Financial Crisis at Major United Kingdom Banks

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During the past few decades, bank terms has become so famous and secure. For the safety and security of money people usually visit banks. Owning a loan has also become so easy by banks. Most of the UK banks offer heavy loans on flexible terms and conditions. Interest mark up is now not a nightmare of people. General public, even a low salary man, also visits bank if he needs any financial support. During past decades, banks have provided flexibility in availing every offer and package through banks. Last days; all regions were surfing from bad financial crises due to terrorism, nuclear wars and several other reasons (Bank of England 2007). Few countries have easily coped up with financial crises and now they are little stabilized but several countries are still facing financial crises and trying to resolve it. One of the famous newspaper states that UK banks are facing bad crises this year. Worst crisis for last 20 years, statement by leading bankers banks David Smith and John Waples. Leading bankers are reporting the worst financial situation in the international money market for the last 20 years, which has already risen in the following session when around £57 billion of market IOUs comes up for reinvestment.

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This biggest refinancing is not only focusing London but now exceeds the $100 billion that got due in the August, and which activated the most dangerous module in the financial-market junctures in which has observed that banks clambering for finances and market mark up costs rising frequently (Bris A, 2006). “This is a serious pressure point,” stated by one leading banker.

All leading bankers stated that this is the worst bank situation they have seen ever. The biggest portion of commercial paper is due to the hangover from the one of the famous newspaper states that UK banks are facing bad crises this year (DeYoung and Rice ,2004).

Royal bank of Scotland is second biggest bank on the globe and it is facing worst financial crises this year. Royal Bank of Scotland faced a 13 per cent decline in its share price as it issued that insurance company Fortis sell its stake in ABN AMRO, purchased as a component of around £50 billion assume led by Royal Bank of Scotland previous year. The complexity of an ABN instigated dealers to misunderstood the situation. The international market was concerned about the issue between Fortis and Royal Bank of Scotland. They wanted to know the degree of effectiveness caused to RBs against this issue. Financial crises also hits to Halifax and thousands of people affect from this biggest financial crises (Eisenberg and Noe, 2001). This unstable market situation made all clients worried where to place their money and what would be the guarantee that their money would remain safe.

All leading bankers stated that this is the worst bank situation they have seen ever. The biggest portion of commercial paper is due to the hangover from the financial junctures in credit markets that started with American prime mortgages. Mostly UK banks charge very low interest rates at flexible terms and conditions, which is also one of the biggest reasons of these financial crises at UK major banks’ financial junctures in credit markets that started with American prime mortgages. Mostly UK banks charge very low interest rates at flexible terms and conditions, which is also one of the biggest reasons of these financial crises at UK major banks (P and S, 2008).

Bradford & Bingley (B&B) is one of the UK’s largest buy-to-let (BTL) mortgage loaner; It is one of the largest bank which offers different mortgage plans in order to attract customers for more capital. There is little news coming up that B&B is facing bad financial crises (P, 2005). It augurs job losses and mortgage repayment boosts for thousands of people, as the banks look to reimburse their loosing.

It took place after the government’s nationalization of Northern Rock and Bank of England’s unexampled “liquidity scheme,” according to which it barters the banks’ credit card-backed securities which are untradeable Treasury bonds at very economical rates (DNB, 2006). Chief executive Steven Crawshaw refused all rumors that bank do not meet more cash but after one month he made an announcement to issues rights to share holders at economical rates. Other leading UK banks are also facing similar crises to B & B. Royal Bank of Scotland, Halifax; Northern Rock is finding difficulties to attract buyers for its insurance and announcing their rights.

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All above mentioned crises at UK major banks facing bad financial crises and most of the banks are announcing job losses, need more cash etc. the main reason behind the whole scene is failure of management control, during past few decades, banks were offering unlimited mortgages on flexible terms & conditions, there were no strict control on mortgages return, refinancing etc. Mismanagement and lack of consideration over risk factors, ignorance of rules and regulations are the biggest reasons for this downfall. No doubt all UK banks are passing through bad phase and such financial crises have not seen before in international market. Leading bankers, analysts are declaring this phase the worst phase of UK banks. The financial regulators, Bank of England and the Financial Services Authority (FSA), were highly involved in the whole matter. UK support and financial aid for the attack in Afghanistan and Iraq are also involved in this domain up to some extent.

