Regulations and Supervision of Northern Bank - Case Study Example

Banking Essay Mistakes of the Northern bank: Northern bank emerged in 1809 originated from Belfast based bank known as Northern Banking Partnership. Northern Bank has emerged over the passing years by performing consistently and meeting the changing needs of customers. Brief reasons leading to the Northern Rock Bank crisis are that they started giving excessive lending which was the important most factor of its downfall. The bank lent huge deposits which were more compared to the deposits they got from their depositors. Second reason was that there was liquidity mismatch which means that when Northern Bank gave high amount of deposits to the lenders they did not have sufficient deposit base to support their lending’s which encouraged them into borrowing money from the money market. Third factor was Sub prime lending which means that there was a direct exposure of Northern Bank in sub prime mortgages which was eventually very less but after some time the mortgages started to climb high in the market. When U.S sub prime crises got hold and spreaded throughout the market, banks feared from lending mortgages from one to another. Fourth reason of downfall is the global macro economic imbalance which means that there was instability in monetary terms and account deficits everywhere in the world especially United States and other European countries. Fifth reason was increasing intricacy of the securitized credit model, which has lower risk-free interest rates compared to other bank products leading to an intense search by customers for higher yield and a faster growth in the complexity of financial products. To prevent their collapse Northern Bank guaranteed the deposits to alarmed savers who were lined up to withdraw their funds. A week before the crisis provoked, Northern Rock had come close to be acquired by Lloyds TSB, but there was no agreement because of funding problems, Lloyds could not get an agreeable committal of funding support from the Bank of England. When crisis occurred, Northern Bank found out that they could not secure cheap funds which were required and at that time credit elsewhere was not available or was very expensive. People rushed to withdraw their savings before government abide guarantee on savings, when first emergency loan was announced by Bank of England. To get a breathing space and avoid emergency sale Northern Rock declared new arrangements with the Treasury and the Bank of England. The tripartite system accumulated the Bank of England, Financial Services Authority and the treasury was a bad concept in the design. Individual banks were to be supervised by FSA and the Bank of England who had the required resources acted as a lender in bad times. When problems aroused in US mortgage sector, The Bank of England was hit badly for not lending the adequate liquidity to the Banks. (Green, 2007). Regulations and Supervision of Northern Bank: At that point Northern Bank was borrowing money from the money market and focusing on their short term profits which they thought would enable them to roll over the loans and when from the date of issuance the three month term would end, another would begin. Now the point where Northern Bank collapsed was when people were unable to repay their mortgage debts which caused the rate to rise at which banks used to borrow from other banks and many institutions stopped lending led to the collapse of Northern Bank after the hit they went to Bank of England. Northern Bank made plan to downsize 1400 employees, with 4000 remaining and planning to manage. The alarming problem of Northern Bank is the failure executed by regulatory authorities. With 20-20 situation, the regulators should not have allowed maximizing its loan portfolio so rapidly. There is a moral fulfillment requirement by the regulators to safeguard that any bank with the required numbers of depositors is either precise expelled from any guarantee or is supervised to confine its divulgement to risky markets. The Prime Minister constructed a regulatory system that was not suitable in purpose of dealing with systemic risk in whole banking system. To avoid the last crash the authorities now believe how the government should had regulated the banks. The obstacle was that all kinds of financial institutions such as insurance company, banks are scared of FSA who follow directly the regulations set by the government. The customers suffer as a result because the financial system is already scared of the FSA. Keep yourself on safe side is more important than taking care of customers. The government, FSA and the Bank of England had equal share in the fall. The following describes what went wrong and what role did each one play to bring such a drastic