In the world, the changes are certain at the each context. Change can be seen at the each level such as the social, economical, technological, political etc. In this, change at the economic level is more important because it affects the wealth of the country. In the economic language, when performance of a country decreased then it is called financial crisis.
In this situation, supply and demand of the product and service in the economy declines at the great level that also affect liquidity position of the country (Peters et al., 2012). In the same concern of this, 10 years ago, a financial crisis was recognised. The financial crisis 2007-2008 is well known among all worlds because its effect was seen at the global level. Due to this financial crisis, it was found that economic conditions of various counties become worst. This financial crisis has begun started from the USA market and reached at the each corner of the world. In this contrast, this report discussed the factors which led to the financial crisis of 2007/8. At the same time, this report also explains how these factors impacted upon Northern Rock and the reasons for the nationalisation (Shiller, 2012).
Furthermore, this report also represents the research the post nationalisation outcome and evaluate whether the net impact has been positive or negative. Along with this, in the further section, this report also discusses present and analyse the steps which have been take to prevent the repetition of a similar financial crisis. In the last section as the conclusion, a discussion is presented that presents an opinion as to whether or not the factor which triggered the 2007/2008 crisis have been addressed and whether you consider the rescue of Northern Rock to be a good or bad thing.
In the financial crisis 2007-08, it was found that the decline in the hosing price one of the main factor that was played main role to lead the financial crisis. In this, it was found that the first sign in the financial crisis was difficulty in the increase in the housing rate since the 2006. Before the crisis, the real estate market had declined at the great extent that affected the economic conditions (Chor & Manova, 2012). It has been happened due to financial institutes and banks were provided the 100% finance on the household. Below are some more factors that leaded the financial crisis:
Subprime lending – At the time of the financial crisis, it was analysed the banks and other financial institution provide high loan to customer due to this, economic conditions were not able to meet with the liquidity liability for long term. The credit conditions were also become easy for customers. It has been proved the biggest reason the financial crisis.
Growth of the housing bubble – Before the financial crisis, economist were found financial bubble in the housing price. In this, it was also surprising thing that the features of the financial bubble were different at the each country. In this, USA market, the price of the household was increased while the European market, the price of the household was increased.
Easy credit conditions – In the financial years between 2000 and 2003, the banks and government established the easy credit conditions. In this, federal government decreased the interest rate 6% to 1%. It affected the reserve value of the government and banks that played the significant role in the financial crisis (Fratzscher, 2012).
Weak and fraudulent underwriting practices – In the financial crisis 2007-08, it was found that weak and fraudulent underwriting practices also the main reason. It is also found that various kinds of underwriting practices were presented in the economy that was reason in the financial crisis.
Increase debt burden or overleveraging – At the same time, it is found that due to all the factors such freedom in the credit policy were increased the dent burden or overleveraging of the governments and banks. The increase in the debt burden and leveraged affected the economic conditions of the various countries due to this, governments were unable to provide the fund on the development and that decreased the opportunities. Hence, it becomes the reason of financial crisis 2007-2008 (Boddy, 2011).
Financial innovation and complexity – The financial innovation and complexity is associated with the ongoing development in the financial service and product. A number of innovations were found but these plans became fail in the implementation. Due to this, market condition become worst and this world has to face the financial crisis.
Incorrect pricing of risk – In the economic, the pricing risk refers the incremental compensation of investor against the additional risk that affects the interest rates and prices. In this, it was found that financial policies were not effective to achieve the determined goals that leaded to financial crises.
Boom and collapse of the shadow banking system –
In the financial crisis, it was also analysed that there was also a significant role in the commodities boom. In this, a rapid increase was found in the various commodities. In this, the price of the crude oil increase $47 to $147 approx. The increase in the crude oil affected the overall economic conditions of the world. At the same time, the price of the various other commodities were also increased such copper, gold and silver etc (Milesi-Ferretti & Tille, 2011).
