Transcript: Why Banks Collapse or come close to collapse? With reference to: 1. Northern Rock 2. Royal Bank of Scotland BY: Samjhana, Keerthana, Mishek Introduction Introduction Banking sector are vulnerable to many forms of risk which have triggered occasional systemic crises. These risk include liquidity risk, credit risk, and interest rate risk. The financial crisis that began in 2008 destroyed the banking sector. A number of banks went under collapse, others had to be bailed out by governments and others were forced into mergers with stronger partners. The common stocks and preferred stocks of banks got crushed, their dividends were cut and lots of investors lost part or all of their money. The same crisis situation also appeared in UK banking sectors and first victim was the Northern Rock medium sized British based bank. Also, Royal Bank of Scotland was affected heavily by the crisis and it was on the verge to collapse. Why Banks Fail Bad loans Funding issues Mismatch of Asset/Liability Regulatory issues Risk management Inappropriate loans to banks insider Runs on banks Northern Rock Northern Rock Failure of Northern Rock 2007 Bank Run The United Kingdom experienced its first bank run in over 140 years in August 2007 In three days around £ 3 billion of deposits were withdrawn (around 11 percent of the bank’s total retail deposits) The bank run from Northern Rock is a special case because it was a ‘reversed bank run’: In the case of Northern Rock, the bank first got into a liquidity crisis and as a result of that, depositors withdrew their money from the bank. Factors that led to the failure of the bank Moral Hazard Large number of loans which has rise to be sub prime mortgages. The bank put deal with Southern Pacific Mortgage Limited (SPML). The decision to invest biggest part of its portfolio in housing loans was the strategy of high risk. The bank changed title of their loans to assets backed securities. By transforming their loans to ABS, they can sold their loans given to customers to acquire foreign capitals. Factors continued Asymmetric Information - The investor who decided to invest their personal deposit in the ABS of the bank only knew about the type of investment . The holder of the ABS did not know about the credit ability of the borrowers. In contrary, bank had information of every client and their credit ability. - This in fact was an investor’s misleading by the Bank’s member. Securitisation Business model which relied heavily on the wholesale markets instead of the retail deposits to finance their lending activities. From the outset, it adopted a securitisation and funding strategy which was increasingly based on secured wholesale money. 50% of its finance was based on the securitisation of mortgages Their assets grew from 17.4 billion pounds to 113.5 billion pounds. However the share of retail deposits dropped from 60 percent to 20 percent in that same period. In 2007, Northern Rock was the biggest player in the securitisation market of the United Kingdom. The strategy worked well till three-month LIBOR rate was low, and the securitisation market was functioning smoothly. Securitisation Market Collapse In 2007 the housing prices in the United States declined, many homeowners could not pay their mortgage anymore. As defaults increase on subprime mortgages, no one will want to purchase mortgage backed securities The confidence between financial institutions drop and the LIBOR increases from 5.3 per cent in January to 6.75 per cent week. Banks lost confidence in the ability of other banks to settle their interbank accounts and interbank loans froze, leading to the credit crunch. The share price of Northern Rock dropped about 40 percent from January 2007 till August 2007. The failure of the northern bank and the source of credit crisis was the collapse of the securitisation process. Securitisation Market Collapse Money Crisis Funding shortfall of multi-billion-pound. The proximate cause of failure of the Northern Rock was the securitization system. The Northern Rock did not fail because of subprime failures. It did not fail because of a credit crunch. In fact, it partly caused the credit crunch. The crisis was all to do with Northern Rock’s belief that it would always be able to borrow cheaply and on a large scale from the money markets. The money failed banking systems. A more stable money mechanism is needed. Active Risk Management Model is required Negligence of FSA And Bank of England The risk signs were not noticed by the Financial Services Authority (FSA), The stress test used by Northern Rock was not flawless as it did not incorporate a scenario in which the markets were illiquid. The Bank of England did not give out emergency loans to troubled banks. To prevent moral hazard, the authorities need to supervise and control banks for its recklessness and its customers for not paying enough attention to their bank’s business model. CONCLUSION Royal Bank of Scotland (RBS) RBS Eligibility Applicant
