UK Financial Recovery Frameworks

In the aftermath of the Global Financial Crisis, the United Kingdom established various structures and systems that will help in economic recovery, and ensure that such a crisis does not occur again soon. Some of these structures have been efficient, while others have been deemed as mediocre frameworks, due to their little or no impact on the current economy towards preventing or upholding a steady economy and price costs. Even so, prior to this crisis, the government had established the tripartite system that aimed at protecting the country from another financial crisis. The tripartite system was a monetary policy that aimed at reforming the mandate of the Bank of England to a formal body that could manage the existing monetary policy. After close to a month the government also imposed another structural reform that stripped the Bank of England it long-standing mandate as a supervisor and manager of the British banking system and assigning this role to the Securities and Investment Board (SIB). The reform entrusted SIB with eight supervisory and regulatory bodies including the Bank of England (BoE), renamed to the Financial Service Authority (FSA), and was transformed into Britain’s main financial regulatory body (The Tripartite Memorandum of Understanding). The distinction of the banking supervision from the newly autonomous management of monetary policy was justified based on the strains for the BoE. The separation of banking supervision from the newly autonomous management of monetary policy was justified on the grounds of the strains for the BoE in possibly having to balance the needs of monetary policy and banking management. A monetary policy such as the interest rate and the discount window affected both the price and financial stability and in the vice versa (The Tripartite Standing Committee on Financial Stability). Whereas a rise in the interest rate was used to reduce inflation, it adversely affected problematic debts, the solvency of the banking system and capital adequacy. Besides, the monetary policy and the banking supervision practice were cyclical in nature. Assigning all these responsibilities to one agency gave rise to conflicts of interests, which compromised the functionality of at least one of them. It is even more note that the relationship between price and financial predictability needs information sharing, coordination, and cooperation between policymakers and banking advisors (Board of Banking Supervision, 1995). However, this framework did not give room for such changes. Such shortcomings led to the Northern Rock Run crisis. For the government to prevent the same mistake the LoLR roles and the Financial Service Compensation scheme was to be restructured, and the responsibility of bailing out individual banks was a made to be a joint decision and not a unitary one. In this respect, the subsequent section will analyse the policies and frameworks that the UK government implemented after the Great Financial Crisis (GFC).

Financial Policy Committee of the Bank of England

The main role of the Financial Policy Committee (FPC), is to identify, monitor, and act to eliminate or diminish risks that impend the resilience of the UK financial systems. The committee publishes a Financial Stability Report that identifies the main threats to the stability of the United Kingdom system. The FCP also has the mandate to guide commercial banks to change their respective capital buffers. In cases, where the committee decides that the threats to the financial systems are increasing, they have the mandate to inform commercial banks and other financial institutions to increase their capital buffer to aid in absorbing the unexpected losses on their respective assets (Hodson & Quaglia, 2009). These capital buffers are part of the “Macro-prudential” strategy- in this case, prudent means being careful in periods of uncertainty.

In order to undertake these duties, FPC uses the data and analysis that have been derived from some financial firms. This is because the United Kingdom’s financial system is partly concentrated and therefore for an institution to make constructive decisions, they ought to collect enough evidence about a problem, or an area that needs to be improved. Through the continuous use of data, the Financial Committee of the Bank of England has been able to make sound and proper policies that have fortified the UK economy. Besides, any decision made by the committee is done by consensus, which means that before a policy is passed, all members of the committee ought to have reviewed it. As much the process takes a longer time, the end result has always been favourable with respect to the current risks in the United Kingdom’s economy (Helleiner, 2011). Especially in recent times, during the BREXIT dynamics, it was expected that the economy of the country would face some turmoil or was at risk of collapsing, however through the intervention of the Financial Policy Committee, UK’s economy has remained resilient to the economic uncertainties that were brought about by BREXIT.

