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Key Topics
- Requirement
- Solution
- Introduction
- Securitization and its importance
- Securitization process
- Importance of securitization
- Effect of Global financial crisis on UK banking system
- Effect on UK banks
- New Framework of UK
- Operational structure and Risk management system
- Challenges faced while managing operational risk
- Conclusion
- References
Requirement
Bank management
1. Produce a final report covering the following issues:
(i) It is often said that banking and financial markets developed in such a great scale due to their degree of innovation, in terms of the financial products they offer through the securitization process. Define and describe securitization, evaluating its relative importance in modern banking.
(ii) Some commentators accused banks of inability to accurately assess the underlying risks exposure from trading such securitized products. Evaluate this statement, in the light of the effects Global Financial Crisis had on the UK banking system.
(iii) Discuss the changes to the UK regulatory system, due to the financial crisis. Do you believe that the new framework is adequately prepared to address future incidents of systemic financial crises?
(iv) Assume that you work for a UK bank that faced serious financial hardships during the last few years. What would you advice the bank’s executives in order to enhance bank’s future performance? Focus your answer on issues related to operational structure and the risk management processes followed by the bank.
Evaluation of UK banking system and financial market
Solution
Introduction
In this present paper we will mainly cover four areas namely: process of securitization and its importance in the modern banking system , impact of global financial crisis on the UK banking system, new framework of UK regulatory system, Operational structure and risk management process for the UK bank to enhance the performance of bank in the future.
In the modern era, securitization process plays a vital role in introducing financial products in the market. It is the process of pooling different kinds of contractual debts which include debt assets as well as non-debt assets. The UK banking system had an adverse effect of global financial crisis due to which cross-border flow of banks collapse and fragmentation of financial market with in the zone of a euro. The new regulatory framework has come with the tagline of building a strong system which covers all the aspects of financial markets and the issues related to compensation, dispute resolution, international and European issues, proper regulatory process with the coordination. The framework ensures that the measures were taken by the government for hedging the risk and ensures stability in the economy. The performance of a bank in the future is directly affected by the operation structure and the process of managing the risk. The operating system of the banks should be very strong and flawless. The managing of risk is a very critical stage which includes the important measures for hedging and controlling the risk. The bank should maintain the policies and review them periodically which helps in measuring the performance and takes appropriate measures.
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Securitization and its importance
The securitization is defined as the process in which the pooling of different forms of contractual debts, for example, commercial mortgage, auto loans, home loans, bonds, collateral securities and others. Principle and the interest are repaid to investors from the underlying assets, and it is distributed through the capital structure. The securities which are returned by mortgage receivables that are known as mortgage-backed securities and the securities which are not backed through securities that are known as asset-backed securities.
The securitization is a complex process due to which investors are unable to monitor the risk aspects. In the financial market, there are some competitors with multiple securities which are particularly prone in reducing the standards of underwritings. In the U.S. subprime mortgage crisis, the competitive mortgage securitization plays a vital role. The securitization is a framework which includes illiquid assets of an organization are converted into a package of securities which are backed by the assets by careful packaging, enhancement of credit, liquidity, and structure (Cetorelli, N., 2012). The securitization helps to enter into the debt market by the low-rated entities which are mainly reserved for high rated institutions.
Securitization process
In the common process, two parties are involved namely: issuer and originator. In which an originator is a person whose assets are being securitized, and the issuer is the one who is acquiring the assets from the originator. The issuer is a company which is mainly set up for securitization process. It is also known as SPV (special purpose vehicle) (Tarullo, 2013). The special purpose vehicle ensures that the pooling of underlying assets is distinct from other assets of an originator. The purpose of distinction of underlying assets is to create no effect of originator’s insolvency.
The securities which are under the framework of SPV that describes the legal terms such as Financial status, originator's credit rating which becomes untuneful for the bondholders. It also involves the rating of credit quality through the third party. The rating of grades is up to AAA grade.