Transcript: The 2007-2009 Global Financial Crisis The financial crisis that began in 2007 on the U.S. mortgage market, led to significant turbulence and uncertainty throughout the global financial system. On February 7, 2007 one of the world’s largest banks, HSBC, announced losses related to U.S. subprime mortgage loans. April 3, New Century Financial, a subprime specialist, filed for Chapter 11 bankruptcy. Chapter 11 is a chapter of the United States Bankruptcy Code, which permits reorganization under the bankruptcy laws of the United States. June, Bear Stearns told an incredulous financial community that two of its hedge funds suffered large losses related to subprime mortgages. Other Wall Street standard-bearers also started reeling from bad investments, including Merrill Lynch, JPMorgan Chase, Citigroup and Goldman Sachs. Before the end of August the crisis had spread to some French and German banks, and prompted the Federal Reserve and the European Central Bank to pump liquidity into the banking system and to reconsider their interest-rate policies. These were only the beginnings of a truly global financial and economic crisis that marked the end of one of the greatest financial expansions in history. The recession officially started in December 2007. By mid 2009, the crisis had brought to their knees major bank and non-bank financial institutions, causing several to collapse, and led to a severe economic contraction, plummeting trade, rising unemployment, and price deflation. The crisis quickly acquired global proportions after hitting Western and Eastern Europe, Japan, Latin America, and the rest of Asia. its origin in the burst of the housing bubble. finance of a bubble is only possible through a corresponding increase in credit – no credit, no bubble. This liquidity financed in the first instance the internet bubble, but because there was no deleverage following the burst of this bubble the liquidity went on to finance other bubbles, including housing, private equity and commodities. Thus, the housing bubble is a transformation of the previous internet bubble. In the U.S., Allan Greenspan injected liquidity and cut interest rates from 6.5% to 1%. This was because of the fear of deflation in the aftermath of the burst of the internet bubble. The low interest rate policy was reinforced by the 9/11 attacks on the World Trade Center. To avoid the negative economic consequences that could arise from anxiety related to terrorist attacks, decisions were made to maintain cheap financing. More important, he was late and slow in draining that liquidity and reversing the rate cuts from the middle of 2004. The Bank of Japan has also contributed to this huge liquidity by printing money aggressively over the period 2001 to 2006 through buying back government bonds from financial institutions. The monetary base increased at nearly 20% per annum in the three years to 2004, in what is called the era of ‘quantitative easing’. But even before that the monetary base was increasing at 7% per annum in 1993-99. This huge liquidity bolstered the yen ‘carry-trade’, which acquired its own momentum by leading into yen depreciation that further bolstered yen carry-trade. financial liberalization had been going on since the 1970s along with financial innovations that emanated from that era, played an equally, if not more, important role than easy monetary policy in creating the huge liquidity of the 2000s. The financial liberalization era allowed financial institutions to initiate a new financial activity, which was based on the discretion of the banks to dispose of their loan portfolio in accordance with risk management. That financial innovation relied heavily on interlinked securities and derivatives, all related to asset backed-securities and subprime mortgages in particular. which refers to the deregulation of domestic financial markets and the iberalization of the capital account Subprime mortgages are inancial innovation designed to enable home ownership to risky borrowers. the origins of the current financial crisis can be explained by three interrelated features that have been going on since the 1970s. Collateralized debt obligations (CDOs) are a type of structured asset-backed security (ABS) with multiple "tranches" that are issued by special purpose entities and collateralized by debt obligations including bonds and loans. Each tranche offers a varying degree of risk and return so as to meet investor demand. CDOs' value and payments are derived from a portfolio of fixed-income underlying assets. CDO securities are split into different risk classes, or tranches, whereby "senior" tranches are considered the safest securities. Interest and principal payments are made in order of seniority, so that junior tranches offer higher coupon payments (and interest rates) or lower prices to compensate for additional default risk. CDS obliges the seller of the CDS to compensate the buyer in the event of loan default. Generally, this involves
