Changes in the UK and US Banking Industry

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Table of Contents

Introduction
Macro Environment
Micro Environment
Conclusion
Reference

Introduction

Over the past decade, the global economy has undergone numerous changes. The effects have been experienced in different sectors of the economy. For instance; the banking industry has undergone numerous transformations in its operation. These changes result from the macro and microenvironments of the banking industry. The discussion of this paper seeks to identify the transformation that has been experienced within the US and UK banking industry from 1980 to 2007.

Macro Environment

Changes in regulation

In the 1980s the US banking industry experienced increased transformation to the regulation of the financial institution by the Federal bank. For instance; there was a limit in the amount of loan the small banks were supposed to advance to their customers. This was fixed at 10% by the federal bank (‘Bank regulation and legislation ‘). This was through the incorporation of legislation that gave the financial institution the capacity to involve themselves with risky financial activities such as the issuing of loans for commercial purposes.

The legislation also made it possible for financial institutions to invest in real estate. They could also receive deposits in form of checks. In the year 1984, the banks were allowed by the federal bank to acquire firms involved in a discount brokerage that had financial difficulties. The increased deregulation of the banks in the US by the federal bank resulted in a massive bank failure. This was experienced from 1985 to 1988 by the savings and the loan association where approximately 500 institutions collapsed. The US banking industry experienced further deregulation in the year 1999. This enabled the banks to diversify investment by investing in financial securities and the insurance industry. This was aimed at improving the competitiveness of the US banks to meet international standards. This was also experienced in the UK banking industry. For instance; in the year 1985, the Royal Bank of UK ventured into the insurance business through the underwriting of the insurance firms. This was through setting up a direct insurance line. By the year 1995, it was the largest car insurance. Currently, it has diversified into other insurance sectors such as the household and the financial securities (Charles 1990).

Technological environment

The banking sector has integrated the concepts of information technology in its operation. Because these economies are developed, there was a wide distribution of automated teller machines within these countries during the 1980s. This increased the convenience of banking. For instance, in 1980, the Royal Bank of UK established a cash line through the Automated Teller Machines (ATMs) which made it become the busiest bank in the world in terms of the number of transactions that were conducted (Charles 1990).

Over the recent past, there has been advancement in internet technology. This has led to the emergence of electronic commerce. The banking industry in UK and US have integrated electronic commerce in their operation. This is through the integration of the concept of online marketing. This enables the consumers to access banking services through the internet. In line with the advancement in mobile phone technology, the banking sector in these economies has incorporated mobile banking. This is through the implementation of automated mobile phone systems that enable their customers to access banking services such as payment of bills and the transfer of funds without having to go to the banking hall.

Culture

Over the last decades, the US and UK banking industries have experienced more challenges from the economic environment. Customers have become more aware of bank products, the cost involved, and the value that is created. This has resulted in the need for culture change in their operation. The two main strategies that have been incorporated are the need to increase their efficiency through mergers and acquisitions. There is also the emergence of a culture aimed at improving their customers’ service through training their employees.

Social level

There has been increased social change in the operation of banks in the US and UK. For instance; banks are more into environmentally friendly financing projects. They are also investing in the renewable energy sector. Other involvement includes increased donation to charitable organizations, education, health, and other community development projects ( Bank Industry report 2007).

Micro Environment

Increased Competition

In the recent past, the banking industry in UK and US have been characterized by intense competition. This is because the bank’s management is realizing the fact that their operation was based on traditional platforms. This has sparked the need for the transformation of these banks to cope with the changes in the economy. In the US, the competitive strategy that is being incorporated is the useful concept of consolidation while in the UK banking industries; more emphasis is being laid on the mergers and acquisition concept. This has resulted in an increment in the scale of operation for banks. This is through establishing more branches within the domestic country and also venturing into foreign direct investment.

Increase in risk management

The banking industries in these economies experienced major bank failures in the early 1980s and 1990s. This resulted from the fact that the quality of assets that individual banks had invested in was poor and that they also had a low level of liquidity. This resulted in a negative impact on the economy. To prevent such failures, banks have developed strategies on how to mitigate or eliminate the occurrence of such risks. This is evident from the fact that banks have developed strategies on how to diversify their portfolio investment. The effect is that their level of profitability increases enabling them to meet their credit requirement. In line with risk mitigation, the banking industry has also integrated the use concept of expense management aimed at reducing the cost of operation.

Power of suppliers

The US and UK banking industry has been traditionally characterized by increased supplier power. Over the last decade, this trend is diminishing. This is due to the increasingly competitive environment. For instance; there has been the emergence of investment banking which is more specialized in a particular sector of the economy relative to other banks. This gives these banks higher supplier power (Justin & Kedar 2002).

Buyer power

Due to the incorporation of advanced technology within the US and UK Banking industry such as online banking and the emergence of more banks, buyer power has increased significantly. This is because the customers can switch their membership with minimum cost depending on the products being offered by a particular bank. The banks in these industries are offering a low switching cost to lure customers (Justin & Kedar 2002).

Threat of substitute

The banking industry in US and UK face a lot of competition in terms of the product and services they offer from the non-bank financial institutions. There is also the emergence of unconventional companies that are lending finances to the customers who purchase big-ticket items at a 0% rate, for instance, General motors.

Corporate social responsibility

The US and UK banking industry has continuously involved themselves with social responsibility. This is from the recognition of the fact that financial services have a great impact on society. Social corporate responsibility has become a key driver for the banks in the process of investing. For instance; there is increased demand for banks in these countries to assess the social and the environmental impacts of their project financing that is above $ 50 million.