Importance of securitization
The financial market shows the importance of securitization of underlying assets because through securitization process the banks are allowed to fund their growth of credit, shed off the risk of credit, and arbitrage of capital requirements. The securitization plays a major role in the liquidity provision for the banks. The securitization allows fundamental changes in the banking sector. It helps to obtain liquidity for the financial as well as non-financial sector. It helps in solving the issue of holding bonds until maturity by issuing a covered bond which refers to the mortgage or a portfolio of a mortgage. It also creates an option for the bank to sale the mortgage partly of fully to SPV and funds the payment to the investor or institution. The proceeding helps to give the interest of residential mortgage-backed securities. In the later stage, banks will get rid of the problem of credit risk related to mortgage, which depends on giving the credit enhancement to SPV in which the bank finds a certain level of risk in losing the mortgages securitized.
There are different securitized products by risk, re-pricing, complexity and others, and there are various strategies which are followed by the banks. Such as: originate to distribute level verse buy and hold model. The securitization permits banks to convert into liquid assets which otherwise will be shown in the balance sheet till maturity. It also creates the raising of new funds while increase the lending's and transfer of risk has subsequently increased because of securitization. With the help of securitization, some banks have also become the originator of loans and distributors of risk. Thus, the securitization has changed the shape of the banking system and emerges new banking system in which the relationship the relation with the customer is reducing for transaction-based where a proceeding is coming from the earning of originating and packaging loans fees.
Effect of Global financial crisis on UK banking system
The UK banking system facing systemic crisis exited markets and curtailed their substantial growth. The organization for economic co-operation and development banks are reducing their presence whereas the organization for economic co-operation and development banks are increasing their presence. The global financial crisis had reversed the global financial integration due to which cross-border banks flow globally, and the financial market is fragmented within the zone. The global financial crisis has accelerated a structural transformation. The impact of the crisis has change the behavior of UK banks entirely (Hind moor, A., (2015). The banks act as a main vehicle for the financial system, but it was adversely affected by the crisis. The international operations of the banks have reduced after the crisis.
The securitized products are defined as the products which transform the risk and returns on the portfolio of underlying assets and resale partly or fully to investors. The features are very complex, and the structure of risk and returns of every product is different. The trading volume is very limited due to which it is not easy to measure the prices of trading. The risk associated with securitized products includes risk associated with the portfolio of underlying assets, product structure, a risk associated with price, liquidity risk, the modern risk associated with pricing and complete portfolio risk. At the time of financial crisis, the stock market does not have high trading volume due to which they are not able to access the risk of underlying exposure accurately.
At the time of financial crisis, stock market starts falling globally, and large financial institutions collapsed. Its effects have started shown in the year 2007 and 2008.The richest nations also start their packages to bail out to rescue their financial system (Claessens, S., 2014). The financial globalization has become very beneficial before the crisis but after the crisis, the balance of benefits and risk has changed, and it starts depending on others factors, such as characteristics of borrowing country. The risk revealed in the crisis includes a unpredicted collapse in the capital flows, shifts in capital flows and cross-border banking.
After analyzing the financial market system, the information reveals that the financial crisis has affected UK banks in several ways. Firstly, in the local financial intermediation, the importance of foreign banks has declined after the global financial crisis, the aggregate demand has not much affected in the host country, but the foreign bank presence has declined from 2007 to 2013. The global system has become more integrated regionally. The presence of non-organization for economic co-operation and development banks has doubled and mainly in their geographical locations.
Effect on UK banks
The Bradford and Bingley Building Society was nationalized effectively in the late 2008 and after that, it was partially sold Santander bank. The UK government has also nationalized Royal Bank of Scotland partially. The UK's largest mortgage lender has also faced the deep trouble due to financial crisis due to which it took 43.4% stake in the combined business. Other banks were also to raise their capital though an issue of new shares. The sharp fall in the central bank interest rate, but lending rates of interbank remains high which directly affects the credit for personal and corporates. The recession was continued till 2009, and the recovery starts in the last quarter of the year, where the GDP starts rising with 0.3%.
