Specific Events and Aspects of the Banking Crisis - Essay Example

What specific events and aspects of the banking crisis demonstrate that a successful strategy for a few can be an unsuccessful strategy for the many?Give specific examples of such a strategy from the banking sector The banking sector has undergone a revamp with rescue funds from the government and new guidelines for operation. There was an increase in optimism in the financial service sector at the close of the year 2009 with lesser possibility for fresh crisis in the banking industry. The optimism is despite the fact that several financial institution reported lesser business than normal. The banking business is comparatively less enthusiastic than investment and insurance management because they do not envisage a sustained growth and are not lending adequately to medium and small business. The reason for poor lending may be due to lesser demand for credit owing to recession or the relunctance of banks to offer loans. The decline in borrowing is a risk since the recovery of the economy would require more credit for the revival of businesses (Pimlott, D. 2010). The intervention of government through the injection of rescue funds has enabled banks to rebuild their capital and insure from further bad debts. The government has served guidelines to increase the accessibility of banks to liquid assets that is equivalent to cash to face potential credit deficits and to reduce the risks while dealing with shareholder’s money. But the cost of increasing liquidity and capital is not mentioned by the government while it urges banks to increase lending. The injection of rescue funds is a temporary ease for bank to recapitalize. The extent of lending is still facing trouble because major funds were sourced from international money market which now continues to be largely closed. The current option for banks is to use saver’s deposit for lending. Therefore if Barclay’s bank lends more funds, the Royal Bank of Scotland has to cut back if it does not get additional funds from the taxpayer. Inherently, lending to wealthy home owners or blue chip companies is a risky business for banks because it requires lots of funds and additional liquidity (Inman, P 2009). The government’s decision to rescue the banks that suffered huge losses in the market received mixed response. The slide of RBS by 40 percent in the market showed signs of serious danger. Banking stocks suffered huge losses while it was already paralysed with the credit crunch. RBS had a deficit of about £30 billion which was run on by enterprises that had huge deposits with the bank. Though the rescue plan sounded well for Standard Chartered Bank and Lloyds Banks, RBS was not interested to use the funds offered through rescue plan because it would not suffice to tide over the existing debt which was due to non-liquidity and not due to non availability of capital. The package offered to the bank was a combination of capital injections, government guaranteed funding and the extension of prevailing liquidity scheme. Such a rescue plan was designed to calm the markets initially. The banks that benefited (at least in the short run) were HBOS and Lloyds (together) and RBS (Griffiths, K 2009). The injection of funds and associated guideline was particularly unsuccessful in the case of RBS because it was forced by the European Union to restructure the business in return for availing state aid. It was rather mandatory for Stephen Hester, the Chief Executive of RBS to redraw the business plan of the bank to deal with a higher level of competition in the banking sector. The use of tax payers funds further made it obligatory for RBS to sell around 312 of its branches while Lloyds Banks had to sell only a part of its branch offices ( Treanor, J. 2009). With the injection of funds into RBS and Lloyds Bank, the government had a stake on the banks as well as its operations. The rescue plan imposed curbs on the banks from paying cash bonuses to staff earning more than £39,000 in the financial year 2009 and the board members had to defer bonuses until 2012. Lloyds Banks is exiting the Asset Protection Scheme of the government and set up a debt swap to raise over £21bn. RBS is in more trouble because it has no other option but to use insurance schemes for its £282bn toxic loans thus increasing the taxpayers stake from 70 to 84 percent through the injection of £25.5bn and a reserve of £8bn for future credit risks (Treanor, J. & Teather, D. 2009). The poor performance of banking shares even after the bail out was due to a general caution that banking shares could be purchased only after it makes up its losses during the financial crisis and have attained a stable state of liquidity. The relatively lower profitability from banking shares was another reason for the poor growth of banking shares (UK economy likely to be downgraded 2010). However, the upsurge of global market has enabled banks to raise capital and prevent further crisis in the banking sector. UniCredit of Italy and BNP Paribas of