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ROLE OF THE GOVERNMENT The UK government has announced a package of measures aimed at rescuing banking system that makes 400 billion pound. 100 billion pound will be available in short term loans from bank of England on top of an existing loan facility. Banks will have to increases their capital by at least 25 billion pound and borrow from government. An additional 25 billion pound in extra capital will be available in exchange of preference shares.
Government described as the root cause of current financial crisis is liquidity, capital and funding At least 200 billion pound will be made available from bank of England for short term borrowing to provide liquidity to banks Those banks who wished to strengthen capital ratios through the government is required to maintain bank recapitalization fund. GOVERNMENT SUPPORT TO NORTHERN ROCK Northern Rock announced that they would be offering ? 14 billion worth of new mortgages, over the next two years, as a part of their new business plan.
This type of new lending will be partly funded by an increase in the government loan, a reversal of previous strategy to pay the loan off as quickly as possible by actively encouraging mortgage customers to leave when their mortgage deal matures. The reason for this change being government policy to increase the availability of credit. This ? 14 billion will be split into ? 5 billion in 2009 and ? 9 billion in 2010. The Government announced guarantee arrangements in all existing retail savings in, certain existing wholesale liabilities of, Northern Rock.
Govrnment asked northern rock bank for immediate financial suppot from bank of England. Government have taken northern rock bank into temporary public ownership using powers under banking act. and announced that it would strengthen Northern Rock’s capital position by converting up to ? 3 billion of the Government loan into equity, and converting ? 400 m of preference shares into ordinary shares. GOVERNMENT SUPPORT TO RBS (Royal bank of Scotland) The government is to own 57. 9% of royal bank of Scotland after share holders bought only a tiny proportion of the new shares being offered by the bank.
The share issued by RBS , which owns NatWest was part of government plan to recapitilise banks. The government pay about 15 billion pound for the majority stake of bank. It will also buy 5 billion pound of shares in the bank. The government altered the terms of the bail out to allow preference shares – which do not carry voting rights – to convert into ordinary shares The preference shares were originally supposed to be held by the government for three years and carried a 12% rate of interest at a cost to RBS of ? 600m.
The Government and RBS’s decision to take this course of action was to make additional core Tier 1 capital available to the bank and was justified on the grounds that it would strengthen the bank’s resources and enable it to “build its capital further Government support to Bradford & Bingley The UK government has taken over the mortgage operation and headquarters of Bradford & Bingley plc , the UK’s biggest lender to landlords. Government used provisions contained in banking act to transfer the bank retail deposit business along with its branch network to Abbey National bank.
Bradford & Bingley assets and Liabilities comprising its mortgage book, personal loan book, headquarters and relevant staff, and treasury assets and its wholesale liabilities was taken into public ownership with the intention of winding down operations. As part of the transfer order, the Government put in place guarantee arrangements for six months to safeguard certain wholesale borrowings and deposits with Bradford & Bingley in order to provide assurance to wholesale depositors and borrowers and preserve wider financial market instability and maximise proceeds in the downturn.
Bank recapitalization was necessary to maintain confidence in the UK banking sector. Given prevailing market conditions it was clear that some UK banks would have collapsed without taxpayer support . The Government’s support in return for stakes in banks that was unable to raise capital through banks that were unable to raise additional capital through the private sector. Since the market began to tumble in 2008, Governments around the world have spent almost $ 11 trillion bailing out falling banks and trying to repair the financial system As per the IMF data all the governments of the world has so far spent more than $ 10. trillion to avoid the ill effects of last years financial crisis. Out of this huge sums are spent by the rich nations. [pic] Out of this the maximum amount is spent as guarantee given to save the existing banking system, which was effected by last year’s crisis. This crisis was worst than the great depression of 1929. US had spent $ 3. 6 trillion to bailing out failing banks and repair the financial system. 25. 8% of total GDP for bailing out ie 25. 8% of the total GDP, which is $ 10,000/- per person. UK had spent $ 2. 4 trillion as 94. 4% of GDP for bailing out failing banks. ie 94. 4% comes around $ 50,000/- per person.
The private financial sectors also have estimated write-offs amounting to $ 4tn, of which two-third are losses suffered by big international banks such as Citigroup and RBS. About half of these losses write-offs of securities backed by failed mortgages. UK government has spent 94. 4% of the GDP to bail out the banking system as follows: [pic] In-spite of this UK is not comes out the recession and the last quarter was the sixth consecutive quarter, were the GDP is continuously declining, whereas Germany, France and Japan have already come out of the recession technically six months back.
UK has been one of the hardest hit by the financial chaos. Due to the recession and credit crunch in the banking industry, this has affected pay cuts, redundancies and acute unemployment throughout the UK. The hardest hits are pensioners, blue collared employees and poor class people. Besides this, there is a wider effect on accumulated personal wealth of the nation. BBC reveals that in the course of 2008 alone ? 815bn was knocked off the wealth of households in the UK that amounted to an average of nearly ? 31000 /- for every household in the UK. This is not all the sudden slump in the house prices have also effected the economy.
