Current Business Issues - Bank Regulations

LB5214 Current Business Issues

JCUS, Study Period 51, 2013

Banks must be controlled strictly because they are inefficient

Lecturer: Dr. John Vong

Tutor: Dr Alan Ang

Pranav Seth - 12814308

Table of Contents

Executive Summary 3

Introduction & Scope 4

Background 4

Issues, Problems & Discussion 5

Bindingness 6

Effectiveness 7

Recommendations 8

Retail Ring-Fencing 8

Volcker Rule 9

Conclusion 10

References 11

Executive Summary

It is very clear from the recent financial crisis and bank failures that the banks and financial institutions are quite inefficient in governing themselves and the devastating economic and financial crisis of the past years will have substantial lasting consequences for financial markets and institutions.

The preservation of financial stability not only depends on the correction of the imperfections of the financial regulations, but also depends critically on the maintenance of a sound and sustainable macroeconomic policy stance (Chowdhury, 2012)

Entrepreneurs' performance represents the driving factor behind investment banking, and they share the profits, but not the losses. Bankers save bonuses while losses accumulate, inducing a financial crisis for whom nobody can be held responsible. Unfortunately, the claim back resolution is not a recovery solution (Taleb, 2009)

The current banking crisis is very similar to past crises, as it started when the lending process was too superficial and did not provide any coverage. The significant difference is that the problem began in one of the most secure markets and it spread quickly all over the world. (SORANA VĂTAVU, 2012)

Form the opinions of the above authors it's very evident that there is much inefficiency in the banking system ranging from the leverage management to lending practices.

The financial crisis the always been painful to the economic system form the British credit Crisis in 1722 to the dot-com bubble in 2001 or the Subprime crisis in 2008, the financial crisis caused economic recessions, unemployment, reduced consumer confidence, however none of these crisis have done as much damage as major bank failures, the fall of Lehman Brothers caused entire countries to come to their knees.

Introduction & Scope

Many major crises were like the Great Depression of 1930 and current financial crisis 2007 till now, have been caused by major bank failures and have created insatiability in global economies.

The Current financial crisis more commonly known as the "banking crisis" has had worldwide implication and no country has been left untouched by it, all word economies have been affected by the Banking crisis in one way or another.

The Basel Committee on Banking Supervision developed some rules in 1988(Basel Accord), they established the rules for maintaining minimum capital that a bank should keep to ensure stability, however the current crisis highlights deficiencies of the Basel Accord.

In this paper I will try to deal with the general effectiveness of global financial regulation and will try to answer the question of whether current global banking regulation will mitigate another banking crisis.

Background

The price of risk is most of the time poorly set when regulators rely too much on a rules-based, Basel II-type, micro-prudential approach. Regulatory attempts to prevent bank failures by defining the amount of capital required for covering risk are regrettably but constantly arbitraged by financial institutions. In this respect, the current strategy of increasing the discretionary price of risk through higher capital requirements (irrespective of the level of systemic risk) is theoretically desirable but falls into many practical pitfalls.(Petitjean, 2013)

On the one hand, a regulation-free banking system is certainly not an option. On the other hand, whilst preventive measures such as the micro-prudential rules aimed at lowering the probability of bank failure are probably unavoidable as part of an overall regulatory regime, they face strong limitations as a large part of banks' business is devoted to exploiting arbitrage opportunities and loopholes created by regulatory innovations(Petitjean, 2013)

Steps taken are not sufficient to fix the underlying problems. The global turmoil that was caused by financial institutions was later followed by the fiscal stimulus program to limit the spill-over effect of the bank crisis. Banks are now seemed to be at the receiving end. Governments are now spending a large amount of public money to rescue the banks(Chowdhury, 2012)

As we can see form the opinions of the various authors above there is still a lot of ambiguity in the regulations that are in place and this poses potential risk which could lead to another major crisis from which the world may not be able to recover.

The current rules do not necessarily ensure efficiency and can be easily manipulated, and are not necessarily prudent in avoiding risky investment by banks.

Issues, Problems & Discussion

The 2008 global financial crisis commonly known as the "banking crisis" because the main cause was the crisis was filature of many banking and financial institutions.

A bank fails when it is unable to pay its creditors and depositors because it is unable to generate enough cash, even from the sale of its assets. A banks main source of income is generated by lending money and collecting interest on it.

However the real estate boom form 2000 to 2007 saw ever increasing property prices & high demand form retail as well as institutional buyers, this increased the greed of banks and motivated by high profits they lent out large amounts of money to subprime borrowers and had exorbitant leverage.

When the housing market crashed these loans became worthless, and naturally depositors now fearing loss wanted their money back. The depositors claim caused the banks to file bankruptcy as their large loan positions were not supported by the cash in their balance sheets.

Therefore