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The banking crisis is the major economic downturn of our time; it has changed the UK if not the world. The credit crisis became a liquidity problem that face the US economy and slowly spread to the whole world, causing the stock market crash on the scale that hasn't experienced this since the Wall Street crash in 1929.
In the UK, the mortgage lending became more relaxed as the years came by; this was show as the prime example Northern Rock. They were lending out loans high percentage of risky loans, also they had the highest percentage of loans financed through reselling in the capital markets.
When the bubble burst and Northern Rock couldn't raise any more funds, they were left with a short fall and had to borrow money of the Bank of England to bail them out, this caused an outburst and customers started to be concerned so they started to withdraw savings. But savings weren't affected, because of this the mortgage market has completely changed and all the risky mortgages have been removed.
In this article 'Lord Turner: FSA failed to spot looming crisis' (Accountancy age, 2009) it talks about how the FSA is to blame for some of the crisis and that the bank had focused to much on banks' processes without spotting the greater risk created by their credit strategy.
TheÂ FSA is an independent non-governmental body and a company limited by guarantee responsible for theÂ financial regulationÂ of theÂ financial services industryÂ in theÂ United Kingdom. They are set up by the government and they exercise statutory powers given to it by theÂ Financial Services and Markets Act 2000.
The FSA has 4 main objectives to follow, those are:
Market confidence - they do this by sustaining confidence in the financial system by supervising financial exchanges or checking transactions by carrying out market observation.
Financial stability - adding to the safety and improvements of the UK financial system.
Consumer protection - protecting the suitable amount of protection for customers.
The reduction of financial crime - reducing the amount to which it is possible for a business to be used for a purpose connected with financial crime.
To find out what happened in this proposal I will research all the events that have occurred and deduct test and interviews to find out what happened and why to blame the FSA.
Aims and objectives
The present study is planned to empirical investigate the following objectives:
Identify evidence to see whether or not Northern Rock was out of their reach to control.
Evaluate evidence to explain why FSA did not see the banking crisis before it happened and if there was a lack of communication in the tripartite system.
Examine why the FSA fail to stand up to the expectations that (i) they are the regulator of the financial services industry in the UK and (ii) that they were willing to achieve their four main objectives which are market confidence, financial stability, consumer protection and the reduction of financial crime.
Primary research question
To conduct a relative analysis on FSA to overlook the credit crisis and what laws/regulation, if any, should have been encountered.
1.4 Proposed Literature Search
In this research I will concern with past studies on Electronic banking, and I will search past journals, news paper, and books on electronic banking.
1.5 Research Methods
There are two different types of writing a thesis - inductive or deductive
An inductive approach identifies a real fact from which patterns are identified and explained, and suitable theories selected to describe and understand the phenomenon. (Carneiro & Merzoug, 2001)
Deductive approach generates hypotheses from an exacting theory and then applied to observed reality. It is believed that developing propositions from existing theory and making them testable in the real world. (Dubois & Gadde, 2002)
This research will be an inductive research. Data which is used to conduct this research will be collected by official website of banks and by their financial statements. Investigation via structured interviews by banks can also help in the research. Data included articles and studies that will be mainly collected from books and journals and from the internet
1.6 Sample Type and Size
In total 5 different banks will be taken as a sample including Bank Alfalah, Askari Bank, MCB Bank, Habib Bank and Allied Bank. Great care will be taken in selecting the sample as the banks selected were large and well renowned.
The Financial Services Authority (FSA) have taken on board the severe criticisms of the accountancy profession in general, and the auditing process in particular, that it failed either to comprehend or to act on concerns about the business models being used by UK banks, such as Northern Rock, the failure of which sparked off the major financial crisis and government taxpayer bailouts. Reveals that the FSA concerns and conclusions have been published in a discussion paper ('Enhancing the auditor's contribution to prudential regulation') that has revealed many disturbing truths about the auditors' roles during the crisis, the most serious charge of which is that auditors exhibited a worrying lack of scepticism. Concludes that there are lessons for auditors to learn as a result of the financial crisis but argues that the system itself is in need of fixing.