downfall. Financial Services Authority: Financial Services Authority admitted their supervision which led to the collapse of Northern Bank included execution of operations with responsibility for regulating the banking system. Furthermore government also has a hand behind the collapse of Northern Bank which was their assumption for taking up Northern Bank into public ownership. They planned to use the Legislation instead of treasury attaining the firm in legislation will be used, rather than the Treasury simply acquiring the firm in the ceremonious way or granting it the authority to operate by administration and then purchasing the assets. Secondly London Interbank Offered Rate (Libor) raised to its peak the highest level making it a record in nine years. The loan of a three month was as high as 6.7975% which was above Bank of England emergency lending rate 6.75%. (Darling, 2008) The FSA has more than a million paragraphs in its prudential regulation manual for banks to utilize but that document of regulation specifically did not work. Rather than making the crash better, International bank capital regulation made it worsen. Some critics stated that there were wrong people doing the job regarding Northern Banks case. Supervision of the bank was in wrong hands, in between January 2005 and June 2006, the regulation of the bank were supervised and taken care by division of regulator who were especially tasked with monitoring insurers. Different mistakes made by Financial Service Authority were the catalogue of mistakes made by the Financial Services Authority (FSA) was shown as the regulator which was published as bowdlerized version of blemish supervision of the bank. Rock reported a capital ratio of 9.74 per cent at the end of March 2007, which was “in breach of its capital requirements. FSA stated capital shortens as extremely serious, among many warning signals FSA allowed Northern Bank to finish or lower the standard of risk mitigation program which was required by almost every bank. FSA acknowledged that it failed to communicate five warning signs which suggested the weakness of Northern Bank; Danger signals which were not communicated: 1. In January 2007 Northern Rock announced that it has an ambition to become the third biggest mortgage lender in Britain. 2. Northern Bank wanted to enter and cater the retail savings market of Denmark in February 2007. 3. It showed their growth in lending’s which are around 34 percent in the first quarter of 2007. 4. In June 2007 Northern Rock sold £833 million commercial loans to Lehman Brothers offending capital rules 5. “Most importantly”, they announced in January 2007 that they will pay greater proportion of its profits in dividends. Then after some time FSA admitted that they had failed to maintain relations with Northern. Bank of England provided Northern Bank £25billion loan. These funds were taxpayer’s money, which were issued to Northern Bank since last September; Rather than using savers deposit, Northern Bank used to borrow funds from the money markets to fund its mortgage business. The mistakes of FSA were their role at the time which was to make sure that the structures, systems and processes of the banks were intact and restructure the banking policies to enhance the credibility. So it analyzed and identified whether there were sufficient number of employees in the risk-management department; or whether the kind of people or management required to work are there right and risk information which had to gathered and educated to the right people; and so on, but it was not credibly proper for the FSA to challenge banks on their rapid growth in the mortgage market, or stuffing themselves up with adjunctive debt responsibility produced from toxic subprime loans, or to get an ever-increasing extent they funded themselves from the sale of mortgage-backed securities. For trading activities of banks The FSA increased the capital requirements by several hundred per cent. This meant that the trading of securities and activities such as investment banking of Bank of England will become more expensive for other banks and much less monetary advancements.The tripartite Treasury Committee report stated that Financial Services Authority (FSA) was demoted to "stress-test" Northern Bank business model adequately. The reports also included that UK’s tripartite financial authorities - the FSA, the Treasury and the Bank of England, were adequately ready to bargain with Northern Rock's difficulties and they needed to acquaint better with each other. Furthermore FSA acknowledged of their four central failings. First was they failed to exercise enough scrutiny which is a high risk strategy formulated by the board of Northern Bank Regulator acknowledged having poor resources for monitoring