Factors impacted upon Northern Rock and the reasons for the nationalisation
One of the factors that impacted the Northern Rock Bank run was subprime lending. The Northern bank has followed risky banking practices since 2000’s by offering loans to customers that bear risk of repayment schedule and making donations for charities and communities and engaging in sponsorships. The banks offered subprime mortgages to people that possesed less income or faced unemployment and have no assets for guarantee and even to those who had bad credit ratings (Swan, 2009). In the same year, the bank has borrowed to a large extent to provide mortgage funding as growth strategy that increased its debt burden. Moreover, during 2007 the bank was not able to generate income as anticipated from loans and faced risk of repayments of borrowed amount. Also, the bank advancement for government support created lack of confidence in public and made the customer concern for the savings (Gray and Akseli, 2011). This resulted in huge withdrawal of savings by bank customers causing the bank run. The growth of housing bubble also impacted the Northern Rock. The bank vision that house prices/value will be higher and once sold would wipe away the debt to the bank. Also, as the bank turned into securitization that permitted to borrow money from the worldwide markets rather than retail deposits against the expected income streams which led to offer mortgages five times applicant income and up to 125 percent for a property value or house (Shin, 2009). Another factor that impacted the bank was incorrect pricing of risk as the bank faced a high borrowing cost over the yield from the mortgage assets owing to sharp rise in interest rates (Gray and Akseli, 2011). This indicated poor financial policies of the bank. In addition this, it is also evident that the credit conditions for customers were easy to obtain loan from the bank which is another factor impacted the ability of bank to receive income from loans. Thus, this highlights the bad lending decisions of the bank as first the bank lending too much money and then move forward to securitisation which resulted in more lending.
The primary reason for nationalisation of the Northern Rock Bank in year 2008 was as a result of the financial challenges. This was due to the sub-prime mortgage crisis. The bank was not able to raise sufficient money to provide funding for its other loans and mortgage. The poor management of the bank made it incapable to earn sufficient money value for tax payers that caused the bank to bring under the ownership of public where the government hold responsibility for mortgages and savings. Another reason for nationalisation was to protect the interest of the taxpayers (Goldsmith-Pinkham and Yorulmazer, 2010). This was a temporary measure to allow the government to take over the bank to secure the savers deposits till the market conditions revived. In addition to this, even after getting loan from bank of England there was failure to draw any buyer for the bank and the disintegration of bank business model are other reasons for the Northern Rock to go for public ownership.
The post nationalisation outcome for the Northern Bank was constructive as it has enabled the re-building of the banking infrastructure and improved the regulations of the banking policies and operations. On the other side, some shortcoming was observed in terms of political constraints and more bureaucracy and administration of the nationalised bank that caused job loss (Huang and Ratnovski, 2011).
In year 2010, the bank was divided into two assets and banking to support the sale of the bank again to the private segment. The bank sold lifetime home equity for £2.2 billion to JP Morgan as a debt repayment measure for Bank of England (Tahtamouni and Al Nahleh, 2015). Under the debt reductions strategy that was followed post nationalisation to reduce government debt in four years which led to loss of jobs. The number of mortgaged were reduced for existing and new bank customers and mortgage assets were sold to lenders. The outcome after nationalisation was also seen in terms of change in board members and appointment of new executives at senior management. At the same time, the confidence of customers increased in bank which led to opening of new accounts in 2009 (Burnham, 2017). The government ownership has provided assurance to the bank investors and other with account holders. The bank strategy got changed to lend mortgages to creditworthy customers. The bank was progressing to regain stability by 2011 (Atkinson, 2012). Also, in year 2012, the government found buyer for the bank and UK Financial Investments (UKFI) sold the bank to Virgin Money for an amount of nearly £1 billion (Burnham, 2017).
The nationalisation of the bank has supported in solving the bank asset problem as banks do not prefer to sell assets at a price that market is ready to pay (Treasury, 2009). The post nationalisation has also addressed the regulatory issue of managing funds buying up the financial institution debt. When bank is nationalised the unsecured debt holder of bank will go down. The public ownership has made improvements in the bondholder position post nationalisation. Thus, post nationalisation has supported the Northern bank to fall to some extent in the short term and protected the bondholders and creditors to prevent total restructuring of the debts in situation of bankrupt. From the perspective of financial stability, the post nationalisation has brought a positive impact on the bank. Around £9.4bn of a loan was paid by the Northern bank taken from the Bank of England after post nationalisation (Tahtamouni and Al Nahleh, 2015). From other standpoints, the post nationalisation has resulted in re-arrangement of monitoring regulations and control mechanisms. All the above factors have led the bank to obtain its functioning during the period of financial crisis and provided time for economic survival by provided their own staffing and systems. This has been successful for the Northern Bank from bailing out from its complete failure in the market.