Northern Rock was a successful mortgage supplier in July 2007 making it the 8th biggest bank in the UK. In the beginning of 2007, Northern Rock sold mortgages valuing a record of £10.7 billion, up by 47 per cent as of a year ago which was comparable to 19 per cent of all latest mortgages sold in the UK making it ahead of the market. But in the next three months, Northern Rock was borrowing from the short-term money markets in the USA in large amounts and loaning out for long-term mortgages in the UK.
When the credit crisis happened in the US money markets in September 2007, Northern Rock they had no where else to go but the UK Government to provide the bail out. This research was done by Muradoglu, Y.G (2010) explaining what happened from the beginning in the USA to the UK and what triggered the credit crisis. Muradoglu, Y.G (2010) concluded that the banking system in the UK failed to spot the level of lending between the two countries and that when the bubble burst the UK government could have controlled the outburst better.
A journal written by Veronesi, G and Keasey, K (2008) called 'Lessons from the Northern Rock affair' it talks about the difficulties occurred from Northern Rock and the UK financial system and also explains how the UK financial system should move more into a more traditional banking system other than having a tripartite system of regulation. Veronesi, G and Keasey, K (2008) mentioned that Northern Rock practised a hostile business model but the UK financial system such as the FSA failed to recognise. This shows doubts that the FSA is guilty of failure to understand the Northern Rock Model. The Northern Rock issue proves that there is a sense of confusion and lack of communication between the three parties to control the financial system.
The researchers say that nobody appears to have worked throughout the detail of the system and it showed that there was a lack of thinking given to how a crisis should be prevented. The FSA was unsuccessful to notice the risk of the aggressive Northern Rock model, the Bank of England concerned about the effect of its behaviour on future crises instead of dealing with the current crisis and Chancellor of exchequer failed to support depositors in a well-timed manner.
They argue about separate the roles of bank supervision done by the FSA given that it depends on thorough information of the dangers inside the system. Another difficulty at present is the relaxed system of the FSA which has been seen as a real problem in the current crisis.
Llewellyn, D.T (2008) researched explaining the Northern Rock problem and the crisis. One of his studies he talks about the weaknesses, the conduct of regulation in the Northern Rock issue, quite a few weaknesses were exposed. One was despite the outstanding business model of the bank, no complete check of the bank had been completed for about18 months.
Second was despite the general liquidity risks by the Bank of England and the FSA, insufficient stress-tests were related to Northern Rock.
Third was Northern Rock wasn't based on adequately poor circumstances or severe assumptions.
Fourth it seemed odd to review things in the past as late as June of 2007, the FSA reduced the bank's necessary capital-ratio which made the bank to carry on asset growth although it was recognized that financial trouble had been exposed.
In the conclusion the researcher mentioned that FSA, the Bank of England and the treasury responsibilities need to be revisited, as he mentions one reason for the crisis was poor management between them.
The House of Commons, Treasury Committee made a report on the 24th of January 2008 called 'The Run on the Rock.' It is a report made by the Treasury Committee and that has been made to talk about the UK financial system and Northern Rock.
In the report it says "The FSA did not supervise Northern Rock properly. It did not allocate sufficient resources or time to monitoring a bank whose business model was so clearly an outlier; its procedures were inadequate to supervise a bank whose business grew so rapidly [â€¦] The failure of Northern Rock, while a failure of its own Board, was also a failure of its regulator [â€¦] In the case of Northern Rock, the FSA appears to have systematically failed in its duty as a regulator to ensure Northern Rock would not pose such a systemic risk, and this failure contributed significantly to the difficulties, and risks to the public purse, that have followed" (House of Commons, 2008). This Section all targets the FSA and blames the fact that FSA thoroughly was unsuccessful in its regulatory responsibility to make sure Northern Rock wouldn't create a universal risk.
Briefly they mentioned that they failed to take action on warning signs such as increase in growth with share price decreasing, they failed to undertake basic flaws in Northern Rock's supply model.