Transcript: financial crisis can america pull back from this devastating disaster??? interview Q: which crisis is most important for us? A: i believe that the financial crisis is our biggest problem. Q: why? while we may be running lower on oli and clean water, our current economic state is not stable enough to survive the impact of rising costs associated with oil and water shortages. what are some of the aspects of our economic crisis? first, a real estate collapse. the real estate collapse began when homeowners with adjustable rate mortgages, had their loan interest rates reset to levels the owners could not afford. They stopped paying back their loans so the banks were no longer making money. The banks in turn could not meet their payments to the investment groups that gave them the working money to begin with. The investment groups withheld further funds and demanded repayment of the funds they were owed. Some of the banks and mortgage companies went bankrupt in the process. As the collapse worsened, home owners began to walk away from their homes because they were worth less than the value of the mortgage, banks had to hold onto the vacant properties that were not making money for them, and they began to sell them at deep discounts that made home values drop further. -- As foreclosures spread, banks could not recover their losses and those institutions that loaned money to them withheld further credit by way of no longer lending funds to the smaller banks. The banks in turn would not loan money they had available for fear of losing it. Businesses that needed the money banks had for new equipment purchases, land acquisition, growth and development, or adding new staff couldn’t get it. Individuals were also in the same situation as businesses. As businesses, institutions, cities, counties, and states couldn’t obtain loans, expenses suddenly had to be trimmed. The largest expense that was trimmed was in the form of personnel. Some businesses could not reduce expenses fast enough and went bankrupt. As people were terminated from their jobs, the unemployment skyrocketed! Some companies began to turn to the federal government looking for monetary help during the crisis. The “bailouts” they received were by way of using taxpayer money and the government borrowing more money from others. These companies did not rehire terminated employees once they received the “bailout” money and further layoffs occurred, which helped push unemployment rates even higher. The unemployment rate went over 9% in April of 2009 and just dropped below 9% two months ago. The problem is that the recent rates are not accurate since many people are no longer looking for work or have run out of their unemployment benefits. These people are shuffled off of the unemployment roster. A more accurate statistic might be the “participation rate”, which is percentage of working-age people working or looking for work. Right now it is 64%; the lowest it has been since 1985. To try and stimulate the economy, the government began lowering the federal funds rate, which is the rate the government charges banks when they receive money from the federal reserve. The current rate is just above 0% at .1%. We have never had rates this low! While this should cause people to want to borrow, many are simply not doing it and the low rates are putting terrible pressure on the value of the Dollar. When the dollar drops in value, goods and services become more expensive. As the costs rise, we have what is known as inflation. Though the government says the rate of inflation is 0, the costs of goods have risen dramatically in the last 12 months so inflation does in fact exist. Inflation causes the Federal Reserve to increase interest rates and this action will force many businesses to raise their prices. It also puts tremendous downward pressure on the value of the Dollar. The government has been borrowing tremendous amounts of money as well as printing loads of money. Printing more money devalues the Dollar and adding to the national debt with more borrowing does the same thing. If the debt continues to increase, fewer countries will view our economy as something worthwhile investing in. With a shrinking tax base, shrinking foreign investments, and the borrowing of more money, the Dollar may lose it place as the exchange currency of the world. Second, we experienced a credit crunch Third, we experienced an incredible rise in the cost of basic goods, i.e. commodities What are commodities? -- Commodities are raw goods that we use everyday like corn, wheat, gold, oil, water, etc.; “natural resources” is a good way to think about commodities. -- It’s important to remember that the entire world is “playing in the same economic sandbox”, all competing for the same resources, and when one country’s economy goes into turmoil, the others are affected as well. It’s just that our economy is so large and powerful that we affect everyone else all the time. Fifth, we experienced a dramatic