According to the govt. figures there is 9% cut in the market value of the residential property. As per the Halifaxes own index the house prices have fallen by 17% which are effected very badly the personal wealth of the house owners. (Two-third of the households in the UK own or are buying their own home). On top of this the bankruptcy of Lehman Brothers has affected the share market very badly. The share index fell from 6,457 at the end of December 2007 to 4,434 at the end of Dec 2008- a drop of 31%. This has hit hard to the pension funds, insurance companies and other professional investment outfits.
The good news is that the recent studies shows that in UK people have now started paying off their personal debts, which means that economy is showing the sign of improvement. Economists worried the recession has still continue even after the 3rd quarter of 2009, despite the measures taken by government and Bank Of England, and they recommend that the government intervention including help for business to get finance and to promote investment are still required. This will help to boost the confidence otherwise recovery will be delayed further. Royal Bank of Scotland In??June 2008??RBS sold??Angel Trains??for ? 3. billion??as part of a ? 10 billion assets sale to raise cash. In late??October 2008??it was reported that the insurance company??Swiss Re??and??venture-capital??firm??CVC Capital Partners??were to purchase the insurance division for a reported ? 6 billion which would reduce some of the funds needed from the Treasury. In March 2009 RBS announced the closure of its??tax avoidance??department, which had helped it avoid ? 500m of tax. The closure was partly due to a lack of funds to continue the measures, and partly due to the 70% taxpayer stake in the bank In September 2009, RBS and Natwest announced cuts in their overdraft fees.
The unpaid item fee was reduced to ? 5 from ? 38 and the card misuse fee was reduced from ? 35 to ? 15. Northern Rock The bank planned to repay the government debt within three to four years; primarily by encouraging mortgage customers to take their mortgage to another lender. As of 3 March 2009 the bank was repaying the loan well ahead of target, owing a net balance of only ? 8. 9 billion of the loan which stood at ? 26. 9 billion at the end of 2007. By October customers appeared to be regaining confidence in the bank, when it emerged that there had been a surge in the number of new accounts which had been opened.
People appeared to see the Northern Rock as a safe place to put their money, given the current status as a nationalised bank which cannot fail. On 23 February 2009 Northern Rock announced that they would be offering ? 14 billion worth of new mortgages, over the next two years, as a part of their new business plan. Bradford & Bingley On 27 March 2009 the Government announced that it had sought approval from the Commission for the continuation of the guarantee arrangements.
On 29 September 2008, the British government announce that the troubled bank, whose profits were adversely affected by the credit crunch had been part nationalized and that the Spanish bank had purchased all of Bradford & Bingley’s 20 billion pound savings business. Following nationalization on Sept. 29, 2008, B&B is wholly owned by the U. K. government. B&B as being of moderate systematic importance to the U. K. B & B creditworthiness is effectively dependent on U. K government. B&B reportedly suffered material credit impairment losses on parts of its structured asset portfolio in 2007 and 2008, in common with many other banks.
The impairment charge on structured credit investments rose to ? 192 million in 2008, compared with ? 94 million in 2007. These investments have thus been substantially written down, and now consist of principal protected notes (PPNs) (? 428 million), and credit funds (? 44 million). Market Capitalisation of banks in FTSE -100 (in billions) |Banks in FTSE- 100 |02 APRIL |07 APRIL |06 APRIL | | |2007 |2008 |2009 | |RBS |62. |37. 1 |17. 2 | |NORTHER ROCK |4. 8 |- |- | |BRADFORD &BINGLEY |2. 9 |- |- | |TOTAL |70. 5 |37. 1 |17. 2 | The Changing Financial Environment After the crises the UK Govt. has invested billions of pounds into HBOS, RBS & Lloyds simply to keep the bank doors open. UK govt. as nationalized Northern Rock and Bradford and Bingley and today govt. of UK owns 43% of Lloyds Bank (which owns HBOS) 70% shares of RBS, which are among top 5 Bank of UK. In return for the investment now the govt. has “say in the management and they control “bonuses” paid to the management. Chancellor Alistair told that the rescue package was required to help people and business of this country and for supporting the economy as whole. After the bad experience of 2007-08, the new management of banks is planning to sell some of their department/business which is not the core business to their overall perception.
It will be not easy and may take few years. Now the total environment is changing and RBS and Lloyds TSB has started mortgaging and giving loans to small businessmen and very soon they are targeting to reach 2007 levels. Now banks are working with more equity, with less leverage and with bigger buffers of liquidity. Executive Summary This project intends to examine the impact of the current financial crisis on UK between the year 2008 to 2009. Here three banks are being mainly focused namely 1). Royal Bank of Scotland 2). Northern Rock 3). Bradford and Bingley
An analysis and case study is done on the above mentioned banks here, carefully examining how these banks were affected by the financial crisis and how they are recovering from it. Governments approach towards Royal Bank of Scotland , Northern Rock and Bradford & Bingley in which government have led a massive support to these banks and helped them from recovering from financial crisis by providing them fund from central banks. The main reason for UK to be one of the hardest hit by the financial chaos is being pointed out in this report. CAUSE OF FINANCIAL CRISIS
The immediate cause of the financial crisis was the crash of the united state housing market which peaked in approximately 2005-2006. high default rate on “subprime” and adjustable rate mortgages began to rise. An increase in loan incentives (such as initial terms) and a long term rising trend encouraged borrowers to difficult mortgages. Once interest price began to rise and housing price began to drop moderately in 2006-2007 in many parts of U. S refinancing became more difficult. Default and foreclosure activity increased and home prices failed to go up.
