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UK Banking Industry – Who Is Paying for Their Profits in 2010

Trends in Banking from 2010

In the beginning of 2011 the four largest banks in Britain were preparing to make public reports that indicate a combined annual profit of £25bn (Griffiths 2011). The increase in profitability appears to have survived the harsh and rigid economic trends are just beginning to be felt across the UK. The four banks namely Lloyds, Standard Chartered, HSBC and Barclays appear to have survived the storm and are reporting a 15% increase in profits from figures posted in 2009.

The hefty profits are due to the reduction in the size of bad loans allowing them to offset lower revenues from investment banking and trading activity (Griffiths 2011). The bumper revenues have seen the government go into talk with banks to increase lending to small business and renegotiate the pay packages offered to senior bankers in the industry. An agreement is yet to be reached with regards to these issues. It is reported that the CEO of Barclays is expected to receive a £8m bonus based on the bank’s performance in the 2009-2010 period (Griffiths 2011).

Following the 2009 economic crisis there has been increased pressure on banks to increase regulation to prevent banks from engaging in risking activities. This comes in light of the need to ensure that banks will not cause massive economic crisis such as that witnessed in 2009 (Griffiths 2011). There have been calls for state backing which has been welcomed if the banks are prepared to negotiate with regards to bonuses and lending (Griffiths 2011).

UK and Global Banking Trends before 2009

In the banking industry from 1990 to 2007, change within the industry was prompted by two factors namely, technological change and deregulation (Wilson et al. 2009, p. 1). The operational independence that was granted to the Bank of England in 1998 marked the beginning of an era that saw the regulation of the financial sector forego strategic in depth risk analysis and opt for lighter regulation policies (Miller et al. 2010, p. 2).

Deregulation removed barriers to competition in both traditional and new products while removing geographical boundaries (Wilson et al. 2009, p. 3). Following this it was assumed that large international banking organizations were allowed to act as regulators and saw them begin to undertake unsustainable risks due to their control in the regulation within of the industry (Miller et al 2010, p. 2).

This deregulation prompted banks to diversify with a view to maintaining competitive position within the industry. This position saw an increase by banks in ventures such as mergers and acquisitions (Wilson et al. 2009, p. 8). The result is ventures that merged with banks such as some mortgage companies went on to make huge profits from the property boom and began to compete with established banks. Another aspect that came with deregulation was an increase in risk taking that was prompted by the large incentives offered by banks and other large companies to increase profitability (Wilson et al. 2009, p. 23).

An example is the tussle between RBS and Barclays for the Dutch bank, ABN AMRO. The tussle saw RBS acquire the company but posted huge losses prompting the UK government to buy a large portion of RBS stock to prevent eminent collapse (Miller et al 2010, p. 3). A similar bail out was used to rescue Lloyds bank from collapse after the purchase of HBOS (Horn 2009). Soon after this came the collapse of the US based mortgage company Lehman Brothers marking the beginning of a major global financial crisis. It should be noted that the main reason banks are allowed to benefit from bail outs is their operations are far too complicated to be wound up as fast and efficiently as would be required under normal bankruptcy procedure (Miller et al 2010, p. 11).

Using the example of Lehman Brothers, it is reported the company had over 600 subsidiaries when it filed for bankruptcy. The collapse of major banking institutions in UK indicated that profitable banks are just as likely to collapse hence the need for independent regulation of the financial sector (Cipolloni & Fiordelisi 2008, p. 2).

UK Banking Practice after the Crisis

Following the financial crisis of 2009 there has been much research on the issues of capital, liquidity, provisioning and fair value. Following the deregulation of the industry it was reported that banks began to retain an increased amount of capital for a number of reasons such as acquisition, advantages of high economic capital, etc (Wilson et al. 2009, p. 25). It has been observed that the banking industry has a tendency to lend excessively during favorable economic periods and become extremely cautious lenders during periods after a crisis (Caprio 2009, p. 4).

This position is likely to be among the approaches that have taken root within the UK banking industry suggesting that the increased profits in 2010 are due to reductions in lending. This is most likely the case as indicated by the position of legislators involved in Project Merlin. The focal point of these talks being issues related to bonuses and lending (Griffiths 2011).

In relation to banking after the crisis another issue that has been raised is related to liquidity. It has been reported that within the UK credit growth was in excess of the deposits collected. It has been established that financial crisis and bank liquidity are related and financial crisis is often preceded by an excess or major decrease in liquidity (Wilson et al. 2009, p. 28). Again based on the statistics that indicate an increase in profits by the major banks in the UK it may be assumed that the banking industry is increasingly monitoring liquidity within the industry. The result is there is a reduction in the amount of credit being availed and an increase in retention.

Also in relation to the 2010 profits posted by the major banks in the UK it would be prudent to consider the role of provisioning in the banking industry. Provisions for loan loss are normally directly linked to an institutions present loan portfolio. During an economic upsurge there is a tendency to reduce the provisioning for loan loss while during an economic decline there is a tendency to increase provisions made to cover loss (Wilson et al. 2009, p. 30). This position suggests that in keeping with banking trends during a decline banks in the UK are currently increasing the provisions to cover losses. This implies the banks have less capital to inject into the economy. This may provide a reason in support of the reduction in lending that has been observed in the UK.

However, following increased pressure by the UK government with regard to regulating the operations within the major banks, it was reported that some banks threatened to take their business elsewhere (Griffiths 2011). It may be assumed that this was meant to arm twist the government in to allowing them independence in their activities. Such apposition is unlikely to be accepted by the UK government given that their role is to ensure banks are better prepared to avert future occurrences of similar crisis.

Despite the attempts by UK government to increase control over major banks operations it would appear the banks ignored the pleas based on current reports. It has been reported that major banks in the UK have managed to generate an exposure to the tune of £10bn in Greece, Spain and Portugal (Treanor 2010). Though there is yet no evidence of losses incurred in the move financial authorities have been keeping a keen eye on the region to avoid any surprises that may result. This is in light of the action by IMF in an attempt to resolve looming financial crisis in the Greek economy.

References

Caprio, G 2009, ‘Safe and Sound Banking: A Role of Countercyclical Regulatory Requirements’, IIIS Discussion Paper 311, pp. 1-36.

Griffiths, B 2011, £25bn for just four UK Banks. Web.

Horn, GA 2009, ‘Assessment of banking rescue packages and the economic recovery plans of member states – The examples of UK and Germany’, pp. 1-16.

Miller, M, Ghosal, S, Hammond, P, Waterson, M & Zhang, L 2010, Restoring Prudent Banking in Britain: evidence and policy. Web.

Treanor, J 2010, Debt Crisis: UK Banks sitting on £10bn exposure to Greece, Spain and Portugal. Web.

Wilson, C, Casu, B, Girardone, C & Molyneux, P 2009, ‘Emerging Themes in Banking: Recent Literature and Directions for the Future’, Working Paper Series, WP 07/09, pp. 1-47.