Transcript: Social structures Why did they know? They are still in a bubble http://en.wikipedia.org/wiki/Credit_default_swap Symbolic intrepretive Allan greenspan - No worries - just borrow, lower the interests. I have an ideology: free market. my he accepts that his ideology was wrong. Social structures- lecture 5 Social silince--> bourdieu Theories Wall street culture Did not take all the stakeholders into account Organic, mechanistic Programmed and non-programmed decisions From instution and career building to quick kills. Many different and hard models: (slide 7) 1. bounded rationality 2. carnegie model 3, incremental decision process model 4. garbage can model Systemic risk What can be said about ethics and corporate social responsibility in the Global Financial Crisis? What is the role that the leaders played? What is the role of incentives? some products: presuming of Banks and lending institution: best capalepe of protecting equitity in their firm and shareholders. Loan officers knew more about the risk. Now that the insurance company is downgraded it may have to undwind the transaction, or unload the debt that was insured. --> chain reaction Rating risks Bending the system Inflation in ratings Structural changes Subscriber or issuer pays? Different measures Agencies’ position Bargaining power Profit-oriented companies Incapabilities of the system Postmodern VS!! Most people don’t act based on economic reason, there are different reason, social value, build culture values, representational value. People don’t account for monetary value only. Look at the last lectures note GFC! actors Institutional theory (S) Stakeholder theory Social structure Power and conflict Decision making Culture No layalty for the institutions - Very fanansial and commercial - deluded. Tips: http://en.wikipedia.org/wiki/Stakeholder_theory Investment Banks Social network theory attempts to explain, in a modernist way, all of these phenomena by describing the structure of relationships between actors. Some main concepts: Social Networks Embeddedness Social capital Hatch (1996) p. 332 Karen Ho, the ethnocraphy of Wall Streeet. Business is dependent on how many deals the push through: If the push subprime morgages, that don't have longtime sustanablitiy --> crisis invoking LEave out power, which mean leacture 6 Look at the tips from all her case days Bonus is not determined on long term strategy. Research Question resource dependence theory (M) Aig finansial derivitive wing absorbing wall street culture. promoting default swap. Different level dependt on how are important No secret is that I would prefer that you take the power angle, combined with culture. It can be a difficult exercise – but you can do it!!! Bourdieu can help you here…a summary of some of his work can be found here: Geetz – symbolic interpretive Max weber – The culture is the web of meaning that these broker was making for themselves. The didn’t look at what actually happened and justified their actions. Shorting bonds Resource dependency Brokers & dealers Trade securities Credit derivatives Based on leverage Great potential for gains and losses. Shadow banking Providing loans based on funds from savers Uncertainty about exposure and failure to analyze true risks Michael burry Environment - 3 different level of analysis GSEs (Government Sponsored Enterprises) – Names of most important? Borrowing funds in capital markets to purchase mortgages Default on loans Conservatoryship Too Big Too Fail (TBTF) Large size/leading in sector Close connection with other actors Public visibility, loss in confidence Credit default swap Insurance Groups Names of most important? Guarantees and elevating credit standings Turmoil by AIG and the uncertainty that followed Retrenchment by insurers the finansicial innovation at wall Street led to more ineffecientcy - It has to be met be skepticism Culture Level of Analysis? Environments: local, international, globalization --> systemic risks), Interorganization network Assumptions Methedology Business Schools - Ivy leaugue Big investment banks And stock market These institutions Aig is sopposed to be outside the culture. They are sopposed the biggist insurance biggest. Credit defaut swap. (insurance contract) with collateral package. downgrade the triple A to B. Bonds can’t be chacked like Ferrari. The predominat with culture success can be measured very easily, same schools. Very identifiable. AIG was emulated by Aig, the Wall street bleeded into. Why would you change a culture that are successful. Aig bough that culture. The wall street theory undermined the stakeholder theory. Environment and level of analysis Lewis is in the SI, looking at emotions, straightforward view. Talking about the role of incentives from a personal view! It will happen again, regulations are not enough, there is also the role of incentives. Moral hazard ”only structuration in which a takes a risk . Principle/agent problems contract uncertatinty, up risk systems. 1. What