UK Prudential Regulation Authority (PRA)

The Prudential Regulation Authority (PRA) is mandated to control and oversee banks, insurance companies, credit unions, and investment companies. It is estimated that the PRA regulates around 1,700 financial firms in the UK. The role of this authority is defined by two major statutory goals, which are to define promoting protection and reliability of these companies and particularly for insurers to help them in securing the right degree of protection for their clients. To achieve its primary objective, the authority has focused on the adverse outcomes that insurance firms can cause the stability of the United Kingdom’s financial scheme (Crotty, 2009). A stable financial system is characterised by the pre-conditionalities where firms continue to give critical financial services, which is a pre-condition for a successful economy.

Since 2013 PRA has been actively engaging on pension charges, general insurance, and asset management among others. So far, the authority has been able to record a direct and positive impact in terms of protecting many households in the United Kingdom. The fact that the authority has taken a preventive stance, rather than a corrective one, has enabled it to prevent various situations, that would have otherwise led to economic turmoil; this translates in a policy-making framework that aims at preventing systematic harm where anticipated and enforcement in the firms that have exhibited some adverse traits (Crotty, 2009). Besides the PRA has been successful in transforming the attitudes of insurance firms. This does not mean that the various misconducts in the insurance industry are no longer existent, however, it implies that most firms have successfully promoted and transformed their attention to the client outcome, which was not evident in the pre-2013 era. PRA works closely with FCA to achieve its objectives; this partnership has given PRA implementation duties, which allows it to compel financial institutions to operate as the policies stipulated. Through the same collaboration, both institutions have been able to establish more policies that will ensure economic resilience in the publication titled “Bank of England Discussion Paper 1/18 | PRA Discussion Paper 1/18 | Financial Conduct Authority Discussion Paper 18/04.” This paper also highlights the finale steps to BREXIT without adversely affecting the insurance industry. Also, PRA has collaborated with the Bank of England, the Financial Conduct Authority, and the Payment System Regulator, under the 2013 Act of Financial Services, which is also known as the Bank reform act (Helleiner, 2011). Through these collaborations, the PRA has been able to conduct its duties successfully, and holistically. So far, the challenges experienced in the pre-2013 period.

The Financial Conduct Authority (FCA)

The Financial Conduct Authority was established on April 1, 2013, as a replacement of the Financial Services Authority. The institution has three main objectives which are; to protect consumers, to improve integrity in UK financial systems, and to lay a suitable platform for effective competition in the interests of consumers. FCA has the authority to introduce and enforce the rules that govern the United Kingdom’s financial services industry, - and it has powers to investigate both organisations and individuals that are suspected of violating the policies within its jurisdiction. To ensure that it attains its objectives, the authority uses the prudential regulations, which are the precautions for the stability of the financial system. These policies are divided into micro-prudential policies, and prudential policies (Damodoran, 2016):). Micro-prudential policies directly touch on private firms such as Banks, insurance companies, and other institutions that deals with financial facets, while Macro-prudent policies help in the regulations of financial systems as a whole, it involves countercyclical capital buffers.

Macro-Prudential Policies

These policies are important when it comes to correcting marketing catastrophes and externalities and compensates macroprudential policy causes. According to reports from ….. , macroprudential policies requires a strong institutional framework for effective implementation, and so far FCA has been that institution in the United Kingdom. When coordinated well these policies have proved to be necessary for lowering cross border international effects, especially in the case of BREXIT. Immediately after the announcement of BREXIT, policymakers argued that such multinational issues could easily lead to insufficient national actions due to the possible transition conflicts between the national institutions and international (E.U) institutions (Helleiner, 2011). However, from experience, Macro-prudential policies have been so far able to prevent such uncertainties.

So far, the UK authority has not been able to utilize these policies because of systematic gaps and failures. Crotty (2009) argues that for the country to harness the full benefits of these policies, they need to give the relevant authorities the right capacity to conduct a systematic risk analysis. Such a system is important for operationalism macroprudential policies. Therefore, the UK government ought to select and assemble macroprudential instruments that can help in supporting the identification of the main potential sources and dimensions of systemic risks. Damodoran (2016) adds that they also need to monitor the policy gaps and act on them as soon as possible and identify the information gaps that can affect the macroprudential analysis.