Credit Crunch

According to Paula & Robert, a credit crunch refers to an enormous reduction in the amount of finance that is in supply for a given type of business (1993). This is mainly experienced when the economy is in the recession phase of the economic cycle. This results in a significant reduction in the amount of finance that is available to be advanced in form of loans. When the economy of a particular country is in a credit crunch, a slow rate of growth in the amount of credit available is experienced. In the period of the credit crunch, both the bank and non-bank financial institutions are affected. The non-bank sectors experienced a credit crunch during the 1990 to 1991 economic recession. Apart from its effect on the banks, the Credit crunch results in a decline in the flow of finances from the finance companies, mortgage firms, and commercial papers.

In the US, a credit crunch was experienced in Texas through the collapse of the banking sector. In the year 2007, various economies such as the UK, US, and France experience a collapse of financial institutions. Various causes result in credit crunch within the banking industry. These include the following

Reduction in the capital level of the bank

In periods when the economy is experiencing a slow rate of growth, there is a reduction in the demand for capital. The supply of credit also declines since it is risky for the financial institution to issue loans during this period. When the economy recovers, banks increase their lending capacity significantly. During the recession, banks experience a large loss in terms of loans. This is because it becomes hard for the borrowers to service the loan. This was the case that was experienced by Northern Rock in UK and US. The borrowers of funds from this financial institution could not be able to continue with their payment. The effect is that the capital base of the bank is greatly reduced. The loss experienced by the banks as a result of loan default may exceed the levels that are set by the bank’s management or the regulatory bodies such as the Central Bank (Robert & Paul 1993).

Upon the occurrence of such an event, the bank manager or the regulatory agencies may result into raising the minimum capital requirement by raising the capital requirement. This requirement depicts the liquidity level that should be maintained by the financial institutions. Upon increasing the capital requirement, the financial institutions have to respond by increasing their capital requirement levels.

The setting of new standards by the banks

Upon an economy experiencing an economic recession resulting in bank failures, there is a change of perception to risk amongst the management and the controllers of the financial institutions. This compels them to undertake strict risk control measures. This culminates in the reduction of the amount of credit to be issued in form of a loan. For investing in various avenues such as securities, the banks reformulate their risk requirement. This means that they increase the amount of capital necessary to carry out such undertakings. This means that it will be possible for financial institutions to minimize the effects of loan defaults (Robert & Paul 1993).

Alternatively, credit crunch also results from the banks reevaluating the credit standards. This means that they improve the credit rating requirement in the process of issuing the loans.

Increased regulation of the financial institutions

Financial institutions are amongst the institutions that experience strict regulation by the government. The result is that they are required to comply with certain legal requirements which demands a high compliance cost. This increases the opportunity cost for the banks since the amount related to the compliance cost does not bear interest. This culminates in a reduction in the financial institution’s asset level. The effect is a reduction in the credit creation for the financial institutions which would have contributed to capital accumulation for the financial institutions. The banks respond by increasing their lending rate to a level that is higher than the rate of interest from investing in securities.

According to Paul & Robert, amongst the regulations imposed on the banks is the requirement of a continuous appraisal of loans that have been advanced to fund real estate. In evaluating their lending capacity, the financial institutions examine the compliance cost involved. If it is high, they respond by reducing their lending even if the capital has been replenished (1993).

Poor monitoring

Despite there being a regulatory body for the banking industry, the monitoring system is not efficient. This resulted in the current credit crunch amongst the financial institutions in UK and US. This is because these firms increased their loan to the borrowers without proper evaluation of the projects that the loans were intended to finance. The consumers used the finances to buy houses that they could not afford. This explains the reason for the crisis that was experienced in the mortgage industry in the US.

Conclusion

The banking industry in US and UK has undergone tremendous transformation in the macro and microenvironment. The changes in the macro-environment include the changes in regulation by the central bank which gave the banks capacity to invest in various assets such as securities. Increased competition has resulted in the integration of new competitive strategies through the integration of mergers and acquisitions and also consolidation. The technological environment is also changing through the integration of new technology such as online and mobile banking. The microenvironment has witnessed a transformation to risk and expense management strategies.

To credit crunch, various causes have been identified to be the basis. These include the increased regulation by the relevant authorities, decline in the capital base for the financial institution. It also results from banks management setting new standards related to the determination of the creditworthiness of the borrowers.

Reference

Bank industry report, 2007: tracking the ethical reputation of multinationals. Cambridge MA: Switzerland. Web.

Bank legislation and regulation: an examination of the banking crisis in the early 1980s and 1990.

Business wire. 2006. “Competition intensities as the retail banking industry reaches maturity.” Data monitor. Web.

Charles, W.N.1990.The rampant Scotland directory: History of Scottish bank and banks notes. Chartered institute of bankers in Scotland. Web.

Economist.com.2008.”who caused the credit crunch.” Web.

Justin, H & Kedar, I. 2002. Adapting to change in the investment banking industry. Web.

Michael, G & Ricardo, H. 1998.The root of banking crisis: the macroeconomist context. Washington: Inter- American Development banking. Web.

Robert, T.C & Paul, T.1993. Six causes of the credit crunch: or why is it too hard to get the loan. Texas: University of Texas. Web.

Simon, D. 2008.Why the credit crunch happened and what it means.

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