As housing prices declined, major global financial institutions that had borrowed and invested heavily in subprime mortgages reported significant losses. The lack of confidence in the market led to an almost complete freeze of credit markets, all banks, hedge funds, lenders etc rely heavily on borrowing money from other banks. Suddenly no banks wanted to lend and nobody could borrow. Lack of lending between banks has forced central banks in the US, UK and Europe to intervene on an unprecedented scale, offering the equivalent of hundreds of billions of dollars in ’emergency’ loans to bail out banks.
This is supposed to have the effect of rebooting interbank lending. But investors have responded by selling off their shares in banks and building societies. How did it affect the U. K banks Banks like Northern Rock in the U. K that relied heavily on borrowing money from other banks, lending it on mortgages, and then selling the loan book for a profit, no longer had a working business model. This caused a liquidity crisis at Northern Rock. They went under others followed. The highly??leveraged??nature of its business led the bank to request security from the??Bank of England.
This in turn led to investor panic and a??bank run??in mid-September 2007. Northern Rock’s problems??proved to be an early indication of the troubles that would soon befall other banks and financial institutions. HBOS was in good state but lack of confidence from investors, savers etc led to its failure. As confidence had fallen so has the share price. Companies directly involved in home construction and mortgage lending could no longer obtain financing through credit markets. Over 100 mortgage lenders went bankrupt during 2007 and 2008. The crisis hit its peak in September and October 2008.
Several major institutions either failed, were acquired, or were subject to government takeover. As a result British banks lost more than $2billion that was equivalent to 3% per GDP. Borrowers face even higher charge rates from the banks which are expected to try to make up their losses by charging for mortgage loans & credit cards. APPENDIX : GLOSSARY RBS Royal Bank of Scotland B & B Bradford & Bingley GDP Gross Domestic Product HBOS Halifax Bank of Scotland FSA Financial Services Authority
IMF International Monetary Fund UKFI UK Financial Investments NR Northern Rock Lloyds TSB Taylor and Sampson Lloyds Bank BOE Bank of England FTSE Financial Times Stock Exchange LITERATURE REWIEW Mervyn King, Governor of the Bank of England “failures in the international monetary system led to imbalances in capital flows between countries that created the conditions of remarkably low interest rates and encouraged risk-taking” Jason Maples, Personal Finance, Denver Business Journal. The combination of decreasing home prices and higher mortgage payments due to increase in the adjustable rate mortgage market causes for financial crisis ” Lord Myners, the British government financial services secretary British banks are partly to blame for the current global recession Poor government regulation on UK’s banks and financial institutions has also been blamed for the recession. The Golden days of huge bonuses in The US and UK and most other parts of the developed world led banks and other financial executives to lose a broader sense of the world around them. INTRODUCTION
The aim of this project is to identify the possible causes of the UK’s financial crisis and to extrapolate ways of recovering from the crisis. The world is currently experiencing an economic downturn and everybody is wondering what could be responsible. The utility of banking, and the special importance of the sector to all other industries, and individuals, in the economy means it is extremely difficult for governments to permit a failing bank actually to go bankrupt. This is particularly true of the very large UK retail banks such as RBS, Lloyds Banking Group, Barclays and HSBC the bankruptcy of one of hese institutions would have catastrophic impacts on depositors and others. The U. S. financial crisis quickly spread worldwide given the interconnectedness of the global economy in trade, finance and investments. The impact on and reaction from developed countries like UK differ based on their global economic integration and policy responses. EVIDENCE FOR RESEARCH http://edition. cnn. com/2008/BUSINESS/09/30/us. bailout. timeline/ http://www. globaleconomiccrisis. com/blog/archives/tag/banking-crisis http://www. telegraph. co. uk/news/uknews/1563266/The-Northern-Rock-crisis-explained. tml http://www. ibscdc. org/Case_Studies/Economics/Economic%20Crisis/ECC0015. htm http://www. marketoracle. co. uk/Article5087. html(with graphs) http://news. bbc. co. uk/2/hi/business/6994160. stm(northern rock) http://en. wikipedia. org/wiki/Nationalisation_of_Northern_Rock http://www. ibscdc. org/economic_crisis_case_studies. asp? action=pg&page=2 (Rs200) http://pajamasmedia. com/blog/financial-crisis-has-odd-effects-in-uk/ http://en. wikipedia. org/wiki/List_of_bankrupt_or_acquired_banks_during_the_subprime_mortg age_crisis