France are optimistic about raising billions of new funds. The International Monetary Fund has noted that Western European banks have been able to recover from worsening credit conditions. Further, it is noted by the European Union that 22 major banks that control large portions of the regions assets have overcome the stress level and can continue to raise capital even if the region does not register a modest economic growth (Barr, C. 2009).TWITTER Yahoo! Buzz DIGG FACEBOOK DEL.ICIO.US REDDIT STUMBLE UPON MYSPACE MIXX IT Subscribe to Economy feed://rss.cnn.com/rss/money_news_economy.rss Paste this link into your favorite RSS desktop reader See all CNNMoney.com RSS FEEDS (close) Citigroup grew enormously with the great moderation following the rules laid by the Federal Reserve that permitted banks to speculate beyond their actual capacity. During the credit crunch the Citigroup ran short of credit to cover the losing speculations. The core problem was the non availability of capital that is usually saved as reserves to meet unexpected losses. Securitization was a technique used to tide over the credit deficit caused by the non-repayment of loans. The bank gathered money by creating pools of loans but this method also led banks to pledge to meet the losses for default in repayment (Appelbaum, B. & Cho, D. 2009). The credit crunch in the US economy brought down almost all financial institutions. The returns from bank’s equity shares are reviving at a far lesser rate when compared to the returns during the housing boom. Goldman Sachs had earned a 38 percent returns in 2007 while the current return on equity is likely to be halved compared to its returns in 2007 though the bank is expected to register the second highest profit in its history. Banks are likely to sustain healthy profits if central banks maintain low interest rates and inject liquidity into the market. The present mantra for a steady growth of the bank is based on four factors that include competition, regulation, economic growth and financing costs (Larsen, P.T. 2010). It may be concluded that the bailout of banks has had different impacts on its operational ability. While several banks have regained their ability to show improvements in terms of growth and returns and are ready to pay bonuses, certain banks are held up in debts requiring more financial assistance from the government that increases the stake of the tax payer. The increase in government stake obstructs the free commercial functionality of the banks. RBS is in a position where it can service only as a National Social Investment Bank that lends liberally for the general improvement of the economy by increasing credit and spending by following the norms of the Treasury (Leading article 2009). This shows that all banks have not successfully benefitted by the rescue plan though they could avoid a double dip recession. Reference Appelbaum, B. & Cho, D. December 21, 2009 Feds approach to regulation left banks exposed to crisis Available: http://www.washingtonpost.com/wp-dyn/content/article/2009/12/20/AR2009122002580_2.html?sid=ST2009122002648. Accessed on January 12, 2010 Barr, C. (October 2, 2009) Europes banks back from brink for now Available: http://money.cnn.com/2009/10/02/news/economy/banks.europe.fortune/index.htm. Accessed on January 12, 2010 Griffiths, K.(October 10, 2009) Britains banking crisis: how it happened Available: http://business.timesonline.co.uk/tol/business/industry_sectors/banking_and_finance/article6868827.ece. Accessed on January 12, 2010 Inman, P. (November 2, 2009) Whats happening to the banks and why Available: http://www.guardian.co.uk/business/2009/nov/02/banking-rescue-plan-eu-ruling. Accessed on January 12, 2010 Larsen, P.T. (January 4, 2010) What’s Acceptable for Bank Returns? Available: http://www.nytimes.com/2010/01/05/business/05views.html. Accessed on January 12, 2010 Leading article: The Government cannot have it both ways with the banks (December 4, 2009) Available: http://www.independent.co.uk/opinion/leading-articles/leading-article-the-government-cannot-have-it-both-ways-with-the-banks-1833729.html. Accessed on January 12, 2010 Pimlott, D. (January 11 2010) Brighter outlook for financial services as crisis fears recede Available: http://www.ft.com/cms/s/0/06f68f24-fe52-11de-9340-00144feab49a.html?nclick_check=1. Accessed on January 12, 2010 Treanor, J. November 2, 2009 RBS axes 3,700 jobs as taxpayer stake hits 84% Available: http://www.guardian.co.uk/business/2009/nov/02/rbs-slash-costs-cuts-jobs. Accessed on January 12, 2010 Treanor, J. & Teather, D. (November 3, 2009) A £39bn handout – and the great British banking sell-off begins Available: http://www.guardian.co.uk/business/2009/nov/03/banking-bailout-rbs-lloyds-darling. Accessed on January 12, 2010 UK economy likely to be downgraded, warns Invescos Neil Woodford (January 8, 2010) Available: http://www.telegraph.co.uk/finance/financetopics/financialcrisis/6952105/UK-economy-likely-to-be-downgraded-warns-Invescos-Neil-Woodford.html. Accessed on January 12, 2010 Read More