Micro-Prudential Policies

The aim of these policies was to reduce the probability of future failures in the private sector, irrespective of their effects on the economy. The ultimate objectives of these policies are to protect consumers who have invested in financial institutions. After, the Global Financial Crisis, the government had to provide guarantees during the crisis. The case is not only experienced in the UK, other countries such as Sweden, Japan, and the United States of America, have established micro-prudent policies that guarantee their citizens during an economic crisis. Hodson & Quaglia, (2009) wrote that unlimited depositor securities and regulatory forbearance increase the fiscal costs of financial catastrophes. Besides, with the existence of these policies implies that the government will use the same solution for any economic/financial crisis that arises, which ultimately will diminish the market discipline, and increase the probability of risk shifting among financial institutions.

Liquidity and Capital Ratios

Liquidity refers to the ease in which assets can be turned into cash and be used immediately as a means of exchange. It is a fact that some assets are more liquid than others, and cash is considered the most highly liquid asset; to be specific, cash that is held in sight deposit accounts is highly liquid, because it can be withdrawn easily without penalties. Other assets that the government could possess, include treasury bills, stock held in large companies and bounds. After the global crisis, the Bank of England adopted policies and frameworks that would enable it to have more liquid assets than before. According to Adrian, Boyarchenko and O Shachar (2017), by July 2016, the United Kingdom Commercial Bank had more than £600 billion of liquid assets; this is around four times the amount the bank had prior of the universal economic crisis. This is due to the fact that in a crisis liquefying some assets such as land and machinery is always a challenge, and in the instance that these assets could be liquefied then they are likely to be sold at a cheaper price than the actual value. Therefore, it is much safer for the Bank of England to have a cash reservoir than assets that are not easily liquified, especially when there is a looming crisis. The bank also restructured its liquidity ratio policy by compelling banks in England to hold enough liquidity ratio that would cover the anticipated demands from depositors in case of a crisis. The same was emphasised by the Basel Agreement (which Britain ratified), which stated that Banks and other financial institutions should have sufficient liquid assets such as cash and bonds that can last them at least 30 days, during periods of the financial crisis (Ehlers, T and P Wooldridge, 2015).

The Monetary Policy adopted by the Independent Bank of England is answerable for establishing the monetary policies in the United Kingdom. The United Kingdom’s treasury is responsible for setting goals and the expected inflation rate of the UK monetary policy, and at the same time, it helps in appointing members to the Monitory Policy Committee (MPC). As per stipulations of this policy, the Bank of England decides on the best strategy and tools to be used to meet the expected inflation rate set by the treasury. The Bank of England, therefore, has the freedom to choose the instrument of achieving a targeted inflation rate but does not have the freedom to establish the policy on inflation.