There were several reasons for occurrence of the financial crisis in 2007-08. For preventing further chance of occurrence of financial crisis, it was required for the UK government and regulatory system to adopt effective practices that could be effective to omit the reasons behind the financial crisis 2007-08. In relation to this, the UK government has made changes in the economic policies including fiscal and monetary policies that helped to reduce the impact of the crisis and prevent the chance of future occurrence of crisis (Mizen, 2008). There were fewer regulations in the UK banking sector that encouraged the banks to provide home mortgages in abundance (Cowling et al., 2012). A proper regulatory framework helped the UK government to control the loan approval process of banks. An efficient creditworthiness assessment procedure was followed to check the credibility of the borrowers and provide the mortgages only those who are really deserve (Joyce et al., 2011).
In addition, it was also ensured by the banks to adopt ethics and corporate governance. It is because the large banks did not follow financial ethics and bet against their customers by using risky credit default swaps during the subprime housing mortgage crisis to earn short-term profitability. Apart from this, the government of the UK started to nationalise the British banking industry as it allowed the government to have better control on the banking operations and activities to ensure ethics and governance (Blanchard, 2009). The nationalisation of the banks also helped the UK government to restore trust and confidence in the banking system and avoid the possibility of future crisis due to unethical practices and lack of corporate governance.
Moreover, the UK government also increased the regulations for the banks as the FSA (Financial Services Authority) has started to investigate the conduct of banks in the lead up to the banks. It also helped the government to regulate the banking operations and ensure financial ethics to prevent the future possibility of the financial crisis. It also enforced the banks and financial institutions to adopt better regulatory practices and control mechanisms that can be effective to prevent the possibility of future crisis. Apart from this, the UK has reformed its regulations of the financial system through creation of the Financial Policy Committee (FPC) (Hodson and Mabbett, 2009). This committee is accountable for identifying, monitoring and avoiding risks to the financial stability to ensure that the regulators could take a holistic way to protect the financial stability.
In addition, the UK banks have also built up the capital resources after financial crisis by increasing their risk-weighted capital ratios significantly. It helped them to avoid in future risks to withstand the potential losses (Whitehead and Williams, 2011). Apart from this, The Bank of England also has taken some initiative related to annual stress test of banking system that helps the banks to manage the adverse situation or stress level. The UK has taken reforms with the aim of managing the possible failure of the banks in future to protect the financial sector and whole economy (Bordo and Landon-Lane, 2010). Furthermore, the UK has also passed the Financial Services (Banking Reform) Act 2013 to make a separation between the core retail banking services and the investment banking services by 2019. It is known as ring-fencing that allows the resolution authority to provide solutions for the retail and investment banking activities in separate way.
Conclusively, it can be pointed out that the mismanagement by the banks in providing the loans to people was a significant factor in occurrence of financial crisis 2007-08 in the UK. The banks ignored financial ethics and good corporate governance and provided mortgage loans to people without determining their creditworthiness. It led to the failure of the borrowers to make repayment of the loans that caused a big gap in liquidity of the banks in the UK and resulted in financial crisis in 2007-08. Apart from this, it can also be summarized that all the factors that facilitated the financial crisis are explained in the essay effectively. In addition, it can be right decision to support the banks like Northern Rock because it helps them to come out from adverse situation and restore the trust and confidence of people in the banking system. Even, this bank became successful to regain trust and confidence of investors and improve liquidity to handle the adverse impact of financial crisis. Nationalisation of the banks ensures the customers regarding the protection of their savings as the support buy the government to the bank was good decision to protect the bank from the impact of financial crisis.
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