How was the Tripartite Financial System Created in the United Kingdom and its Role in Credit Crunch - Essay Example

How Was the Tripartite Financial System Created In United Kingdom and its Role in Credit Crunch Table of Contents 0 Introduction 4 1 Background and Context 4 1.2 Scope of the Research 4 2.0 Research Statement, Aims and Objectives 5 3.0 Methodology 5 3.1 Research Philosophy 5 3.2 Research Approach 6 3.3 Research Strategy 6 3.4 Research Constraints 6 3.5 Data Collection 6 3.6 Ethical Considerations 7 4.0 Literature Review 8 Arrival of Tripartite System 8 Role of Tripartite Financial System in the Credit Crunch 11 5.0 Conclusion 12 6.0 References 14 1.0 Introduction Historically financial system has been playing a crucial role in the development and overall betterment of a particular country as well as of its economy. However it is very difficult to successfully maintain and regulate the financial system of an entire country for a long period of time. Over the years different countries have come out with different systems with the purpose of regulating their respective financial system. The significance of a financial system is again proved during the recent credit crisis when most of the developed countries like US and UK have realised that their financial systems are needed to be redesigned and restructured. In fact it is found that the credit crisis is actually the result of poor regulatory process of these countries’ financial systems. 1.1 Background and Context This research is all about the Tripartite Financial System which was developed in UK in 1997. Prior to the period of recent financial crisis, it was apparently seemed that the system is quite effective in maintaining the stability in the UK financial system. However once the credit crisis started the actual effectiveness of the tripartite system came out. 1.2 Scope of the Research This research is started with a proper plan. A specific research statement is developed. Aims and objectives of the research are then properly identified. Precise research strategy and philosophy have been followed throughout the research. Data are collected in the pre-defined ways. A well structured literature review includes the detailed description of the topic. Finally the research ends with a proper conclusion. 2.0 Research Statement, Aims and Objectives This research mainly focuses on the Tripartite Financial System and its role in the recent credit crunch in UK. The specific research statement is “how tripartite financial system was created in UK and its part in credit crunch”. The major aim and objective of this research is to identify all those processes and incidents that led to the formation of tripartite financial system. Furthermore the research also aims to find out the significance of this system in the recent credit crisis situation in United Kingdom. 3.0 Methodology 3.1 Research Philosophy Each and every research is based on certain philosophy. In fact researches can be categorized into different types according to their philosophy. There are mainly two philosophical paradigm – phenomenological and positivist. In the first type of research, world is considered as an external object. Furthermore he/she should be independent. Most importantly in this type of research focus should be on facts. Furthermore the researcher should also focus on fundamental laws. On the other hand in case of phenomenological paradigm focus should be on meanings (University of Pretoria. Research Philosophy). In this model researcher should look at every situation closely. He/she should try to understand exactly what is going on. As far as this research is concerned, it follows ‘phenomenological’ philosophy as the focus is mainly given on meanings and every situation is looked at closely. 3.2 Research Approach The approach of this research is inductive in nature as it starts with some specific aspect which then becomes a broad aspect. The research starts with tripartite system and gradually its focuses on the role of this system in the recent credit crunch. 3.3 Research Strategy There are several research strategies like empirical, explanatory, exploratory etc. Generally empirical researches are conducted in order to test something. In this type of research hypotheses are tested. However in case of exploratory research no earlier model is used. On the other hand in an explanatory research researcher goes deep into the topic of research. In such a research interviews are taken in order to gain insight of the subject. Finally predictive research is something where researcher predicts about the future occurrence of the similar situation. This research is exploratory in nature as no earlier model is been used. Moreover it does not predict anything about the future occurrence of the similar kind of situation. 3.4 Research Constraints The main constraint of this research is time. This research is conducted within a limited time period as the project has to be submitted within a specific time. In addition to that constraints were also there regarding data collection as collection of reliable and authentic data require significant amount of time and money. 