Monitory Policy Committee

The main aim of the Monitory Policy Committee is to ensure that price constancy, by controlling economic inflation. De Haas and van Lelyveld (2014) wrote that price stability can only be ensured when inflation stays low and relatively steady for a longer time. As per this monetary plan, the public declaration on inflation is assumed hence its name Inflation Targeting. In the UK, Inflation Targeting is inured on the anticipated rate of inflation, instead of what it is in sight of the time intervals in the monetary plan. Subject to obtaining and upholding price steadiness in this manner, the Bank of England is also likely to preserve the economic plan of the administration, which comprises of economic development and employment opportunities. Price constancy is therefore perceived to be a pre-condition for accelerated economic development and employment. After 1997 reforms the Monetary Policy Committee was rendered accountable to Parliament (Wagner, 2010). The parliament through the House of Commons Treasury Select Committee exercises regular scrutiny through reports. The House of Lords also exercises the same scrutiny through the Select Committee on Economic Affairs. The Monetary Policy Committee is also answerable to the public through the periodical of the records of the MPC meeting and the inflation information. The government instead retains the responsibility for monetary policy, which means that it holds the responsibility of designing the scheme and establishes the inflation target. Once the government has established the inflation target, it becomes the main issue to what level of interest rates is suitable to attain the stipulated targeted (Wagner, 2010). The MPC has the responsibility of establishing the necessary interest rate to attain the anticipated inflation targeted by the head of the exchequer. Therefore, it can be concluded that the Bank of England is instrument independent, but goal dependent while pursuing the monetary policy. In such a situation, the Bank of England follows the principle of controlled decision, which is the middle platform between discretion and rules. The improved responsibility is given to the Bank of England for its responsibility to the parliament, the administration, and the public, which means that transparency in definite policy-making is imperatively attributed to this plan. The efficacy of this policy ought to be measured by its functions.

Low Inflation Rates

The major aim of the monetary policy is to check on inflation and prevent any situation that could lead to the same. However, Claessens, Kose, & Terrones (2010) argued that even before the implementation of the policy in 1992, the rate of inflation had been stabilizing and in fact, the policy was only implemented after inflation in Britain had been tamed. Ball (2009) also argues that the period after 1992 up to date (well apart from the BREXIT dynamics), the fiscal climate in the United Kingdom has been relatively quiet. After the peak of the Global Financial crisis, the inflation rate annualized to around 4% just before the monetary policy was announced. Afterwards, the accounts of inflation would never surpass the upper limit established by the Treasury in 1992 and in 2003. Even so, a quick look into the involvement of the financial policy discloses another challenge. The trends observed between the period before and after the independence of the Bank of England give a different story about the monetary policy. In the first stage of initiation, that is between 1992 to 1997 the real rate of inflation was slightly overhead the median of the 1-4% range. Since the Bank of England was given its freedom to come up with the right strategies of controlling inflation (De Haas and van Lelyveld, 2014). In 1997, the same rates of inflation enjoyed in the previous years only occurred for a very short time. While most times in the concluding period, definite inflation has been closer to the lesser bound, which evidence suggests that monetary strategy has been fairly tight, and constricted than the earlier regimes; to the degree, that fiscal strategy can have real impacts on either domestic or exchange rates.

Problems with the Exchange Rate

Another problem with monetary policy entails the exchange rate, which up to this point has never been given enough consideration. From the stipulations of the policy, it is clear that the Bank of England does not perceive the exchange rate to have a significant part in affecting interest rates. Even so, the rates’ parity theory shows that the variation between national interest rates, and external interest rates is equivalent to the anticipated rate of alteration of the exchange rate. A high national interest rate is linked with a denigrating currency (Wagner, 2010). Besides, there might be some indirect effects on the exchange rate influence prospects on impending inflation. The exchange rate, thus it can be an essential platform through which the impacts of interest rates might function. It conveys a portion of the impacts of variations in the policy apparatus and affects foreign shock (International Monetary Fund, 2013). In this case of the potential serious part of the exchange rate in the transmission progression of the fiscal plan, extreme instabilities in interest rates could lead to a higher percentage of output instability. The discussions conducted by the House of Lords in 2004 through its Select Committee on Economic Affairs gives another perspective to this issue. According to Wagner (2010), the economic model chosen by the bank of England, in its initial year 80% of the result of an intensified in interest rate was through an increase of the exchange rate. for a matter of fact between 1996 to 1997 the pound's exchange rate increased by 23%, which post dire challenges to the manufacturing sector whose annual turnover decreased. The annual turnover of the manufacturing sector decreased between 1997 to 2002 after it had recorded a gradual increase between 1992 and 1997. subsequently, the decrease in the annual turnover of the manufacturing sector affected the employment opportunities offered by companies based in the industry (Abiad, Balakrishnan, Koeva, Leigh and Tytell, 2009).