New Framework of UK
The new regulatory framework is created by the European Union, who has the monopoly to set the regulations; it seeks to develop a standard set of framework for super visionary practices which have to be adopted by all regulators. The objectives, remits, and power of new regulations align with the new European supervisory authorities to ensure that the view of UK's is communicated at European level (Betz, 2016).
The banking regulatory structure of UK has unified all the financial service sector regulation through one regulator centrally.UK regulatory system aims to protect the market failures Such as Externality, monopoly and information asymmetry. The regulatory system has two aspects which include: the safety net, prudential supervision, and monitoring of inadequate capital and macro-prudential analysis. The regulatory system embodied as a Basel framework. The process was started by the Basel committee for the supervision of banks. The banks are using Basel I and Basel II for decreasing the capital and returning the funds of shareholders by deducting the risky financial assets. Although, Basel committee has contributed at the time of global financial crisis the Basel approach is complex (Lindquist, 2015).The committee treats risk as an exogenous characteristics, and it is also dangerous.
Following are the significant changes in the regulatory authorities of UK’s financial sector after the global financial crisis:
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The current tripartite structure which was introduced in the last Labor government that has been replaced by the financial service act.
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The money market is over viewed by the Bank of England, supervision of individual banks will be done by the financial service authority, and the public money is provided by the Treasury.
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Three new bodies will be introduced in the new financial regulatory system which includes two bodies within the Bank of England which will regulate the financial services. The new bodies include Financial Conduct Authority, prudential regulation authority, and financial policy committee.
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The Financial Policy Committee will be responsible for the overall workings. It has the power to instruct, provides a guideline and strategic insights on the future conditions of the financial market.
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The financial conduct authority is responsible for protecting consumer’s interest against such illegal practices and makes sure that the workers follow the rules and regulations in the financial services.
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The prudential regulation authority deals with macro-prudential regulation which focuses on SIFIs.
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The maximum payout for the depositors has been increased from 31,700 pounds to 85,000 pounds.
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The independent commission in the banking system has appointed for to make the banking system safer.
The arrangement of UK includes the features of clearing bank engage in commercial and investment banking. The subsidiaries include merchant banking, activities related to insurance and real estate activities. The stake of 15% and more taken by the firm in the UK bank requires an approval of Bank of England. The banking and commerce encourage traditional separation. Thus, the new regulatory framework remit risk factor and the regulations are prepared adequately by considering all the factors which address to the financial crisis.
Operational structure and Risk management system
The bank which has been selected is HSBC, London. The HSBC is the largest banking in the world. The bank network contains 7,500 offices across 80 countries and five territories. The HSBC is among the four major players of the clearing house in the United Kingdom. The operational structure of any organization is very important because it ensures the smooth running of all the operational activities of an organization. An operational structure supports overall corporate structure through physical assets and resources of an organization in the operational domain. The operational structure builds with the corporate strategy to keep pace with the growth of a company. Risk management is another aspect which is very crucial for the growth of a bank. The managing of risk has two aspects: the cost of the product and services and uncertainties in the business. The managing of risk acts as a controller in an organization. The managing of risk includes Market risk management, investment risk management, and operational risk management (Khan, 2015).
Major challenges faced by the banks:
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Constant profit margin
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Expectation of customers
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Growing Competition in financial, technological market
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Financial regulatory pressure
Challenges faced while managing the risk
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Regulatory cost acts as a barrier for moving capital and liquidity. The regulatory cost includes a monetary outlay for managing the risk and waiting period.
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Information cost is defined as the cost of integration and analyzing the information which includes transmission, processing, recording the information and the amount of delay in the time value of money.
Challenges faced while managing operational risk
• System
The system requires external apparatus which includes the use of machinery, tools and computer system which becomes the barrier for processing the system.
• External event
The external disruptions include natural disasters, political chaos, weather conditions and other events.