3.5 Data Collection Data collection is one of the most important processes in case of any research work as the entire research report is prepared based on these data. Generally there are two types of data – primary and secondary. Primary data are mainly gathered by directly asking questions, taking interviews, and by visiting the spots. The research that involves this type of process of data collection is renowned as primary research. On the other hand secondary data are mainly gathered from sources like books, news paper articles, journals and from website contents. It is needless to say that the research that involves this type of data collection process is called secondary research. This research is a secondary research as the data that are collected are secondary in nature. Data are mainly collected from various secondary sources like publications of some institutions and news paper articles. Various books and journals are also thoroughly searched for finding out reliable and authentic data. Data are selected on the basis of their reliability, authenticity and relevance. Since it is not a primary research no questionnaire is formed and no interview is taken. Analysis of data is entirely qualitative in nature. 3.6 Ethical Considerations Ethics should be given proper importance in case of any research work. Especially in case of primary research if interviews are to be taken then the individuals who are to be interviewed are needed to be given prior notice. Since this research is a secondary research, ethics are only related to the use of data. This research contains no data which is unethically used. In other words data that are used in this research are freely available online with the due permission of the author. Information is properly cited. Each and every piece of information is strictly used for the purpose of this research. 4.0 Literature Review Arrival of Tripartite System In May 1997 a comprehensive monetary policy was announced by Gordon Brown who was the Chancellor of Exchequer of UK’s newly formed Labour Government. This policy was granted by the country’s central bank, Bank of England. After three weeks a structural reform took place in the regulation and supervision of the financial services. Such step reduced significance of Bank of England in the country’s financial system and it was then transferred into the Securities and Investments Board (SIB). Such structural reform gave SIB the authorities of controlling eight different regulatory and supervisory agencies in the country. Bank of England was one of them. Furthermore SIB was renamed as Financial Services Authority and it was made the sole financial regulator of Britain. Such unification of financial regulatory system was actually the result of much needed coordination among different regulators in the country. Moreover there are several other factors that motivated such unification. For instance there was no clear demarcation line between non-banking and banking institutions. Moreover there were several cases of supervisory duplications where financial institutions had to answer to multiple regulators. Furthermore due to presence of multiple regulators significant amount of resources for both industry and regulators were wasted (Blei, Sharon. The British Tripartite Financial Supervision System in the Face of the Northern Rock Run). The above mentioned step was mainly justified on the basis of the fact that Bank of England was under tremendous pressure as it had to maintain the balance between the banking supervision and requirements of monetary policy. Monetary policy instruments like discount window and interest rate affect both financial stability and price – yet they are in opposite directions. On the other side, an increase in interest rate may be required to deal with the inflation rate. There is possibility that such increase in interest rate might have adverse effect on the problematic debts, solvency of banking system and on the capital adequacy. In addition to these, banking supervision and monetary policy are found to be opposite in nature. As a result if one authority is assigned to deal with both the responsibilities then there might be conflicts of interests. Moreover it is also possible that one of the responsibilities will be comprised. However it is very important to remember that the interdependence of financial stability and price requires coordination and cooperation between banking supervisors and monetary policy makers. Moreover information sharing is also important. Hence assigning the responsibilities of handling both banking supervision and monetary policy to two different authorities might affect the achievement of supervisory and macroeconomic objectives. There was another fact that was in favour of the amalgamation of financial regulation in the country. Bank of England being the central bank of the country was responsible for regulating and supervising the whole financial system in UK. In addition to these responsibilities if it was allowed to conduct the monetary policy of the country then it would have been considered itself as an extremely powerful institution (Blei, Sharon. The British Tripartite Financial Supervision System in the Face of the Northern Rock Run). In 1997 a MOU (Memorandum of Understanding) was signed between the FSA (Financial Services Authority), the bank and the treasury. This Memorandum of Understanding made the framework for the much needed cooperation among the three major authorities in the country’s financial system. Based on this MOU responsibilities were assigned to each party. Moreover ways of information sharing were also determined on the basis of this Memorandum of Understanding. The most important fact is that this MOU was an attempt of eliminating the potential difficulties in the cooperation and coordination among the different financial institutions. There are four fundamental aspects of this MOU. These are transparency, clear accountability, regular flow of information and ‘no duplication’. In order to make sure the cooperation and coordination between the Bank of England and the FSA