Bank structure and regulation in the uk.


Part 1

Bank structure and Regulation in the uk.

The uk's banking system falls into the “restricted universal” category because banks are discouraged from owning commercial concerns. It is made up of: commercial banks consisting of the “big bang” uk banks, HSBC (Hong Kong & Shanghai Banking Corporation), the Royal Bank of Scotland group, HBOS (Halifax Bank of Scotland) and Barclays, with tier 1 capital in 2005 ranging from $35 billion (HSBC) to $19 billion (Barclays) and the group together with about a dozen or so other major banks including Lloyds-TSB ($ 2.5 billion), abbey national, standard chartered and Alliance and Leicester ($ 2.5 billion). The big four, and some of the other banks, engage in retail, wholesale and investment banking, and some have insurance subsidiaries. By the turn of the century, many of the traditional English merchant had been bought by foreign concerns, beginning with Deutsche's purchase of Morgan Grenfell bank in 1988. Kleinwort Benson was bought by Dresdner, and the Warburgs by the union bank of Switzerland. Barings having collapsed in 1995 was bought by ING, but Later closed.

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Some building societies converted to banks following the building societies Act,

1986. Effective January 1987, the Act allowed building societies to convert to bank plc status, to be supervised by bank of England and protected from hostile takeover for five years. Most of the top ten (by the size) building societies in 1986 had, by the new century, given up their mutual status. The early conversions were Abbey National (1989), Bristol and west, Cheltenham and Gloucester (1992; a subsidiary of Lloyds TSB). Building societies that converted between 1995-7 were the Halifax (after a merger with Leeds BS), Alliance & Leicester, Northern Rock and Woolwich (taken over by Barclays in 2000). Birmingham Midshires was purchased by the Halifax in 1999; Bradford & Bingly converted in 2000.

Building societies have a long history in British retail finance. Member of the a society paid subscriptions, and once there was enough funding, a selection procedure determined the member who would receive funds for house purchase or building. In 1945 permanent societies began to form, members kept a share a (deposit) account at a society and could, after period of time, expect to be granted a mortgage. Over time, depositor and mortgages were not necessarily from the same group.

As mutual organisation, every customer (depositor or borrower) has a share in the society, with the right to vote on key managerial change. Each vote carries

the same weight, independent of the size of deposit mortgage or loan.

In 1984, an informal but effective cartel linking the building societies dissolved after Abbey National broke ranks,(2008 Abbey bank merger with European bank Santander) .by the time , many of the large societies viewed the “big four” and other banks as their main competitor. The building societies Act (1986) took effect in January 1987, and allowed building societies to offer a full range of retail banking services typical of a bank. The Act specified the financial activities a building society could undertake, namely:

  1. offering a money transmission service through cheque books and credit cards.
  2. personal loans, unsecured.
  3. foreign currency exchange.
  4. investment management and advice.
  5. stock broking.
  6. provision and underwriting of insurance,
  7. expansion into other Eu states.
  8. real estate services.

However, there important restrictions: 90% of the building society's asset had to be resident mortgage, and wholesale money plus deposit could not exceed 20% of liabilities, subsequently raised to 40% then 50%.

In 1986 act also gave these organisations the option of converting to bank status and as a results, the number of building societies fell dramatically as table1.1 shows

Table 1.1 Number of banks and building societies 1985-2005


Years Authorised uk incorporated MBBG building institutions members societies


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1985 21

1986 23

1987 23

1988 22

1989 21

1990 19

1991 18















The investment banking industry is dominated by major us and European banks including Goldman sachs, Morgen Stenly, Lehman Brothers, Merrill Lynch, uBS, Deutsche bank and credit Suisse. In additions the main uk banks also have investment banking subsidiaries (e.g. Barclays Capital). There are few independent uk merchant banks as most have been acquired by overseas investment and commercial banks.

Recent Changes in Retail banking structure.

To operate in the retail markets, bank have traditionally required an extensive branch network. However, technological developments in particular the growth in automated teller machine (ATM) networks, telephone/internet banking, mobile phones and interactive digital television have enabled a new type of bank to emerge that does not need branches to conduct business. In uk the pioneer was First Direct, which began as a telephone bank in 1989 and is an operation of HSBC, one of the large clearing banks. By 2002 First Direct had around 1 million customer and offered a full range of retail bank services, from cheque accounts to personal loans. Over half of the customers First Direct regularly use internet to access their account. Most of the other established banks in the uk have followed the lead of HSBC and started up a remote banking service that allows customers to access their account using the telephone, internet or mobile phone. The british Bankers' association (2002) reported that, in 2001, one third of all bank accounts were accessed through the telephone or internet. Of these remote transactions, it is the internet that now dominates, accounting for 167 million transaction in 2001 compared with 127 million telephone transactions. In late 1980s numbers of branch declined because of technology innovation. the introduction of ATMs (at the branch and remote location grew significantly. there was also a substantial growth in electronic funds transfer at point of sale (EFTPOS) terminals from 4,640 in 1993 to 8,984 in 1997 further reflecting the trend to supplement tradition with new distribution channels. These terminals are placed in retail stores, shopping centres , petrol stations and so on.

