A4.
In order to restore its capital ratio level to the legal minimum a bank has two major options;
1. Increase total equity
- Find new investors to put in money and thereby increase Equity
- Delay the payments of dividends thereby increasing retained profits.
- Improve profitability, either by increasing its loan rates & bank charges, or by laying off staff and closing underperforming branches (or both).
2. Decrease risk adjusted assessments
-
Change the composition of assets in favour of those which have a lower risk weighting. Therefore over time, reduce lending to private individuals and small businesses
The effect of both of these actions will re-build the capital ratio level , however these actions will have an adverse effect on the economy by forcing us into a downward spiral of small and mid level companies going bust ,which will in turn make unemployment levels rise , mortgage payments and loan payments will then get defaulted and spending is reduced in most sectors .
B.
At the turn of the New Year and ultimately a new decade, the British public are being reassured by politicians and financial experts alike that not all is doom and gloom and that we are starting to pull ourselves out of the recession. However there are several articles stating the contrary and that if we are not careful as an economy that we might slip into a second credit crisis within the next few years.
A extract from times article written by Louise Armitstead sums up the credit cock-up in terms of leading institutions and companies perfectly “Britain's once-proud financial services sector witnessed the part-nationalisation of three of its leading banks and the country's mortgage market lies in tatters. The toll on US titans is worse: Bear Stearns gone; Lehman Brothers, gone; Merrill Lynch swallowed by Bank of America; Citigroup bailed out. Even the survivors, Goldman Sachs and Morgan Stanley, were forced to take government money.”
With the public and the economy still reeling from the last credit crisis, unemployment levels are still high and people are finding it increasingly hard to find jobs. This is causing a fall in demand across for the country for goods and services which in turn is meaning supply needs to fall resulting in more job cuts and in some areas the main employer (often for non-skilled labour) closing down. This vicious circle means the public have to tighten their belts and many are defaulting on mortgage payments. More and more households are falling into negative equity and are being forced to take up a higher standard variable rate on their mortgage. This isn’t a great scenario to be faced with especially when more and more are becoming unemployed, in this case people are going to struggle to pay off debts, loans, credit cards, and overdrafts which in turn will mean bank assets are going to take a very big hit which could spark a second credit crisis.
Several leading academics have agreed that unemployment could be one of the major factors that could make the economy relapse back into recession .The director of the London School of Economics, Sir Howard Davies said that “the UK is facing a “second credit crunch” as massive unsecured personal debt becomes a problem as unemployment rises”
Looking to the future “I think there will be some important changes when things get a bit better, and one will be that credit is back as a future of monetary policy. Now we are seeing the consequence of over-borrowing we will in future need to pay much more attention to credit conditions.
There are several different schools of thought to how we may slip into yet another recession. An article published in The Times newspaper regarding a new book by author Josh Kosman looks into the idea that it’s the vast number of American private equity firms that have flooded the UK market buying up British companies that could trigger a second credit crisis as they are leaving huge amounts of corporate debt behind. According to Kosman a staggering percentage of nearly half of all private equity firms on both sides of the pond are likely to collapse by the year 2015. The effect of this he says will be monumental and that close to 2 million jobs are at risk stateside with another 300,000 at risk in the UK. Even though the book is called “The Buyout of America: How Private Equity Will Cause the Next Great Credit Crisis” Kosman says that the threat of a second credit crisis is more so in the UK than the US .He explains that this is down to the openness of the British market and that so many firms have rushed over here and bought up so many companies and he draws attention to the recent trend of private equity companies trading amongst each other. The problem with this is that these companies were being bled dry not once but twice and in some cases even three or four times not leaving much of a company to be saved. However this is all one persons opinion in this book and we will need to look at several other resources to argue that there is a chance we could experience another credit crisis.
Another factor that some experts say could lead to another credit crisis is the fact that the economy is slowing at an alarming rate, far faster than expected. Financial authorities fear that this could cause an even bigger downturn as this is going to create a lot more bankruptcy. This means banks are going to have to yet again raise more capital this year in a marketplace that is scarce of potential investors ultimately culminating in a lack of credit as banks will continue to experience greater losses. To combat this best thing that can be done is to encourage banks to start lending again and that the government may need to enforce capital raising in the early months of 2010 in order to increase credit availability.
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References
Thornton ,P. (2009). Brace yourselves for Credit Crunch II . Available: .
Scotney ,T. (2009). Director of LSE warns of second credit crunch. Available: http://www.birminghampost.net/birmingham-business/birmingham-business-news/financial-business-news/2009/02/10/director-of-lse-warns-of-second-credit-crunch-65233-22890897/. Last accessed 15/03/2010.
Robbins ,M. (2008). British banks may face second credit crunch in the New Year. Available: .
Armitstead, L. (2008). Looking back on the year global finance was humbled