thus increased economic investment, which boosts a Government revenue, which may be used to offset the budget deficit. In the United Kingdom, the economic policies which could be used to avoid a double dip recession may include: Controlling Government lending. When Government borrowing is under check, then a double dip recession may be avoided. Countries such as Japan have fairly had stable economies for they borrow money from within the economy (among savers). Firmly regulating the banking industry, so as the large banks do not act as monopolies, influencing the lending rates. Similar economic crisis have been experienced in the European countries with regard to Euro and Euro zone. This has affected countries including but not limited to Germany, Greece, Italy etc . Financial crisis deepened in Rome after Italy succumbed to a huge debt deficit, and needed a bail out. The problem in Italy came as a result of the investors shunned away from investing in the economy which led to Italy’s borrowing costs escalated to a level that required it to seek bailout from other euro zone countries. Greek also succumbed to he economic crisis after borrowing euros from foreign investors, and well established European lenders such as Société Générale, Deutsche Bank, etc. which willingly accepted to lend money to Greece though at high rates, in parallel to its budget deficits, the country’s economy succumbed to deep imbalance. Conclusion All in all, deregulation of the banking industry significantly contributed to the economic crisis in the United Kingdom. This is because it gave an opportunity for large banks to buy small financial institutions, this increased dependency on the few banking institutions, which increased their interest rates. When this factor is combined with the spilling effect of the global recession in UKs economy led to a big economic and baking crisis in the country. This can be reversed when proper measures are taken by both the Government and the financial institutions. The banking crisis spilled to be an national economic crisis since, the economy is run through the flow of money from these institutions. References Bie, V. Effects of deregulation on safety. London: Springer, 2003. Print. Roussakis, E. Commercial banking in an era of deregulation. London: Greenwood Publishing Group, 1997. Print. Sharma, S. Management Of Financial Institutions: With Emphasis On Bank And Risk Management. London: PHI Learning Pvt. Ltd.2010. Print. Shull, Hanweck Bank mergers in a deregulated environment: promise and peril. New York: Greenwood Publishing Group, 2001. Print. Read More