Newcastle-based lender and lack of vigor by FSA management to enforce supervision.FSA brought out number of plans to enhance its supervision of Britain’s financial Institution after being charged guilty. Last there was senior FSA staff that brought in confusions in regulators department which monitored the risk position of lenders. (Wallop, 2008) Government: Government made series of mistakes which led to the downfall of Northern bank such as their statement of running the bank temporarily until it can find a suitable buyer this forced to borrow loan money from Bank of England. When customers found out that the bank is collapsing they withdraw their deposits. Alistair Darling stated in a statement that "In the prevailing market conditions, the bank cannot deliver value for money what taxpayer expects. He continued that “Under public ownership the Government will protect the entire payoff from the upcoming sale of the business and in return bear the risk which will prevail in unsettled market” (Barr, 2008)Under the requirements laid down by the government to FSA stated that they are required to have a troubled concern with the unexpected changes in inflation. Their remit restricts them to acknowledge the impact of their actions on the economy unless that has an impact on inflation. The government made bank loans risky for corporate and consumer debt by offering to overcome expected losses, the government did it because it hoped that it will encourage banks to lend again. The government mistakes as well which is related to the crash of future financial regulations under UK views. At the start, there was humility on the government institutions which seemed visible which was certainly justified. There was weak monetary policy which significantly was an important contributor to the crash, knowing the situation Bank of England’s MPC ignored the warning signs. When government made bail out they asked IMF for funding. Most of the current problems are bad but the biggest problem is the inflation which kept rising. Mr. Darling gave confidence to investors that if they invested it would be still profitable for them and also the bank remaining solvent. He stated that as they were from the Bank of England was it necessary to show the arrangements that guaranteed all the previous deposits in Northern Bank during the prevailing fluctuations in the financial market. "This meant that customers can still take out their money from Northern Bank. But on the other hand if they choose to leave their deposits, it will be guaranteed safe and secure and give a good interest." The Government declared a new authority promising 100% of an individual's deposit and setting up society savings up to £35,000. Government promised the Northern Bank customers a guarantee which extended to cover on all new deposits. Through the sale of Government guaranteed bonds to wipe off £24 billion lender’s debt the treasury declared their plans to create a private-sector rescue for Northern Bank. (Collapse and Fall of The Rock, 2009) The government wiped bourgeois offers to handle Northern Rock in a different way and to avert the taxpayer by executing responsible strategies for all jobs, mortgages, loans, properties and bills. Instead, the government declared to bring a one third cut down in the workforce, downsizing the size in terms of sale of assets in business. The Treasury had no idea about the prevailing economy when it failed to sustain Lloyds TSB’s acquisition over Northern Rock which would had affected softly on its liquidity crisis. The Treasury had no right to nationalize Northern Rock which emphasized the inability of New Labor tenet because this simply deter investors from pledging to the much needed right issues necessary for recapitalizing the Banks. Bank of England: Rare decision which is becoming the “lender of last resort”, Bank of England made consultation Financial Services Authority (FSA). It is an unmatched facility which showed an interest rate known as "penal rate" of more than 1% above Bank basic rate. Now Northern Bank had to obtain the money so they had to deposit some of their clientele deposits as corroborative, which Bank of England made mandatory. The Treasury agreed to prolong its guarantee of the bank's deposits; to make sure Northern Bank does not get a commercial advantage it will pay a fee to the Treasury on new funds. For Northern Bank to offer security as loans, The Bank of England had to lower its criteria for the assets and will let it put up for any of its assets. About four weeks back Northern Bank had borrowed approximately £11bn from Bank of England since the emergency funding facility was focused. The Bank of England wanted to bail out an individual institution by pumping liquidity into the inter-bank market. Even