Price Stability

The goal of the monetary policy to ensure price stability raises concerns on whether this objective is enough. Hodson & Mabbett (2009) contended that the quest of such objectives has diminished the rate of inflation and benefitted the countries that have adopted them. However, realising price constancy in the short run is not enough to prevent some macroeconomic recessions in the long-run. In fact, Claessens et al. (2010) used the case study of the United States of America to argue that reducing price level inconsistency by 18% leads to an upsurge in output inconsistency by 21%, which ultimately increases the unemployment rate by 19%. Besides, previous examples from periods of very low or no inflation rates followed by major economic crises such as the period between 1920 to 1930 in the United States of America was characterized by financial innovations, rising productivity, and technological innovations, which led to higher consumer credit (International Monetary Fund, 2013). All these factors contributed to the 1930s great depression in the USA, which was characterised by high unemployment, a decrease in annual turnover, and financial distress. Bennett & Kottasz (2012) reports that between 1930 and 1939 unemployment in the United States of America was about 18.2%. The prices of commodities fell drastically in the same period. Another example is in Japan during the 1980s, when the country enjoyed a decade of price constancy, with a low annual inflation rate of 2.6%; this, however, does not prevent Japan from falling in economic problems in the early 1990s. At this point, the growth per capita was only 1%, unemployment rates rose, while several banks witnessed several bankruptcies. The Asian crisis also had similar dynamics, and most recently in 2001, the stock market in the United States of America fell. In all these cases, price stability was not enough to ensure sustainable economic growth (Claessens et al., 2010). An interesting fact is a post-2001 period, in the United States of America was characterised by a record monetary policy that as much as it accomplished to restore economic development, the pace of economic growth was sluggish to have ever been recorded ever since the post second world war era (Hodson & Mabbett, 2009). The conclusion from all these case studies is that ensuring price stability does not certainly imply that it helps the economies using such policies.

Economies that have not implemented the Monetary Policy have done as well as the United Kingdom

Economies, where the Central Banks have not implemented a policy that aims at controlling inflation, have also performed as well as the United Kingdom, where the Bank of England has strongly focused on implementing the monetary policy. To achieve this purpose Yeoh (2010) uses the inflation rates that have been observed in states which have implemented the inflation policy versus those that have not implemented the same policy, which in this instance is used as the control group. The results revealed that both states had a relatively equally inflation rate and price stability. In 2006, the International Bank for International Settlement yearly report recommended that the low and relatively steady inflation rates experienced in most countries in the world might be as well as due to the direct and indirect impacts of globalisations. The statement advises that globalisation might have enabled governments to deploy less stringent monetary policy measures. The report gave five explanations of how this phenomenon might have operated. The first reason for a sustained stable price and inflation was the liberalisation of the global market in goods and services and cross-border investment are claimed to have condensed the cost of humanising and preserves low inflation tariffs (Rudd, 2009). The resulting competition might have detached 25 country-specific restrictions and allowed the smoothing of business sets in the course; this ultimately might have rendered Central Banks more fixated on preserving low inflation (Hodson & Mabbett, 2009). Amplified global competition could also have increased the consequences imposed on states judged to have sound policies, which imposes more disciple on policymakers. The fact that globalisation helped in reducing inflation, the integrity of bankers has also been improved considerably.

The International Monetary Fund through its study conducted in 2006, concurred with the globalisation explanation and gave an extra explanation. As per explanation was given by the IMF, globalisation might have given economies necessary incentives to raise productivity through an improved pressure to innovate in tandem with stronger price competition (Hodson & Quaglia, 2009). These dynamics lead to an assumption that globalisation has altered the occurrences in the inflation resolve, and all credit cannot be given to the monetary policy adopted by the Bank of England.

References

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Yeoh, P. (2010). Causes of the global financial crisis: Learning from the competing insights. International Journal of Disclosure and Governance, 7(1), 42-69.