Critically assess the structure, conduct and recent performance of the UK banking sector. By Ambika G.

Introduction UKs banking sector has grown at an average rate of 2.3% annually since 1990 from 1,266 billion to 7,616 billion in 2009 and is one of the most important sectors of the countrys economy. Over 50% of the assets in the UK are owned by foreign banks. The banking sector is currently in a state of crisis which according to most economists was caused by the large surpluses and deficits in the current accounts of the balance of payments of many countries. Historically, the banking firms in UK were confined to retail banking and were limited to certain types of business and Since1960s, retail banking in the UK has been dominated by the big four Barclay's, Lloyds, Midland and National Westminster who were accused of being an oligopoly and of cross-subsidization. Thus began a slow process during which policies changed and the UK government encouraged greater competition in the banking sector by loosening up restrictions in banking industry. After deregulation, the free market economy helped to generate hypercompetetion (Zuboff 1996). Traditional lines within the sector were broken down and gave birth to wider product range. (Thwaites1991).

Root cause of Crisis The root of the problems of the British banks is the same as that of American banks: shaky mortgage-backed securities (Richard Anderson,2009). These assets which were valued as AAA weakened by the rising mortgage default rates and their values dropped sharply.

Effects of Crisis 1.By March 2009,because of the major slowdown in the UK economy, Bank of England reduced its base rate to 5.5% which was 5.5% on Dec 6th 2007. to 0.55%(see figure no. 2),

Source:-bankofengland.co.uk last accessed Feb,21st ,2011

Source:-bankofengland.co.uk last accessed Feb,21st ,2011

2. Evolution of loan loss provisions During the time of economic downturns, banks face external financial frictions such as financial crisis; during this period it becomes difficult for banks to immediately restore reduction in equity capital.

Source: www. Reuters.com, last accessed 21stFeb ,2011

3. Evolution of capital to assets ratio Capital to assets ratio determines the amount of capital that a bank needs to maintain in the form of shareholders asset. This determines its ability to meet the time liabilities and other risks such as credit risk, operational risk.

Source: - www.reuters.com Last accessed Feb 21st, 2011

4.Return on Equity The efficiency of banks can be measured through the use of the return-on-equity (ROE) ratio, which shows to what extent banks use reinvested earnings to produce future profits.

Source:-www.reuters.com last accessed 21st Feb,2011 Post Crisis The British government aggressively planned to resolve the financial crisis issue through various measures, precisely through mixed system of capital injections and asset guarantees. One of the major steps taken by UK government was recapitalization and asset insurance for some banks. The U.K. government has introduced a mixture of bank recapitalization's and asset insurance for some banks. The government elicited a promise from the banks that they would maintain their lending to small, medium-sized enterprises and households in exchange of capital injections. The UK government also introduced Asset Protection Scheme, a program to provide protection against credit losses occurring on specified pools of assets above a certain threshold(Huertas,T,2010). Following mergers and acquisitions took place in the mid of 2009.

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In June 2009, Temasek sold its entire stake in Barclays. In 2009, Lloyds banking acquired HBOS and Lloyds TSB Group and was renamed as Lloyds Banking Group. On January 14, 2009, RBS sold its entire 4.26% stake in Bank of China. On February 2 2009, Standard Chartered acquired Cazenove Asia Limited from JP Morgan Cazenove. On July 1 2009, it completed the acquisition of its remaining interest in First Africa Group Holdings Limited.

Post-crisis business model drivers Post-crisis operating environment changes 1. Some regulatory and policy initiatives were taken on different areas of banking sector. These areas include, activity and asset mix, funding and liquidity, leverage level and quality of capital, as well as some business practices, risk governance and management.(Huertas,T,2010) 2. Higher and better Quality capital requirements were improved when higher credit cost for private sectors were implemented. 4. Less chances of arbitrage. 5. Financial firms have been trying hard to cut costs and improve efficiency .However, There will also be upward pressure on costs in several areas, like a higher degree of regulatory compliance, new IT and other infrastructure investments, and spending related to preserving the quality of services provided to consumers.(Huertas,T,2010) Retail and commercial banking Retail and commercial banking will continue to be liability-driven. There may still continue to use the covered bonds and may limit the usage of securitization.

Wholesale and investment banking WIB firms responded by divesting and refocusing their business models on core activities by reducing costs and restructuring their most severely impacted assets. There is likely to be a shift from high-margin products to lower-margin products.

Building societies and other mortgage lenders In the broader European landscape, Some of the mortgage market such as Germany, France, Spain, Italyand other countries have moved from independent to group banking system few years ago, However UK building society still retains its old method of being independent specialized mortgage lenders.

IMPROVING BANKING STRUCTURE According to Dr.Thomas F. Huertas there are many reasons for financial instability. He quotes the Modigliani Miller and explains the concept:-

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In perfect markets, the value of the firm is invariant with respect to its choice of financing. Increase in leverage should not be calculated as increase in value of the firm, as the fall of value of debt may offset the value of equity. The market is perfect- It means that imperfections (Taxes, bankruptcy costs) exist and this would not affect the capital structure of banking industry. However these concepts are based on certain assumptions: - the value of the firm is not dependent on liabilities that firm issues. Secondly, it assumes that market is perfect.

Source- www.fsa.gov.uk, last accessed 23rd Feb,2011

CONCLUSION

The global financial crisis has revealed the weaknesses in the financial regulatory system. Some of the important areas of regulation which involve the current regime for the regulation of bank capital ratios like ratio of shareholder equity to total assets, it is crucial because equity is the powerful tool that absorbs losses in the event of write-offs of non-performing assets. So a clear change in the system is needed. Statutory frameworks needs to be revised and a new regulatory system must be encouraged. The major objective should be cutting costs and reducing the systematic risk by focusing more on benefits over costs. Under the risk-weighted capital regulation regime of Basel 2, the use of backward-looking models for risk assessment creates a unstable tendency for capital. The effectiveness of risk mitigation techniques should be systematically reviewed and revised periodically.

References 1)Bank of England Financial Stability Report Monetary and Financial Statistics www.bankofengland.co.uk 2)Brunnermeier,M.k.(2008), Deciphering The Liquidity and Credit Crunch 2007-08,, The National Bureau of Economic Research, NBER Working Paper No. 14612 (accessed November 112010) http://www.nber.org/papers/w14612 3)Huertas, T(2010),Changing dynamics for banks and building societies business models, Financial Services Authority 2010 http://www.fsa.gov.uk/ 4)Huertas,T.F,2010 Improving Bank Capital Structures,BankingSector,FSA http://www.fsa.gov.uk/pubs/other/th_18jan10.pdf 5)http://iimc-finclub.com/, Finance club,last accessed 23rd Feb 2011 6)Ifsl Research Banking 2010 http://www.ifsl.org.uk/media/2372/IFSL_Banking_2010.pdf 7)www.Reuters.com http://uk.reuters.com/sectors/industries/significant?industryCode=128&categoryId=225 8)Thwaites,D.,1991Forces at Work: The Market for Personal Financial Services, International Journal of Bank Marketing (9:6), pp. 30-36.a 9)Trading Economies Country Ranking By Central Bank Interest Rates http://www.tradingeconomics.com/World-Economy/Interest-Rates.aspx 10)Zuboff, S. 1996The Emperors New Information Economy, in W. J. Orlikowski, G. Walsham, M. R. Jones, and J. I. DeGross (eds.), Information Technology and Changes in Organizational Work, Chapman & Hall, London.