• Processes
The process comprises of all the business activities such as a sequence of the day to day work. The sequence of events become complex, and it is difficult to execute.
• People
The operational works are mainly done with the human resource, and the mistakes were made by an employee's intentionally or unintentionally which becomes another operational challenge.
Suggestive measure to enhance bank future performance
• Operational structure
Following are the steps for an effective operational structure:
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1. Outline the capabilities and sub-capabilities of core business and after that identify the target flow of data, which is based on the business strategy.
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2. The second step is to document the business process which includes the data flow of each entity and the product within the bank which will be impacted by the business strategy.
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3. Prepare a resolution strategy by capabilities, business process map and various issues relation to the product, entities, and others.
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4. Based on the resolution strategy streamline all the structure of a bank.
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5. Realign supporting control model to ensure monitoring of all the products and services.
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6. Prepare a well-defined metrics to measure the efficiency of the operational structure.
• Risk management
Following are the substantial implications which should be used for managing the risk by the bank:
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Optimization within a regulatory framework: The capital, liquidity, funding and the leverage ratio forces the bank to construct a balance sheet, and all the compliance aims to utilize all the resources within the ratios. It restricts the banks to make new demands, strategic setting process with the high analytical business strategy which helps to manage the risk (Matthews, 2013).
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Compliance based on principles: The principles protect themselves from future rules and interpretations with retrospective effects. The entire sales of the product and service reviewed by the banks which is an approach for examining end to end process with the structure of prices.
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Automated compliances: The rules and regulation are very complex, and banks can't remove human inventions because the risk dealings with customers and the right behavior towards the product and services cannot be automated. The robot surveillance and monitoring will be more difficult. This will ensure the small rate of error within the defense.
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Collaboration with businesses: Regulatory preparedness will be attained only by the close working of risk with companies. The protection of risk is an integrative part of the thinking process which helps to delete the risk.
Conclusion
In this report, all the four areas which are discussed has concluded that the securitization plays an important role in the modern banking system because it helps to remove various barriers such as liquidation of securities and visibility of bonds in the balance sheet till maturity. The securitization process has given a new shape to the banking system through the degree of innovations and new techniques. The securitized products have limited trading, so it is difficult to measure the risk exposure from trading, and the market condition has badly affected by the global financial crisis. The new three regulatory bodies have introduced in the new UK regulatory framework which shows that the regulatory framework has considered all the aspects related to the future systemic financial crisis. The operational structure and risk management play an important role in managing the future performance of the banks.
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Betz, F. (2016). International Grid of Capital Flows: Innovation, Crisis, and Off-shore Banking. In Stability in International Finance (pp. 19-49). Springer International Publishing.
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Cetorelli, N., & Peristiani, S. (2012). The role of banks in asset securitization. Federal Reserve Bank of New York Economic Policy Review,18(2), 47-64.
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Claessens, S., & Kodres, M. L. E. (2014). The regulatory responses to the global financial crisis: some uncomfortable questions (No. 14-46). International Monetary Fund.
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Hindmoor, A., & McConnell, A. (2015). Who saw it coming? The UK’s great financial crisis. Journal of Public Policy, 35(01), 63-96.
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Khan, M. I. (2015). Effects of Operational Risk Management on Financial institutions. Journal of Business Strategies, 9(1), 82.
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Lindquist, E. A., de Vries, J., & Wanna, J. (2015). 1. Meeting the challenge of the global financial crisis in OECD nations: fiscal responses and future challenges. The Global Financial Crisis and its Budget Impacts in OECD Nations: Fiscal Responses and Future Challenges, 1.
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Matthews, K. (2013). Risk management and managerial efficiency in Chinese banks: a network DEA framework. Omega, 41(2), 207-215.
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Tarullo, D. K. (2013). Evaluating progress in regulatory reforms to promote financial stability. Intervento al Peterson Institute for International Economics, Washington (DC), 3.
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