That process credit and debit cards payments. The number of such terminals is believed to have exceed 11000 by 2004. Some of the banks proved pay-in machines out side the banks branches for 24/7. The reason for shifts from branches to other means of financial service firms desire to improve operating efficiency as well as customers increasing demands to access banking services outside traditional hours.

As the banks and building societies branches fall rapidly the unemployment increased. The fall in staff employed is particularly noticeable for retail banks (it fell by round 75,000 between 1990 and 1996), although retail bank employment increased from then onwards by over 45,000 to reach just over 346000 by the of 2004. But from early 2008 to 2009 many branches closed because of recession (banking crisis), and by 2010 RBS plc will closed 300 more branches, in results 3,500 bank staff will become jobless. The increased in employment after 1996 is imputable to building societies conversion to bank plc. In addition there has been a substantial increase in employment by foreign banks since 1996 up to 2001 reflecting the booming capital markets activity of foreign owned investment banks in London.

The graph shows that all the main banks have maintained relatively stable staff levels in recent years. It should noted that RBS acquired NatWest in 2000, large decline in NatWest is mirror by the increased at Royal Bank of Scotland. In 2004 330,700 staff were employed by Major Bank British Groups. Interesting to note that 63 per cent were female, of whom 76,300 were employed as part time worker. Throughout the 1995 there has been a gradual increase in the number of part time employed in the banking sector mainly in retail banking sector. Again the general decline in total employment in the banking sector and the increase in part time employment, are indicators of the banks desire to improve their operating efficiently.

Recent development in the uk financial system.

There has been a tremendous change in the uk financial system since the early 1980s. The change that have been taken place can be analysed in a systematic way. This analyse adapted from Llewellyn (19985, 1991), provides a framework for assessing and interpreting the more specific discussion of event in financial market.

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Some of the main force leading to the modification of any financial system are.

  1. Change in the market environment.
  2. Change in the portfolio preferences of user of financial intermediation services.
  3. Change in the preference of and constraints on the providers of financial intermediation services.

The interaction of these forces produces financial innovation, which is essentially the development of new financial instruments and techniques of financial intermediation, and structural change in the financial system with appearance of new financial markets and change in the organisation and behaviour of institutions.

Over the postwar period up to the end of the 1960s the uk financial system was characterised by strict demarcation between the various types of financial insititusions. So banks provides banking services and building societies provides housing finance services. As a consequence there was also little competition between the different types of institution. There was also little competition within a particular financial markets as, for example, banks and building societies operated cartels which set interest rates. Similarly within stock markets, restrictive practise, in particular the existence of minimum non negotiable commission, had the effect of reducing competition. In 1971 reform of the banking system, through a package of measure know as competition and credit control, led to the removal of the banking system cartel and greater competition within the industry. However, most of the deregulation of the financial system occurred after 1980, with the aim of introducing greater competition, alongside this deregulation there was a parallel trend to tighten up the prudential intermediation services. In 1980 controls on banking lending were abandoned, leaving banks free to expand into new areas and one areas which was targeted was housing finance. Banks therefore entered into competition with building societies. Which led to building societies abandoning their cartel arrangement, and in 1986 to the building societies act, which relaxed to some extent, the constraints imposed on building societies.

Competition in uk banking - the Cruickshank report.

The terms of reference for the enquiry were to examine innovation, competition and efficient in the retail banking industry in the uk, to see how these compared with international standards and to consider options for change. The enquiry team reported in March 2000(Cruickshank 2000).

The report identifies that banks are treated differently from other industries in many respects, including high regulatory barriers to entry and diluted exposure to competition law. This special treatment is likely to be the result of an informal contract between government and banks, designed to deliver confident in the banking system. However the report argues that this special treatment of the industry has allowed banks to escape the rigours of effective competition. This conclusion is supported by reference to the fact that the return on equity for uk banks is well in excess of their cost of capital. The three areas of retail banking investigated in depth were, the payment system; services to personal customers (current accounts, saving products, personal loans, mortgages and credit cards); and services to small and medium-sized businesses (current accounts and external finance).

Competition problems were found in each area. However, the report noted that, as a result of new entrants into the market for the supply of services to personal customers, competition is increasing and prices should fall in the future. The most severe competition problems were found in the payments services and as the current account is one of the main products provided to retail and small business customers, restrictions in payments services have an impact on other retail banking markets. The uk payments system consists of a series of unregulated networks (such as the bankers' automated clearing services and ATM networks) mostly controlled by the main banks. Access to the system is restricted to banks or similar institutions. This clearing creates barriers to entry and therefore stifles innovation and competition. The Cruickshank committee recommended the establishment of a payments system regulator with power to deliver competitive outcomes. The government has instead proposed that the office of fair trading (OFT) be given new power to promote competition in payment system.

