AC942 Modern Banking

1
AC942 Modern Banking

• Dr. Paul Hamalainen
• pkhamal_at_essex.ac.uk
• Office Hours
• Monday 2-4
• Tuesday 9-10

2
Lecture 4 Banks and the credit crisis I-
Liquidity Provision, Bank Runs, Deposit
Insurance, Northern Rock

• Aims of the lecture
• Understand the events leading to the current
  financial crisis
• Explain the Importance of liquidity in bank risk
  management
• Explain the role of deposit insurance in banking
  supervision and regulation
• Explain the key structures in deposit insurance
  schemes and weaknesses in the UK scheme
• Critically appraise the regulatory authorities
  responses to the failures in UK banks

3
Events leading to the financial crisis

• Outcome 9th August 2007
• Money markets dry up
• Credit market (securitisations) seize up
• Causes?
• Growth in originate and distribute banking
  model securitisations
• Low interest rate environment search for
  yield combined with excess liquidity
• Complexity of products and tranching
• Lack of transparency
• Role of credit rating agencies

4
(No Transcript)
5
Fallout from the crisis (1)

• Northern Rock
• Reliant on securitisations and wholesale money
  markets
• Depositor run Commenced Friday 14th September
  2007
• Ceased Monday 17th September 2007

6
Fallout from the crisis (2)

• Northern Rock
• 17th September 2007 existing retail deposits
  100 guaranteed
• 20th September 2007 guarantee extended to cover
  existing and renewed wholesale deposits
• 9th October 2007 guarantee was further extended
  to all new retail deposits

7
Objectives of deposit insurance

• Increasing consumer protection
• Reducing systemic risk (i.e. increasing financial
  stability)
• BUT, Must balance protection with cost of moral
  hazard behaviour right incentive structure.

8
Weaknesses in UK DIS

• Coverage limit / Co-insurance element
• Slow payout (liquidity risk to depositors)
• Net payment
• Based on registrations not brands
• Ex post scheme funding
• No risk-based contributions

9
Other weaknesses in UK supervisory regime

• NR exposed weaknesses in UK regime to deal with
  failing banks bank resolution policies
• No specific bank resolution regime
• PCA Prompt Corrective Action
• Supervisory structure Tripartite arrangement
• Poor communication
• Lack of clear leadership and roles
• Uncertainty concerning resolution procedures
• Speed and certainty in dealing with crisis
• Evidenced in both points above
• 17th February 2008 Banking (Special Provisions)
  Act 2008
• Poor supervision
• March 2008 FSA report into supervision of NR
• Enhance liquidity measurement and monitoring

10
UK DIS developments

• October 2007
• co-insurance removed
• 100 of 35,000
• October 2008
• Coverage limit raised to 50,000
• Consultation on future deposit insurance scheme
• Ongoing with 2009 implementation likely
• Gross payments
• Faster payout
• Funding scheme

11
UK authorities response to subsequent failures
(1)

• September 2008 Bradford Bingley
• Govt applied Banking (special provisions) Act
• Immediate certainty ALL depositors protected
• Showed that can transfer deposits quickly
• Cost passed to other banks and BS
• October 2008 Icelandic banks and December 2008
  London Scottish Bank
• Govt applied Banking (special provisions) Act to
  UK subsidiaries
• Immediate certainty ALL RETAIL depositors
  protected
• Showed that can transfer deposits quickly

12
UK authorities response to subsequent failures
(2)

• Protect all retail depositors
• Extends to non-systemic risk banks as well
• moral hazard issue?
• Future bank crises Time consistency problem?
• Cross-border issues
• overseas banks and treatment of uninsured
  (non-retail) depositors
• EU competition issues Ireland
• Deposit scheme harmonisation
• Small banks and treatment of uninsured
  (non-retail) depositors
• Re-evaluate classification of retail depositor?