Intrdutry Securities and Markets - Example

INТRОDUСТОRY SЕСURIТIЕS АND МАRKЕТS Student’s Name Course Professor’s Name University City (State) Date INТRОDUСТОRY SЕСURIТIЕS АND МАRKЕТ Issues that have arisen for banks since the financial crisis in 2008 Introduction The financial crisis of 2008 affected the banking sector, which made many banks lose a lot of money on mortgage defaults, credit to consumers, interbank lending to freeze, and business to dry up. Internationally, the financial crisis affected the banking sector by spawning the new regulatory actions through Basel III. In America, the banking sector was affected by the financial crisis through the Consumer Protection Act and the Dodd-Frank Wall Street Reform. Before the financial crisis happened, America had passed regulations that pressured the banking sector to make it easy for customers to buy homes. As such, the banks received high margin and charged large fees from the subprime mortgages, where they also used the mortgages to obtain private label and mortgage-based securities. However, after the recession took place in 2008, many customers were not able to pay the mortgages, which affected the banks, not only in America but also across the world. In analyzing the effects of the financial crisis on the banking sector, this essay explores how the bank sector was affected, where it focuses on changes in regulation, vertical integration and specialization, complexity, horizontal integration, geographical scope, and different competitive advantages of some banks. Changes in regulation The subprime mortgage crisis in America made the domestic and foreign financial firms record major capital losses that had been invested in securities that used the real estate loans as collateral. As a result, it affected the credit crunch in America severely, which resulted into a major global finance. The major financial crisis resulted in banks changing their regulations. For instance, in 2009, banks were forced to reduce their dividends, where they planned on issuing new shares. The reason behind this was the fact that the banks had to make sure that the liquidity of the banks remained at good levels (McGuire & Goetzvon 2009). However, people across the world were receiving limited income, which affected the profitability of the banks. The financial crisis resulted in the funding costs of the banks going up. For example, the credit risk premiums reached a high point for the bank’s long-term funding, with the prices of the long-term financial plans exceeding the demands, which resulted in some of the major companies in the world facing liquidity problems. As a result, some governments, such as the Icelandic government, took over the largest banks in their country, which affected the branches of the major banks in these countries. The crisis demonstrated to the banks the importance of having and knowing risk management. As a result, many banks have been advocating the need of having stress tests in the banking industry at a global level, which saw the European financial ministers hold several meetings in 2009 (Milesi‐Ferretti & Cédric 2011). The main importance of the meetings was that it helped the banks restore mutual trust with the aim of getting to economic recovery. Different competitive advantages of particular banks The financial crisis resulted in the banking sector record a decline in the competitiveness level. After the Lehman Brothers collapsed, other banks, with a good example being the Royal Bank of Scotland were bailed, while other banks such as HypoVereinBank, and ABN AMRO were nationalized. According to some experts, the financial crisis in 2008 was caused by inadequate banking regulations, financial innovations, and too much competition (McCauley & Jenes 2008). The reason behind this is the fact that the increased competition made banks make risky decisions, which affected the stability of the banks negatively. Another important thing to note is that the great competition eliminated the weakest banks. After the 2008 financial crisis, major banks such as the Standard Chattered and Barclays realized the importance of keeping the competition simple and adequate to make sure that the banking sector has stability. The banks realized that lack of stability would affect the whole banking industry, including them. The crisis made the banks monitor major changes in the determinants of competition and competitiveness. According to some scholars, regulatory policies during the 2008 crisis affected the competition between the major factors (McCauley & Jenes 2008). The effects were due to the law framing the scope and sector of the bank activities. The crisis caused a major credit risk just as the competition between banks was affected by the market climate. The major effect of this credit risk was the major banks regulating their competitiveness by changing their structures of incomes and concentrating on providing the banking services to the market. The major effect of the financial crisis on the banking industry was an increase in income from fixed and provisions administration fees and a simultaneous decline in the interest income. The tendency was caused by the banking regulations that were designed to limit the levels of deleveraging and risk. Vertical, horizontal integration versus specialisation The major financial crisis in 2008 affected the banking sector, where many banks adopted the act of vertical integration and vertical specialisation. Weak corporate governance in some banks transformed the vertical integration of these banks from an efficient organizational structure to a structure with perverse incentives, weak oversight, and destructive employee behavior, with a good example, in this case, being the Washington Mutual bank (Mian & Sufi 2009). The Washington Mutual Bank became one of the largest banks to fail in American history during the financial crisis in 2008. The reason behind this was that the governance quality of the bank was poor, which saw financial mismanagement resulting in an increasing default of mortgages. The bank officials approved the changes to give the executive team with compensation packages, with the main aim being to exclude home foreclosures and loan losses as the main performance metrics that were used to determine pay. Poor governance of the bank resulted in it recording major losses. In this case, vertical integration aligned with division incentives, though it aligned them towards myopic goals of deception, short-term growth, and excessive risk. The perverse incentives were caused by three governance reasons. The first reason was the board failing to supervise the management team. The second reason was the managers coming up with a consistent and self-serving compensation plans to support the aggressive growth