Britain’s largest mortgage banks, Northern Rock will receive emergency funds of more than £4 billion ($8 billions) from the Bank of England due to the reason that the mortgage bank runs out of cash and is not capable to get hold of credit on the interbank money market because of the current liquidity squeeze and the banks own large subprime mortgage book risks. The Bank of England offered loan of around 6.75% which was much higher than 5.75% base rate (Walayat, 2007).

Just after 6 months of setting highs in share price, it was down gains by 50%, the current rate of 6.75 may also increase due to profit margins and bad debt provisions higher than the range of 14-17. Stock holders may send stocks to new multi-year low because of risk involved for banks to run out of cash and a risk of run on bank as saver. Stock holders may withdraw (Walayat, 2007).

Investors and savers were warned of the increasing tribulations Northern Rock is facing due to the huge size of its subprime mortgage book.

World’s central banks efforts to relieve the global credit crunch with a cash input did not impress the markets. This decision is very crucial to ensure the “solvency” of the financial system internationally.

The next goal for monetary authorities is the identify problems of liquidity and solvency for current issues of Northern Rock. The Northern Rock crisis seemed to be at first like a liquidity crisis (Kaletsky, 2007).

The primary value of the Rock’s mortgages and its capacity to pay back debtors in the long term is questionable. “Crisis happen on huge withdrawals by the depositors while the bank will not be able to sell off its mortgages or “liquidate” their long-term assets fast enough to pay back to the depositors” It is now apparent, however, that Northern Rock also faces a solvency problem. Due to the loss of confidence in the British housing market, the Northern Rock market value of its mortgages has reduced.” (Kaletsky, 2007)

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It’s not just a matter of liquidity and timing for Northern Rock’s, but all it’s assets value are far less than then the total money it has to payback to depositors. Until Government will not nationalize Northern Rock, it may not gain back in stock market. Almost undoubtedly Government after putting it into administration has to nationalise Northern Rock (Kaletsky, 2007). The nationalisation and administration will improve Northern Rock’s market share. “This Government can help to stabilize the bank by putting it into bankruptcy, hence wiping out the shareholders claims and seize control of its assets. The Treasury can buy the bank for £1 from its administrator, taking control of its mortgages and assets while paying off the depositors out of public funds in exchange. Treasury can recover the investment gradually.” (Kaletsky, 2007)

Money is the most important invention for economic welfare after language itself. Money is almost as important as language because it allows time and distance of trade to increase with no bounds as long as the parties involved believe that it exists. Neither banks nor governments are necessary to the existence of money and indeed money is so useful and so profitable to all who believe in it that for most of history it has existed in some form in almost every society for which records exist. The development of banks and paper/electronic money is a modern phenomenon and in many currencies there is still at least a linguistic link to an earlier physical commodity currency.

The role of government and banks is therefore as guarantors. It is as if there was a gigantic auction of promises with the auctioneer guaranteeing the delivery of each promise. Northern Bank is a British based bank in North East England which is owned by the UK government. It was formed in 1997 by distributing shares to members who held savings accounts and mortgages (Financial Times, 2008). It was demoted back to the FTSE 250 in December 2007. It was suspended from the LSE due to the nationalization of the bank (Financial Times, 2008). In February 2008, the bank was nationalized after unsuccessful bids to take over the bank. Northern Rock fell from grace when it announced in January that it had recorded pre-tax profits of pounds for six hundred and twenty seven million for 2006. This was higher at twenty seven percent compared with 2005 (Walters, 2007). This was a decade of success since the late 1990s when it converted from a building society to a bank listed on the stock exchange. Each year would witness assets grow despite the small number of branches. Northern Rock had become Britain’s fifth largest mortgage provider with ambitions of becoming the third largest. It relied on wholesale markets as compared with retail deposits to finance its lending activities (Stephens, 2008). It securitized its mortgages which led it to bundle loans together and package them into bonds. They were sold to investors around the world. By January 2007 it had six billion pounds which increased to ten billion pounds in May. This made the company the top securitizer in Britain (Economist, 2008). “There are numerous reasons for expecting some sort of government intervention if the markets fail to arrive at a private-sector solution by the time the year-end results are published. If shareholders refuse to believe the banks’ audited financial statements or if their auditors find themselves unable to express true and fair options on the value of mortgage assets.” (Kaletsky, 2007)