at the risk of infuriating inflation, The Bank of England has to flood the markets with money. Interest rates will go down by 4.5 per cent by mid 2008, but this forecast includes a wide margin of error. The mistakes of Bank of England, the list of complaints has been continuing to stretch down more and more over the past 12 months. Some of the complaints are: Only in crisis why did not the bank pump extra liquidity into the market? Why was there an attack on banks remuneration structures? Why those terms set on which the Bank lent out cash so bleakly? Why did King apparently hider the rescue merger which was proposed between Northern Bank and Lloyds TSB back before the bank became unsuccessful in its operations? The Bank of England had to come out in Nat West why because in 1975, everything turned wrong all of a sudden: GDP fell down by the scale at which it was measured was 3 per cent at the time (for recession which is measured at a scale which has been revised down to only 0.6percent). Inflation climbed high at 28 per cent till mid year. The British Pound devalued itself, there was a tremendous collapse in the stock market, and there was a deficit in government reserves which reached 10 per cent of GDP (equivalent to 130bn). Bank of England was more concerned about inflation than recession, they threatening to take shelter under the balance of payments and government borrowed at very high levels to minimize risk of consumer spending slowdown. We read above what actually happened with Northern Bank and the factors which caused its collapse. However above are few suggestions that government thought about on implementing, those regulations will help Northern Bank serve its customers more efficiently and allow more security on their deposits. Bibliography Alistair, M. (2008). Banking Crisis Solutions Old and New. Barr, A. (2008, February 27). U.K government to nationalize Northern Rock. Retrieved May 02, 2009, from MarketWatch: http://www.marketwatch.com/news/story/uk-government-nationalize-northern-rock/story.aspx?guid=%7BB54FB0C9-FD45-4796-9FB0-DD042DA18612%7D BBC. (2007, September 14). Northern Rock shares plunge 32% . Retrieved April 27, 2009, from BBC News: http://www.news.bbc.co.uk/2/hi/business/6994328.stm Blame for liquidity crisis does not lie with Northern Rock alone. (2007). Financial Times . (2009). British banking in crisis. Collapse and Fall of The Rock. (2009, February 16). Retrieved May 02, 2009, from http://money.uk.msn.com/investing/articles/morecommentary/article.aspx?cp-documentid=14245119 Could the crisis of Northern bank have been predicted? London. Darling, A. (2008, August 5). Timeline: Northern Rock bank crisis . Retrieved May 2, 2009, from BBC NEWS: http://www.news.bbc.co.uk/2/hi/business/7007076.stm David, H. (2009, March 20). Gordon Brown defends rescue of Northern Rock after NAO report. Retrieved April 27, 2009, from Guardian: http://www.guardian.co.uk/politics/2009/mar/20/northern-rock-mandelson Edmund, C. (2008, September 30). Financial crisis: Can the Bank of England's Mervyn King survive? . Retrieved April 24, 2009, from Telegraph: http://www.telegraph.co.uk/finance/financetopics/financialcrisis/3111227/Financial-crisis-Can-the-Bank-of-Englands-Mervyn-King-survive.html Fair Investment. (2009, February 24). Northern Rock: More mortgages + losses = bonuses. Retrieved April 27, 2009, from fair Investment: http://www.fairinvestment.co.uk/deals/news/mortgages-news-Northern-Rock-More-mortgages-plus-losses-equals-bonuses--2969.html Financial Services Authority. (2008, August 5). Annual Public Meeting 2008. Retrieved April 27, 2009, from FSA: http://www.fsa.gov.uk/Pages/Library/Corporate/Meetings/qanda_advance_08.shtml FSA. (2009). A regulatory response to the global banking crisis. Green, W. (2007). Branded regulation system branded a disaster. Journal Live . Group, D. B. (n.d.). History. Retrieved April 24, 2009, from Northern Bank: http://www.northernbank.co.uk/en-gb/About-the-bank/Bank-in-brief/Pages/History.aspx Nicholas, A. (n.d.). Banking Collapse: The Northern Rock Chips. Retrieved April 24, 2009, from The Global Guru: http://www.theglobalguru.com/article.php?id=163&offer=GURU001 Ravi, K. (2007, October 4). Northern bank goes down: Reasons and Lessons. Retrieved April 24, 2009, from Meri News: http://www.merinews.com/catFull.jsp?articleID=126772 Rochet, J. C. (2008). The future of banking regulation. New York. Tim, C. (2009, march 30). http://blog.iea.org.uk/?tag=bank-of-england. Retrieved April 27, 2009, from http://blog.iea.org.uk/?tag=bank-of-england Wallop, H. (2008, March 27). FSA admits string of errors over Northern Rock. Retrieved May 02, 2009, from http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/2786957/FSA-admits-string-of-errors-over-Northern-Rock.html Read More