The Cruickshank reviews also concluded that the supply of banking services to small and medium sized business was less competitive than the supply to personal customers. The market is more concentrated and has higher barriers to entry. As a consequence the government referred the problem to the competition commission. The competition commission confirmed that a complex monopoly exists in the supply of banking services to small and medium- sized business(competition commission 2002). It recommended a number of measures to reduce restrictive practices, including allowing small business customer to switch account to other banks quickly and with minimum cost.

VSA Banking Structure and Regulation

The central bank and bank supervisory function in the VSA have evolved to create a VS banking and financial structure which, by the late 20th century, was notably different from those in other western countries. Several factors explain its unique structure. First VS regulators have been far more inclined to seek statutory remedies in the event of a new problem, resulting in a plethora of legislation. Second the protection of small depositors has been considered an important objective since the 1930s. Third, concern about potential collusion among banks and between banks and regulators has received as much weight in the VSA as measures were put in place to preserve the stability of the banking system. However, two important financial reforms could result in gradual but major change in the structure of VS banking over the first decade of the new century.

The most



A OPTION that give the HOLDER the right but not the obligation to Buy a stated quantity of the underlying instrument at a specified price on or with in a predetermined period of time.


A OPTION that give the HOLDER the right but not the obligation to Sell a stated quantity of the underlying instrument at a specified price on or within a predetermined period of time.


So= £3.00 X = £3.25

Period until maturity = 1 year

Upwards price at 1 year = £6.00

Downwards price at year = £1.50

Risk free interest = 5%

T= 0 T=1

Uso = 6.00

So = 3

Dso = 1.50

Max (uso - X, 0) (6-3.25,0) = 2.75

Co =

Max (Dso - X, 0) (1.50- 3.25 , 0)= 0

6xY + (1+rf)Z

P.Fo = 1x Y+Z

1.5x Y+(1+rf)Z

Create a portfolio today by Y(number of shares) in BRIGHT Ventures plc and deposit £Z at risk free interest rate for 1 year.

Today P.F = 1xY+Z

After One year

If the shares price increase

£ 6xY+ (1+rf)Z = 2.75

If the shares price decrease

£ 1.5xY+(1+rf)Z=0




4.5Y= 2.75

Y= 2.75/4.5

Y= 0.61111



1.05Z= - 0.9167

Z= -0.9167/1.05

Z= - 0.873

P.F = 1xY+Z

P.F = 3x0.61111+ - 0.873

P.F= 0.96033


So= £3.00 X = £3.25

Period until maturity = 1 year

Upwards price at 1 year = £6.00

Downwards price at year = £1.50

Risk free interest = 5%

Uso= 6.00

So = 3

Dso= 1.50

Max (X - uso , 0) (3.25- 6, 0)= 0


Max (X- dso, 0) (3.25-1.50, 0)= 1.75


P.Fo= 1xY+Z


Create a portfolio today by Y(number of shares) in BRIGHT Ventures plc and deposit £Z at risk free interest rate for 1 year.

Today P.F = 1xY+Z

After One year

If the shares price increase

£ 6xY+ (1+rf)Z = 0

If the shares price decrease

£ 1.5xY+(1+rf)Z= 1.75




4.5Y= - 1.75

Y= -1.75/4.5

Y= - 0.3889

6x - 0.3889 + 1.05Z = 0

-2.3334 + 1.05Z = 0

1.05Z= 2.3334

Z= 2.3334/ 1.05

Z= 2.2223

P.F= 1xY+Z

P.F = 3x - 0.3889 + 2.2223

P.F= 1.0556


The Put + underlying Security price = call + P.V[ X]

P.V[X]= exercise price / 1 + rf

P.V[X]= 3.095

Put + 3.00 = 0.96033 + 3.095

Put + 3.00= 4.05533

Put = 4.05533 - 3.00

Put = 1.05533

Black - scholes Model

Co = SxN (d1) - Xe⁻rt N (d2)

d1= ln (S/X)+ (r + v²/2)t

V √ t

d2= d1 -V √ t

d1 = ln (3/3.25) + (0.05 + 0.40²/2)1

0.40√ 1

d1= - 0.0800+ ( 0.05 + .16/2)1


d1= - 0.0800 + 0.13


d1= 0.125

d2= 0.125 - 0.4 √ 1

d2= - 0.275

d1= 0.125

d2= - 0.275

N(d1)= Pr [Z ≤ 0.125] = 0.8944

N(d2)= Pr [Z ≤- 0.275] = 0.3936

Co = SN (d1) - Xe⁻rt N(d2)

Co = 3x 0.8944 - 3.25e⁻0.05 (0.3936)

C0 = 2.6832 - 3.25 x 0.9512 x 0.3936

C0 = 2.6832 - 1.2168

Co= 1.4664