Corporate & Wholesale Finance
Banks are financial institutions that accept deposits and provide financial products. Also, they have great influence on financial markets and offer services such as investment funds and loans.
Various studies showed that the structure and function of nowadays banking system changed radically through the appearance of important facts. Deregulation, financial innovation, globalisation and the emergence of new technology gave another breath on how the banks should work in order to increase their performance. As a consequence, banks, as exist today, have created more complex products by using risk and securitisation models.
The financial crisis led to the collapse of banking system and created an incredible uncertainty in financial world because of the indebtness, the overleveraging and the loss of liquidity.
The main purpose of this paper is to highlight the main trends that the wholesale banking faced twenty years ago and how these changes influenced it.
One of the most fundamental trends that appeared in 1970s-1980s was deregulation. Deregulatory process is the repeal of regulatory rules and was created as a response to competitive pressures and financial innovation. (Kasi, 1990) It is a fact that deregulation has enabled financial institutions to diversify their products and services in all areas.
Historically, there are three important stages of deregulation from which only two can cover the basic dimensions that influenced by deregulation.
The first stage characterised by the repeal of quantitative controls on assets and of interest rates that banks imposed on deposits. The beginning of deregulation was implemented in UK by the Competition and Credit Control (1971). This encouraged the competition between banks, enhanced liability management and increased the assets. In the USA began with the abolition of Regulation Q (1982) which limited some restrictions. Furthermore, the Exchange Control Act (1979) in UK repealed the restrictions in currency exchange which resulting the enhancement of financial internationalization. Lastly, minimum deposits abolished and market forces encouraged by the Hire Purchase Control Act (1981). (Kasi, 1990; Matthews- Thompson, 2005)
The most significant fact to mention in the second stage of deregulation is the lifting of Glass- Steagal Act (1933) which introduced great competition between banks by dividing commercial banking into other kinds such as investment banking.
Finally, deregulation contributed to supervision and prudential control of banks in order to avoid problems in market efficiency and bank's capacity.
2.2. FINANCIAL INNOVATION
Another trend that financial system faced in the 1970s and early 1980s was the financial innovation. With this term, we mean the changes on financial services offered by financial institutions. Particularly, in 1970s, there was a tendency to change the tools and the techniques that used by banks in order to facilitate financial institutions and customers. (Llewellyn, 1985)
Various studies showed that three factors forced by financial innovation and these are the financial instability, the regulation and the growth of technology. The first was associated with high inflation and interest rates which created uncertainty and reductions in domestic demand. The second dealt with the relocation of financial institutions into offshore due to rules that imposed in financial intermediaries. Regulation led to the establishment of Eurocurrency market offshore. The third factor basically changed the nature of banking system the last 20 years. Banks created a wide range of products and services through technology which helped them to reduce costs and make transactions in real time without the need of physical presence. It, also, facilitated communications and information technology. (Matthews- Thompson, 2005)
The above three factors forced banks to innovate and generate demand for new financial services and products, having as a consequence profitability and competitiveness.
According to Goodhart (1984), three considerable dimensions occurred because of financial innovation. First was the shift from management of loans to management of deposits. Second was the bank's enhancement to provide loans and money to customers in variable rate. Third was the establishment of cash management technology which minimised costs and raised competition.
a. Another important trend was the internationalisation of banks that caused by deregulation, the appearance of technology and the integration of large organisations globally. (Ul- Haq- Howcroft, 2007)
The globalisation of banking system was influenced by “push” and “pull” factors. “Push” factors refer to rules that forced banks out of the domestic market. Examples of these were the development of USA banking abroad due to the restrictions of Regulation Q, which set caps on deposits rate; and the growth of Eurodollar market as a result of the above. “Pull” factors had to deal with the extension of USA multinationals into Europe. American banks created branches in Europe to support their customers. (Matthews- Thompson, 2005)
According to Canals (2002), globalisation has three important parts. The first is the creation of branches in different countries around the world. Typical example is the Citibank and Barclays. The second is mergers or acquisitions. Example of this part is Deutsche Bank's purchase of Morgan Grenfell in 1984. The third is the strategic alliances of banks which led to the expansion of production capacity and market effectiveness. (Ul- Haq- Howcroft, 2007)
b. A significant trend can be characterised the securitisation, due to financial innovation and globalisation. According to Gardener (1986) securitisation is “the technique that transforms, or repackages, financial assets into securities that can be resold to investors in the capital market”. Securitisation can be separated in two parts: in the Asset- Backed Securities which are banks' assets (such as loans, leases, etc) that converted into securities ; and, it includes the process of bank disintermediation where corporations prefer to be financed by the capital markets than from banks and in this case, banks played the role of investment advisor.
Competitive pressures that released by deregulation, financial innovation, technology and globalisation strongly affected the profitability in wholesale banking industry and increase the banking risks. (Llewellyn, 1992) Banks faced the competition in their assets by the influence of intermediation and Non- Bank Financial Intermediaries (NBFIs); and in their liabilities in the form of mutual funds and products from NBFIs. Moreover, the emergence and development of technology minimised the costs and increased the competition, influencing bank margins. Additionally, competition and deregulation ruined endowment profits which are profits that banks earn via reserves and interest- free deposits. The most important implication of endowment profits was that operated as entry barriers to foreign banks. (Llewellyn, 1994)
b. Purpose of bank restructuring was to enhance bank performance. This could be achieved with the recovery of credibility and profitability, with improvement of bank's capacity with the assistance of financial intermediation and with retrieval of lost public trust. (Dziobek- Pazarbasioglou, 1998) Restructuring took the form of mergers and takeovers in order to reduce the size of banks. Additionally, a package of operational reforms included reduction of branches, management changes and cuts of personnel. Finally, the greater use of technology and diversification helped in bank restructuring with the elimination of unit costs and with the changing of banks' financial services into non- intermediary (off- balance sheet activities- OBS).
4. RECENT FINANCIAL CRISIS
One of the major facts that shook the world market was the credit crisis. Credit crunch began as a sudden reduction in the availability of loans or credit to financial markets, leading banks to impose stricter conditions with high costs to obtain a loan. The factors that led to credit crisis were many with the most important to be the high debt levels, the over- lending of banks and the effects of the US sub-prime mortgages in conjunction with the interconnected global markets.
The financial crisis of 2007 until today provoked by US banks which have liquidity problems due to defaults of subprime loans. Essentially, the crisis starts in August 2007. The buyout of Bear- Stearns in March 2008 and the failure of Lehman Brothers in 15/09/2008 affected seriously many global markets. The result was the global loss of confidence, solvency and reliability towards of financial institutions. By late October of 2008, the markets around the world were unstable; the records of credit losses were huge; and many investors lost their credibility. The recession, by mid- March 2009, strongly continued by having more and more deep effects on financial markets. However, some signs of recovery occurred after government interventions without significant results.
It is a fact that the recent financial crisis was the worst of all time by affecting all global markets. The crisis led to the collapse of major financial institutions such as Lehman Brothers and many other smaller US banks, to reductions in the availability of funds and securities and generally to global falls in economic activity.
To summarise, the forces of deregulation, financial innovation and globalisation changed significantly the function of banking system. Banks faced increased competition and structural changes through deregulation. Technology reduced costs and financial innovation developed new financial products. Finally, globalisation led to the expansion of banks globally through alliances, mergers and takeovers in order to increase their performance. The financial crisis turned down the global market, eroded investments and created socio- economic instability.
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