They say that it was mistaken to let Northern Rock to deteriorate its stability at an instance when it itself was alarmed about trouble of liquidity that might have an effect on the financial.
However, the FSA isn't the only group involved in the credit crisis, the Bank of England was unsuccessful in their goals as mentioned by the treasury committee. They said that the Bank of England had a breakdown to widen the variety of satisfactory security at a past stage in the confusion, a letdown to correctly believe the potential for support action much earlier.
They say that there is a failure to grip sophisticated negotiations with Northern Rock concerning the support facility earlier than 10 September.
Maximilian J.B. Hall (2008) talked about the specific roles of the tripartite and how the Bank of England i.e. the central bank was the main culprit of not doing what is told. The taking part of the Central Bank is essential because of its continuing lender of preceding option role and its duty for keeping the financial system stable, while the FSA's job is clearly necessary as the core regulatory power and the primary port of call for whichever financial company which gets into problems. The Treasury is first and foremost in charge for the international formation of rules and the regulation which oversees it and has to be discussed with if there is a supposed need for a certified support operation. On the whole then, in the case of the liquidity salvation given to Northern Rock, the FSA's job was to decide whether or not the Bank was in credit, having an plea for aid from the Central Bank; the Central Bank had to make sure whether its breakdown creates a systemic risk and the Treasury as warden of the country to decide the receipt of advice from the former bodies, whether to authorise a support operation.
Although both the FSA and the Bank have been at pains not to criticise the working of the arrangements during their interrogations at the hands of the Treasury Select Committee, outside commentators have taken a different view. Moreover, the Treasury, in its evidence before the Committee has indicated that it will seek clarification, in a future draft, of its power to ultimately determine the outcome of tripartite talks in a wider set of circumstances than it believes is currently covered by the agreements. Additionally, like the Bank, it is keen that the central bank is involved more directly in the monitoring of individual banks' financial health, notwithstanding the FSA's broader remit in this area.
The current crisis has raised concerns that the bank has been overly focused on its monetary/inflation role and has lost touch with the detail of its market and hence, potential instabilities. Given what has been occurring in the UK housing market, it is surprising that house prices do not form part of the general price index. If this had been the case, the bank may have been forced to give a bit more attention to the housing bubble.
It has been argued that central banks should deal with asset bubbles as they are inflation but others have argued this is easy said than done. More specifically, it is not always clear when a bubble is inflating because of their inherently irrational nature - effectively, why should a bank know better than the market? But surely, this is the very purpose of a bank - to offer insights/clarity when markets are blinded by their own dynamics. There is also the argument that banks should steer clear of pricking bubbles because they are unsure how monetary policies will pan out (just consider the early attempts of the Bank of Japan). While the wider impact of bubble deflating monetary policies may be difficult to predict precisely, this seems to be a case of admitting defeat, ignoring the fact that monetary policies can give rise to bubbles and, therefore, banks have a duty of responsibility to know how to deflate them and that by leaving bubbles to market correction banks will never learn how to control them. We do not agree that it is best to let bubbles burst of their own accord and then be prepared to swiftly sweep up the debris. The current crisis shows how deep and broad the consequences of asset bubbles can be.
To our mind, the current crisis gives a clear mandate to the BoE going forward. First, it needs to continue with the standard stuff on prices and outputs. Second, it needs to spend more time understanding what the banks are doing and this will help it understand what risks are to be faced in the longer term.
The current crisis has also emphasised the need for banks to understand how to deal/respond to illiquidity in the system so as to prevent panic. Mervyn King has argued that the transparency required by the UK version of the Market Abuse Directive (MAD) prevented him from quietly and covertly dealing with the illiquidity of NR when the money markets closed. It is unclear how far MAD did prevent covert action but it looks as if the British Civil Service has "gold plated" EU regulations to make them at best difficult to work with. However, even allowing for the restrictions on action created by the MAD, the UK Financial Press has been critical of Mervyn King for a lack of a decent plan to deal with the crisis. The crisis clearly shows a failure to read the situation as it developed and a failure to communicate across the key organisations (Treasury, FSA and BoE). There may even be an issue with the term "lender of last resort" as this offers strange signals to the rest of the money market in the context of the UK's custom and practice - hence, the failure of the BoE's use of an auction to provide additional liquidity to the system.
