De-regulation of a bank


De-Regulation of a Bank:

The de-regulation of a bank is typically referred to the purging, or generalization, of different laws that apply to banks. This concept is often promoted by free-market advocates. These proponents stress minimal, if any, interference by the government in the private sector. Normally bank deregulation, however, does not refer to the eliminating the laws against frauds and other criminal practices.

Below are some points given, which refers to history of the de-regulation of banks,

Until the 1970s banking was governed mainly by state laws, and banks could be able to business only in their home states. A Nebraska bank solicited customers from Minnesota but charged them Nebraska's higher interest rate. Minnesota's Marquette Bank filed a lawsuit to stop this practice, and the case went to the Supreme Court. In its "Marquette Decision," the Court ruled that banks could export interest rates into other states. This prompted banks to establish headquarters in states that would allow them to charge the highest interest rates, and the tax base of those states grew substantially. To stay competitive, other states raised caps on the interest rates banks could charge. This effectively led to the deregulation of state interest laws, also known as usury law.

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The Depository Institutions Deregulation and Monetary Control Act of 1980 (DIDMCA) abolished state caps on interest rates that could be charged for primary mortgages, giving banks the incentive to approve mortgages for people with problematic credit histories. Banks made more money by charging higher rates to riskier customers, and a broader range of people were able to purchase homes.

Before the Alternative Mortgage Transactions Parity Act of 1982 (AMTPA), all mortgages were fixed-rate amortizing loans. This legislation opened the doors to non-traditional mortgages, paving the way for adjustable rates, balloon payments, interest-only loans, and optional adjustable rates, which allow borrowers to underpay substantially during the first few years of the loan.

The Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (IBBEA) swept away all state barriers to interstate banking. It allowed financial institutions to locate branches in other states and to purchase or merge with banks headquartered in other states.

The Gramm-Leach-Bliley Act (GLBA), also referred to as the Financial Services Modernization Act of 1999, repealed part of Glass-Steagall, tearing down the walls between banking, insurance and investments. Companies could now merge, partner and operates freely within each other's industries. The act also made it possible for the financial industry to group mortgage and other portfolios, selling them as investments.

The Role of De-Regulation in the Financial Crisis Faced By the Royal Bank of Scotland:

Royal bank of Scotland in 2008 was hit by a 13 per cent drop in its share price as it emerged that insurance company Fortis must now sell its stake in ABN, bought as part of the near £50 billion takeover led by RBS last year. (Telegraph 2008, 29th September).

1-Asset bubbles

The Royal Bank of Scotland crises is preceded by high economic growth, a build-up of asset bubbles reflected in a huge run-up in equity and real estate prices, and a disproportionate growth of loans to these sectors (Reinhart and Rogoff, 2008). The rapid and unsustainable build-up of asset bubbles is invariably followed by a collapse.

The fall in asset prices had a double-whammy effect on bank. A decline in the price of stocks held by bank eroded its capital base and forced a reduction in lending. In addition, a drop in land prices reduced the collateral value for bank's loans, increased its non-performing assets, and necessitated a write-down of its loan value and a provision for these losses.

2- Non-performing loans (NPLs)

The NPLs problem erupted into Royal Bank of Scotland crisis when different companies those provide consumer and mortgage loans were saddled with huge amounts of non-performing housing loans. Even though non-performing loans were rising but still RBS and its policy makers were slow to reluctant to face the problem and they did not take the proactive actions. Policy makers mistook the slump for a short business cycle correction and did not apply enough fiscal stimuli to resuscitate the bank.

3-Credit Rating Agencies

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The Royal Bank of Scotland financial crisis was also due to the credit rating procedures and the incentives model for credit rating agencies. Credit rating agencies assign ratings to bonds and other debt instruments.

With the mortgage-backed securities created by RBS however, the rating of credit rating agency were off the mark as they assigned AAA ratings to what were by definition subprime and high risk loans. Ratings on these products were based on flawed mathematical models, which depended heavily on assumptions derived from historical data and the diversification of risk. With subprime loans and their pooled securities, however, very little data exists on which to make sound assumptions. Another part of the reason credit ratings performed poorly in assessing the risk of mortgage-backed securities was a conflict of interest in their incentive system.

The Diamond - Four Determinants of National Competitive Advantage

Four attributes of a nation comprise Porter's "Diamond" of national advantage. They are,

  1. Factor conditions (i.e. the nation's position in factors of production, such as skilled labour and infrastructure),
  2. Demand conditions (i.e. sophisticated customers in home market),
  3. Related and supporting industries, and
  4. Firm strategy, structure and rivalry (i.e. conditions for organization of companies, and the nature of domestic rivalry).