strategy, which was caused by lack of supervision. The third reason was the myopic shareholders failing to provide pressure and oversight to consider the long-term objectives of the bank, which resulted in the major banks fearing to invest in the bank (Novak & Stern 2009). The combination of poor governance and vertical integration created perverse complementarities, which enabled excessive fraud and risk. Lack of banks vertically integrating into securitization resulted in the banks finding it hard to find loan outlets without external risks. As a result, the banks recorded major losses. Recovering from the crisis Banks have recovered in a slow speed after the 2008 financial crisis, which has seen a major change in investment banks. After the Lehman Brothers bank went bankrupt in 2008, the banking industry recorded its lowest point. However, the bank industry is now making slow advancements in the evolution and recovery option. In this part of the report, we shall look at how investment banks have changed, including how these banks carry out their operations today. Some of the changes in the banking industry due to the financial crisis have resulted in: Banks returning to core businesses The financial crisis made the bank board think about what they are good at, which made them realize the business areas that they should be in. Even though this process has been deemed painful, it has been seen as cathartic. It has resulted in the banks having a renewed focus on facilitating trading, lending money, and giving financial advice (Cetorelli & Linda 2009). At the same time, the banks have stepped away from activities such as reselling and repackaging loans. The banks have also avoided putting large amounts of money into hedge funds and private equity. Better regulation Banks have developed regulations that aim at making the banking systems safe. The regulations have asked the banks to hold more liquid and more capital assets. The regulations have also asked the banks to be more rigorous and thoughtful in their stress-testing and risk management, with a good example being to record all the losses that the banks make in their accounting systems (Khwaja & AtifMian 2008). Recording of losses helps in reflecting the actual financial position of the banks. Global restructuring The financial crisis resulted in many banks rethinking about how they have organized and structured their businesses globally. The crisis resulted in policymakers looking for best ways to protect the best interests of their countries, which have made them put regulatory walls that restrict the free flow of money across nations (Lane & Gian 2012). In looking for ways to respond to these changes, banks have considered restructuring their businesses. One of the changes is in the funding structure, where banks have delivered. As a result, banks have started holding more capital with the aim of reducing its usage, which means that the money can be used for short-term funding, and at the same time making the banks more resilient to extreme shocks. Geographical client trends The banking industry has seen the number of emerging market companies operating globally rise over the last few years, which has made them focus on working with them. The countries with strong economies mean that its clients will be more profitable to the banks compared to countries with weak economies (Raddatz 2010). As a result, some of the major banks have restructured their businesses by increasing the number of banks in countries with strong economies, and at the same time reducing the number of banks in countries with weak economies. However, the banks have also developed some ways of helping the clients in countries with weak economies, with a good example being the restructuring of the business, or increasing the amount of capital to strengthen the balance sheet (Schoenmaker 2013). The use of localized banks and Boutique banks The weakness of the European banks has made European companies focus on borrowing money from the global bond markets rather than borrowing from these banks. As a result, major banks such as RBS, Standard Chartered, Goldman, and Wells Fargo, which have expertise in capital markets, have seen this as an opportunity to make a recovery (Van Horen 2011). These banks have seen this as a positive trend not only for themselves but also other major investment banks across the world Banks such as Deutsche, Barclays, and HSBC can provide their clients with a better range of advisers compared to boutique banks, which has been a big advantage of these banks. The financial crisis made it hard for many companies raise capital, which resulted in the chief financial officers and chief executive officers of the above banks discussing the capital structure of the banks (Strahan 2013). As a result, it has been easy for these banks to advise companies on how to strengthen their balance sheets, and how the banks can provide them with good funding. This has provided these banks with a competitive advantage over the other banks. Conclusion In conclusion, the financial crisis of 2008 affected the banking sector, which made many banks lose a lot of money on mortgage defaults and credit to consumers. The financial crisis resulted in banks changing in their regulation, specialisation, and changing in vertical integration. Major banks across the world found it hard to remain in business, with a good example being the Lehman Brothers. However, banks are making a slow recovery from the 2008 financial crisis, which has resulted in investment banks making major changes to survive in the market. Despite the fact that the banking industry is recovering from the 2008 financial crisis, it is important to note that good risk management should be observed to avoid getting into another major financial crisis. REFERENCES LIST Cetorelli, N., & Linda S. G. (2009). “Global Banks and International Shock Transmission: Evidence from The Crisis,” mimeo (available at: http://www.ny.frb.org/research/economists/goldberg/IMF-BOF-PSG_121409all.pdf ). Khwaja, A. Ijaz & AtifMian, (2008). “Tracing the Effect of Bank Liquidity Shocks: Evidence from Emerging Markets,” American Economic Review, 98(4), 1413-42. Lane, P.R. & Gian M. Milesi-Ferretti, (2012). “External Adjustment and the Global Crisis” Journal of International Economics,88(2), 252-265. McGuire, P. & Goetzvon P. (2009). “The US Dollar Shortage in Global Banking,” BIS Quarterly Review, March. Milesi‐Ferretti, G. & Cédric T. (2011). “The Great Retrenchment: International Capital Flows During the Global Financial Crisis,” Economic Policy, 26(66), 285-342. McCauley R. & Jenes Z. (2008). “Asian Banks and the International Interbank Market,” BIS Quarterly Review, pp. 67–79, June. Mian A. & Sufi A. (2009). 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