there has to be a Deputy Governor in the Bank of England. This Deputy Governor is likely to be responsible for financial stability. This person is also required to be made the director of Financial Services Authority. The FSA chairman is required to be a member of Bank of England Court (Blei, Sharon. The British Tripartite Financial Supervision System in the Face of the Northern Rock Run). A Tripartite Standing Committee is formed as per the Memorandum of Understanding in order to deal with the financial stability. This committee is made of the Governor of BoE, the Chancellor of Exchequer and the Chairman of FSA. The committee meets up circumstantially in order to review and address the potential micro and macro economic threats to the financial stability. A framework was developed by the standing committee for enhancing the coordination among the three authorities regarding various financial contingencies such as gathering of information, evaluation of situation, effective decision making, taking actions, monitoring and dissemination. According to the MOU, in case of any exceptional circumstances final responsibility for authorisation lies on the Chancellor of Exchequer (Blei, Sharon. The British Tripartite Financial Supervision System in the Face of the Northern Rock Run). In the current system of tripartite Bank of England is mainly responsible for looking after the money markets. On the other hand FSA is responsible for supervising individual banks. It is also responsible for looking after the interests of the consumers. Finally the treasury is responsible for providing the public money and setting up the regulatory structures (Anonymous. Q&A: UK banking regulation). [Source: BBC] The above discussion is basically a brief overview of the arrival of the Tripartite Financial System. Role of Tripartite Financial System in the Credit Crunch The actual effectiveness of the Tripartite Financial System is actually found out in the recent credit crisis. One of the major objectives of the Tripartite Financial System is to maintain financial stability especially at the time of credit crisis. However it is found that the system has failed to maintain the financial stability in UK. In fact according to a report of Telegraph The House of Lords Economic Affairs Committee stated that Tripartite system “was unable to fulfil one of its main purposes” which is ensuring financial stability at the time of crisis (Armitstead, Louise & Edmund, Conway. Lords say tripartite system of financial regulation is a failure). It is found that Lords report regarding banking regulation and supervision concludes that the main powers should be given back to the central bank of the country – Bank of England (Armitstead, Louise & Edmund, Conway. Lords say tripartite system of financial regulation is a failure). In the crisis situations like the recent one FSA is supposed to identify the bank which is likely to fail. Bank of England is then supposed to take decisions regarding the required actions that should be taken. BoE can take actions like ‘transferring its assets’ and establishing a temporary bridge bank. Treasury is supposed to take the decision regarding the use of public funds (Anonymous. Q&A: UK banking regulation). After the recent credit crunch several reports have been published by several committees and most of them have blamed the present tripartite system. It has been said in various reports that this system has made the situation worse. Moreover actions taken by Bank of England and the FSA are also criticised in these reports. Report of The House of Lords Economic Affairs Committee said that the problem in this system was that there was no clear instruction regarding who should take decision in a crisis situation. The House of Commons Treasury Committee said that there was lack of communication among the authorities. Moreover the committee also said that FSA has mainly failed in handling the situation properly. Both The Conservative Party and The House of Lords Economic Affairs Committee believes that bank of England should be given more power (Anonymous. Q&A: UK banking regulation). 5.0 Conclusion Tripartite financial system was developed with the objective of strengthening the financial system of UK. It was also aimed at maintaining the stability of the financial system in the country. The system includes three most important financial institutions of UK – treasury, Bank of England and FSA (Financial Services Authority). Main purpose of developing such a system was improving coordination among the three main regulators by proper sharing of information. However the recent credit crisis has shown the actual reality. Analysis of this crisis reveals that the tripartite system has failed in tackling the crisis. Most importantly there was communication gap among the three crucial authorities. It is observed that some of the special committee has suggested that the system needs to be redesigned. 6.0 References Armitstead, Louise & Edmund, Conway. Lords say tripartite system of financial regulation is a failure. June 02, 2009. Telegraph. June 02, 2010. < http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/5424014/Lords-say-tripartite-system-of-financial-regulation-is-a-failure.html> Anonymous. Q&A: UK banking regulation. June 18, 2009. BBC News. June 02, 2010. Blei, Sharon. The British Tripartite Financial Supervision System in the Face of the Northern Rock Run. 2008. Federal Reserve Bank of St. Louis. June 02, 2010 < http://www.stlouisfed.org/banking/pdf/SPA/SPA_2008_01.pdf> University of Pretoria. Research Philosophy. No Date, Research methodology. June 02, 2010 Read More