With money coming from capital markets, securitization was helping boost the company. It was able to raise money quickly as compared with its rivals as it priced its mortgage offers more openly and carried out a quick expansion. They had plans for more securitizations in the year (Julian Marshall, 2008). The first six months of 2007 led to lending of thirty one percent on the same period in 2006. It’s net of redemptions increased to forty seven percent (Marketing Week, 2008). Many customers in September 2007 began to withdraw their savings. Many savers flocked to many banks to withdraw their savings (New Statesman, 2008). Northern Rock’s shares had lost forty percent of their deposits. (Northern Rock investor) This was considered to harm the reputation of the British banking industry.

Britain’s actions to provide aid to the bank were approved by the European Union regulators in December 2007. By January 2008, Northern Rock’s loan had grown to twenty six billion pounds from the Bank of England. It also announced that it had sold its portfolio of home equity to JP Morgan for two billion pounds. It was announced in February 2008 that Northern Rock would be nationalized (The Times, 2008). It was claimed that private bids did not offer any value for money for the taxpayer. It was said that the bank would be brought under a temporary period of public ownership. The government would be shareholders as it would manage the bank on a commercial basis. An arbitration panel would decide on the fair price for the compensation to be offered to investors for their shares. The parliament passed a law which called for the nationalization under the Banking Act of 2008 (The Times, 2008).

It will also cut its workforce by two thousand workers since 2011. It also confirmed that it would launch negotiations with unions and most job losses would be later in 2008 (Alistair, 2008).

It also announced the termination of its Danish savings operation. SRM Global and RAB Capital are hedge funds which owned twenty percent of the bank. They plan to take action against the government because they accuse it of being responsible for the problems of the bank.

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HBOS which was Britain’s largest mortgage lender stopped issuing mortgages also witnessed Northern Rock increase its share of the net new lending market by nineteen percent. This was high for a bank which had only seven percent of outstanding loans at the end of 2006. However the bank’s share was sliding down as the Bank of England pushed interest rates sharply (Wall Street Journal, 2008). The city was worried by the prospects of the mortgage lenders. Northern Rock had a good loan book as repayment arrears were half as compared with the industry. The bank suffered as financial analysts began to research how the United States excessive high risk lending might spread.

The problems of nationalization do not end there. Shareholders would demand compensation, something that the Treasury has suggested it would provide. But arriving at a valuation that is satisfactory to all parties would be all but impossible, especially because there is a danger that the government could fall foul of EU rules on state aid. There is also a fear that nationalization could trigger repayments to Northern Rock’s bondholders, who own about GBP2bn of the bank’s debt, and that investors in the offshore securitization vehicle Granite could call in their loans. On the brighter side, in so far as one exists, Northern Rock need not be a constant drain on public resources (Parker, 2008).

Prime Minister Gordon Brown has indicated that its assets would eventually be sold back to the private sector and, as the recent sale of the GBP2.25bn equity release portfolio to JPMorgan showed, they can fetch book value. The speed with which Northern Rock has be reprivatized, or more probably sold off piecemeal after nationalization, was critical in the damage. It became politically unpalatable, as well as fiscally and morally extremely hazardous, for the government to prolong its involvement in the business of lending to consumers and of repossessing the homes of voters. In all these circumstances, an immediate private sector solution must be the preferred option and was still possible as The Banker went to press. The Northern Rock Crisis caused inevitability about it. When the once-unthinkable finally happened, there was a weary inevitability about it.