Transcript: The goods, which is going to be sold or leased, must be real. Conditions to ensure that the contract will save the both side . Saleh In conclusion. The main cause for the financial crisis over the world are Riba, which is interest* and usury**, and Maysir, which is gambling or some activities similar to gambling.*** * ( Chapra, 2008). *the extra money that you must pay back when you borrow money. **the practice of lending money to people and making them pay interest. ***According to Khan. http://aalhathle.kau.edu.sa/Files/121/Researches/55495_25818.pdf Makiyan, S. N. (2008). Risk management and challenges in islamic banks. Retrieved from http://www.ibtra.com/pdf/journal/v4_n3_article3.pdf Sole, Juan A. (2007) Introducing Islamic Banks into Coventional Banking Systems . Retrieved from http://ssrn.com/abstract=1007924 The contract must be a real trade transaction with full intention of giving and taking delivery The Islamic Based System: if the project fails the low gain and the loss will be shared between the bank and the investors. For example, if the contract has profits the profit will be shared between them, and if the contract loos both of them will share the loss. over 51 countries over the world. United Kingdom and Japan which have Islamic banks . PLS: Profits and loss sharing modes. In the back of history there is a time where there were no poor people. Achieving a primary rule in Islam which is justice. * ( Makiyan, 2008). The Islamic Financial System Against The Financial Crisis * charity for poor people. The risk* Outline: There are two based system for financial system which are Banking-based and Marketing-based. Lessons from Islamic financial system. The Islamic based system. The risks of using Islamic banks. The Islamic banking has used in many Islamic countries such as Sudan and Pakistan and they rely in the exact Islamic finance, while other countries such as Saudi Arabia and Egypt use the Islamic banking alongside with the convenience system( Makiyan, 2008) The seller cannot sell the debt, and the risk related with it must be principled by the lender himself. + That would motivate the creditor to more cautious in evaluating the risk as well . Lesson from The Islamic Finance: The risk Introduction: the Islamic finance has shown a strong system during the world financial crisis. Because of those practices like Zakah, and Awqaf*, which help the market to meet its financial needs, in the islamic institution the issues of adverse selection, moral hazard, and transaction cost Do no occur in Islamic banks. The PLS will help to eliminate the excessive lending. The Islamic finance has existed before the western countries were colonized. In the PLS modes the Islamic bankers cannot guarantee to eliminate the risks. The references CARMASSI, J., GROS, D. and MICOSSI, S. (2009), The Global Financial Crisis: Causes and Cures. Journal of Common Market Studies, retrieved from http://onlinelibrary.wiley.com/doi/10.1111/j.1468-5965.2009.02031.x/full Group of Researchers: Islamic Economic Research Center King Abdulaziz University (2009). Issues in the international financial crisis from an islamic perspective. In M. F. Khan (Ed.), World Financial Crisis: Lesson from Islamic Economics (Vol. 3). Retrieved from http://aalhathle.kau.edu.sa/Files/121/Researches/55495_25818.pdf Group of Researchers: Islamic Economic Research Center King Abdulaziz University (2009). Issues in the international financial crisis from an islamic perspective. In Dr. M, Chapra (Ed.), The Global Financial Crisis: Can Islamic Finance Help? (Vol. 2). Retrieved from The Islamic based system is Marketing-based system of goods and services. e.g deferred payments and sale contracts with advance payments
Transcript: 1. Global Effects Senate passed the Restoring American Financial Stability Act in 2010 January 2010 Obama proposed additional regulations limiting the ability of banks to engage in propreietary trading. House cleared the Wall Street Reform and Consumer Protection Act in 2009 U.S. economy has been spending and borrowing too much for years. Pension assets lost $1.3 trillion Over 100 mortage companies went bankrupt from 2007 to 2008 $700 billion dollar emergency bailout Effects on the Global Economy Falling house prices resulted in many foreclosures Debt of households and financial institutions greatly increased In 2001 the average home price was 3 times household income Gave false information and statistics Countrywide has dangerously low interest rates 4. Sub-prime Lending U.S. unemployment rate increased to 10.1% by October 2009. 1. Impacts on Financial Institutions "Free Cash" given to the public was doubled from 2001 to 2005 Banks give out reckless amount of loans and most were inappropriate Background 1. Emergency and Short Term Responses Government gave out $14 trillion, of which $7 trillion was invested or spent 2.Easy Credit Conditions The very rich lost relatively less in the crisis than the remainder of the population. 