1. Factor Conditions

Factor conditions refers to inputs used as factors of production - such as labour, land, natural resources, capital and infrastructure. This sounds similar to standard economic theory, but Porter argues that the "key" factors of production (or specialized factors) are created, not inherited. Specialized factors of production are skilled labour, capital and infrastructure.

Non-key factors or general use factors, such as unskilled labour and raw materials, can be obtained by any company and, hence, do not generate sustained competitive advantage. However, specialized factors involve heavy, sustained investment. They are more difficult to duplicate. This leads to a competitive advantage, because if other firms cannot easily duplicate these factors, they are valuable.

Porter argues that a lack of resources often actually helps countries to become competitive (call it selected factor disadvantage). Abundance generates waste and scarcity generates an innovative mindset. Such countries are forced to innovate to overcome their problem of scarce resources. For example, Japan has high priced land and so its factory space is at a premium. This lead to just-in-time inventory techniques (Japanese firms can't have a lot of stock taking up space, so to cope with the potential of not have goods around when they need it, they innovated traditional inventory techniques).

2. Demand Conditions

Porter argues that a sophisticated domestic market is an important element to producing competitiveness. Firms that face a sophisticated domestic market are likely to sell superior products because the market demands high quality and a close proximity to such consumers enables the firm to better understand the needs and desires of the customers.

If the nation's discriminating values spread to other countries, then the local firms will be competitive in the global market.

For example the French wine industry. The French are sophisticated wine consumers. These consumers force and help French wineries to produce high quality wines.

3. Related and Supporting Industries

Porter also argues that a set of strong related and supporting industries is important to the competitiveness of firms. This includes suppliers and related industries. This usually occurs at a regional level as opposed to a national level.

4. Firm strategy

The phenomenon of competitors (and upstream and/or downstream industries) locating in the same area is known as clustering or agglomeration. Some advantages to locating close to your rivals may be

  1. Potential technology knowledge spill overs,
  2. An association of a region on the part of consumers with a product and high quality and therefore some market power, or
  3. An association of a region on the part of applicable labour force.

Some disadvantages to locating close to your rivals are

  1. Potential poaching of your employees by rival companies and
  2. Obvious increase in competition possibly decreasing mark-ups.

UK Government to Utilize Porter's Theory:

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Now that government has a direct stake in a number of banks, it may be better able to provide and stimulate finance for proactive innovations and the funding of particular technology projects more directly. As the recession is prolonged the need for finance for SMEs will be more evident. Other high-risk ventures may also require venture capital funding. Yet, finance should be viewed as something more than merely ‘saving' an industry or organisation. Finance should be regarded as having some form of leverage or generate a burst of new ideas, business forms or activities, rather than a subsidy to continue with existing business and product/service paradigms. Hence, participants suggested that government should focus more on supporting new business ideas rather than on propping up incumbent firms, whose business models belong to the period prior to the structural break and may no longer be appropriate for the emergent economic environment.

According to the Porter's theory's first attribute the UK government has the win-win situation in order to protect the competitive advantage for the financial services industry as the government has got all the positive factors. But if the government want to utilize Porter's theory to get the competitive advantage for its financial services industry, it has to be more creative, and innovative in term setting the regulations for FSI (financial services industry). Government should strive to harness the talents of financiers exiting the city as well as people working in the creative industries. The strengths of the UK economy need to be elucidated and emphasised in the international arena. Perhaps there is scope for sense-making and reframing of UK competitive advantage. This is associated with identifying innovative ideas and pockets of growth and helping them to flourish. It also involves government questioning the fundamentals of its existing approaches to encouraging business enterprise: is business policy that was once regarded as fit for purpose, still appropriate? Additionally new, relevant policies and initiatives may involve the adaptation to environmental trends which offer key business opportunities. For instance, climate change, a low carbon economy and an ageing population are issues that may unleash new opportunities for business. The key here will be to assess in which areas the UK should lead, and where it should follow. Above all it will involve making the UK the best place for clever, ambitious young people an open economy with opportunities for harnessing global talent.

The author is agreed that the current UK recession is unprecedented in its characteristics. The prevailing uncertainty meant that it is impossible to predict outcomes or advocate detailed solutions without qualification. It is clear, however, that this is a frame-breaking event, and one which presents both threats and opportunities for UK business.