Several criticisms have been levelled against the Bank of England's actions and stances during the evolving NR crisis in September and October of 2007:
It is alleged that the bank operated too late and generally underestimated the nature of the financial market turmoil and its specific impact on NR.
Excessive emphasis was given to the dangers of moral hazard at a time when the markets in general, and NR in particular, were particularly vulnerable.Â Goodhart (2007)Â has argued that: "sticking to proper principles in a crisis may be admirable but it can be a dangerous game to play". The contrary argument is that it is precisely in such circumstances that the moral hazard implications of intervention need to be emphasised.
The bank has been accused of being excessively restrictive in the range of maturities and instruments against which it intervenes in the money markets to ease liquidity and interest rate pressures at a time when three-month Libor had risen significantly above the bank's intervention rate. This is in contrast to the interventions of the ECB and the Federal Reserve in their respective money markets. Unlike the other two central banks, the Bank of England at first chose to restrict its interventions to the overnight market and against a very restrictive range of collateral. In particular, it would not accept mortgage-based collateral.
NR, and some commentators, has argued that the problems of NR might have been alleviated, and the bank run avoided, had the bank been more willing to intervene in the three month inter-bank market and against a wider range of collateral.
The bank has been criticised for inconsistency in that it later conceded to pressure to liberalise its intervention policies by widening both the maturities and the range of instruments for collateral.
It has also been alleged that, early on in the evolution of the NR crisis, the bank obstructed a possible take-over by LloydsTSB.
Methods and ethical issues
Primary Research Question
To conduct a relative analysis on FSA to overlook the credit crisis and what laws/regulation, if any, should have been encountered.
Object of study
The object of study is the FSA's involvement in the credit crunch and what could they have done to prevent the banking crisis.
FSA's was part of the tripartite system and from the beginning was the greatest success story of the labour government which came into power in 1997.
After the banking crisis, there was only one group to blame for it, which was the FSA. As we know they are the regulator of the financial system in the UK, they have full control of the system and can bring in any sort of regulation to prevent anything bad that happens.
In mid 2007, the crisis occurred with Northern Rock but before that they had an increase of 47 percent in the year; this should have been an alarm bell for the FSA to investigate how that increase occurred and whether their borrowing from USA has any effects from any systematic risk.
What the FSA should have done is targets and regulations set to keep close supervision on high impact firms. Examples could be the FSA having a close eye on the firm such as day to day supervision, making reviews and having a strategic plan. This can be done by regular meetings and if patterns are seen by FSA they can make an assessment with identifying the issues, this is just an example of what they should have done, they could use all other methods, but what I have read the FSA did not do this on the right time.
Northern Rock was the start of the whole credit crisis in the UK, when the FSA found out that Northern Rock had to be bailed out by that time it was too late for them to control, if the FSA did their job correctly maybe they would have found out what they did earlier and controlled the situation differently without having an outbreak causing the general public to withdraw savings.
The tripartite system is the FSA, Treasury and the Bank of England, many can blame FSA but not many have criticised the Bank of England as they are part to blame too. Their job is to maintain financial stability in the UK, I believe that they controlled the situation badly and the communication between the FSA and the Bank of England was very poor, if they were communicated properly the outbreak and controlling the situation of the public getting worried would have been different, plus if the Bank of England had a regular check on Northern Rock they could have told the FSA to supervise and control what they are doing.
There are two choices of research methods I can choose from, those are quantitative and qualitative approach.
Quantitative approach is an approach based on numerical data that can be used to get hold of information, it is more of an objective and another word for it is deductive approach. It creates a hypothesis of numerical data from real life situations, examples could be from questionnaires surveying.
Qualitative approach is an approach