2. Regulatory Proposals and Long Term Responses Output of goods decreased at an anual rate of approximatley 6% THE END Iceland's banking collapse Government and competitive pressures led to an increase in the amount of sub-prime lending Financial Crisis Immediate cause - burst of US housing bubble which peaked 2005 - 2006 On average, people lost 22% of their retirement money Countrywide advertised false information Crisis hit its peak between September and October of 2008 2. U.S. economic effects Responses to Financial Crisis In one week $144.5 billion was withdrawn 6. Increased Debt Burden 2.Wealth Effects Between 1996 - 2004 deficit increased by $650 billion Fannie Mae and Freddie Mac owed $5 trillion in mortgage by September 2008 Financial Market Impacts Countrywide was sued for "unfair business practices" and "false advertising" US and European banks lost more than $1 trillion due to bad loans from January 2007 to September 2009 Easy credit and money inflow started housing bubble Total losses globally measured in trillions In 2006 in was 4.6 times the household income Governments have bailed out a variety of firms incurring large financial obligations. Studies show that crisis can be directly traced back to loans made by Fannie Mae and Freddie Mac Did not take the crisis seriously enough Did not let the public know how bad it really was 3. U.S. Congress Response Between 1997 - 2006 house prices increased 124% in US By September 2008 average house price declined by 20% from 2006 peak with potiential 35% drop Central banks purchased $2.5 trillion of the government debt and troubled private assets from banks. 5. Predatory Lending US housing and financial assets decreased after the housing bubble burst In 2008 there were 2.3 million foreclosures Deficits required the US to borrow money from abroad 1. Growth of the Housing Bubble Lower interest rates encourage borrowing Lowered wages Overseas Development Institute Many institutions were taken over by the government or failed 3. Weak and Fraudulent Underwriting Practice Obama and key advisors introduced a series of regulatory proposals in June 2009 Fannie Mae, Freddie Mac and CRA were primary causes of crisis 1993 - 1998 $467 billion of mortgage loans were made by CRA (Community Reinvestment Act) Studies show that US banks are about 60% done with their losses
Transcript: Housing Bubble In the United States Bursting of the Housing Bubble 4.35% increase over 2 years slowing of the housing market defaults on mortgages Shared Recessions: Worldwide Economic Consequences Fiscal Policies DJIA peaks at 14,198 in October of 2007 reaches trough at 6,469 in March of 2009 Causes Crash Crisis Consequences Understanding the Financial Crisis lower home equity 25% decline in wealth debt & foreclosure Fed buys securities: interest rates fall Globalized Financial System bad securities lead to lower interest credit markets freeze banks reluctant to loan to each other Economic Consequences in the U.S. Financial Markets Mortgage Backed Securities The Recent Financial Crisis Freezing the Housing Market Monetary Policies Rising Interest Rates In Short Bailouts declining GDP & growing unemployment a recession too big to "self-correct" fiscal & monetary changes public sentiment & uncovering of the U.S. government's pro-business policies how should we view this? Recovery stimulus package: spending our way out U.S. aims to preserve jobs Outline Sub-prime Lending High-risk loans
Transcript: Financial Crisis But more and more families default on their mortgage. Introduction Definition Is it a bank crisis? Families Banks 2009 Consumers DSB Bank There is more supply than demand. Years leading up to crisis Europe Everyone happy! They came up with a new idea Bankrupt Banks No! Banks wants more! 2 Groups Prevent a collapse Low interest rates Sub-Prime Mortgages Increased housing demand drove up housing prices in the early 2000s, and started to fall sharply in 2006 Subprime mortgages became prevalent in 2000s, and by 2006, about 20% of all U.S. mortgages were subprime. The crucial factor for 2008 financial crisis Some families default on their mortgages When housing prices plunged, many borrowers found themselves in a situation where the mortgage exceeded the value of the house. In this situation, a mortgage is said to be "underwater". €3.7 Billion This is the turning point! Government A type of mortgage that is normally made out to borrowers with lower credit ratings. Lenders charge interest at a rate that is higher than a conventional mortgage to compensate themselves for carrying more risk Good system right!? No problem, right? Banks will sell the house FORTIS ABN AMRO Social aspect Government took over for €16,8 Billion Mortgage
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