Any private sector bank did not have a chance to get the bank to run smooth operations and to repay the government in loans and guarantees. The first impact will be what the bank’s new managers run the operations. Prime Minister Gordon Brown will have to assess the damage caused by the nationalization. Nationalization is a controversial subject in the United Kingdom (Euroweek, 2008). It reminds of the 1970s when Labor party presided over the failing state owned firms and bitter strikes. It was voted out of office for eighteen years. There was a struggle to exclude the concept of nationalization from the movement’s manifesto. However it was only after the election of Tony Blair that the commitment to public ownership of production was ditched. Many of Brown’s associates will use Northern Rock to show that his economic management is backsliding. The Tories have labeled Northern Rock as “Labor’s Black Wednesday”. They believe that it will affect the British financial system. “The announcement of the nationalization of Northern Rock caused a political outcry on the news as no one doubted that Parliament had passed a law which would bring the bank into public ownership. Since its cash dried up and turned to the central bank for help, its rescuers had fallen one by one.” (Kaletsky, 2007)

Mr Brown and his team have escaped the worst of political repercussions. However the decision to nationalize Northern Rock has wounded them. There have other embarrassing moments on the economic field due to the taxing of capital gains, growth and inflation. Northern Rock adds to the problems for the government as it is seen as an insolvent bank rescued by the government which has a budget deficit of three percent of GDP. Most voters believe that Northern Rock will be a thorn for years to come. However ominous the symbolism, Britain’s first nationalization for a generation has not killed Mr. Brown’s government in the way that Black Wednesday finished the Tories. “The upshot is that the year-end results season offers stock markets a last chance to make plausible estimates of mortgage losses and to recapitalise the banks.” (Kaletsky, 2007) But it could prove one of the thousand cuts that do. It is not that government should not be involved in business but that it should do so in a transparent and businesslike way. This is nationalization of a failed institution, deliberately undertaken for political reasons but clouded in the pretence of commercial pragmatism. One big institutional investor said the government’s decision to nationalize the bank was driven mostly by the fear of embarrassingly large profits being made by the private sector.

Halifax Profitability, Liquidity and Gearing ratios over past decades has proved the biggest saving ratios among all other banks. The ratio arrived repeated lows in 1971 was 5.0%, in the year of 1988 was 4.9% and lows reached in the year of 1999 was about 4.9%. In direct contrast, there were two clear repeated peaks in the saving ratios as it is proved that in early 1960s: 1980 it was 12.4% and in 1992 it was 11.6%. These changes are highly dependent on UK economic cycle.

List of References

  1. Alistair MacDonald (2008). Credit Crisis: Northern Rock Collapse Spurs Changes. Wall Street Journal (Eastern Edition), p. C.2.
  2. FSA review slams mishandling of the Rock. (2008). Euroweek
  3. George Parker, Jane Croft. (2008). Northern Rock to announce loss for last year. FT.com
  4. Kaletsky, A. (2007) This crisis is no longer a simple problem of liquidity.
  5. Northern Rock Sees More Losses. (2008). Wall Street Journal (Eastern Edition), p. C.11.
  6. Northern Rock starts talks to cut one third of staff. The Times (2008).
  7. Northern Rock to retain brand identity. (2008). Marketing Week,6.
  8. Bank of England (2007), Financial Stability Report, Issue 21.
  9. Bris A, (2006), ‘The Costs of Bankruptcy: Chapter 7 Liquidation Versus Chapter 11 Reorganization’, Journal of Finance, Vol. 61(3), pages 1253-1303.
  10. DeYoung and Rice (2004), ‘How do banks make money? The fallacies of fee income’, Federal Reserve Bank of Chicago Economic Perspectives, Vol. 28, pages 34-51.
  11. Eisenberg, L and Noe, T (2001), Systemic risk in financial systems’, Management Science, Vol. 47 (2), pages 236-49.
  12. Sveriges Riksbank (2007), Financial Stability Report, 2007.
  13. Whitley J. (2004), ‘An empirical model of household arrears’, Bank of England Working Paper no. 214.
  14. Gai, P and Kapadia, S (2008), ‘Contagion in financial networks’, mimeo.
  15. Allen, F and Gale, D (2000), ‘Financial contagion’, Journal of Political Economy, Vol. 108 (1), pages 1-33.
  16. Tucker, P (2005), Where are the risks?’, Bank of England Financial Stability Review, Vol. 19, pages 73-7.
  17. DNB (2006), Is the Dutch financial sector stress-resistant?’, DNB Quarterly Bulletin, pages 35-41.

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