Management of Financial Institutions and the Banking Crisis
Introduction
In the UK, the repercussions of the recent banking crisis affecting the financial sector are now being observed in the wider economy. In January 2009, it was confirmed that the UK is officially in recession as the criteria of two consecutive quarters of negative economic growth has been met. Gross domestic product (GDP) fell by 1.5% in the last three months of 2008 following a 0.6% drop in the previous quarter.
Many events leading to the current situation have stemmed from the managerial decisions made within various financial institutions. The following gives an insight into how the crisis evolved and also explores the two key aspects of why Northern Rock opted for their chosen business model and secondly, the actions of the Bank of England (BoE) as the crisis unfolded.
The Northern Rock Affair
The crisis witnessed at Northern Rock widely demonstrates how poor management can contribute to the failing of a huge financial institution. In pursuit of continuing rapid expansion and growth, the bank adopted a business model they believed would enable them to become one of the market leaders in mortgage lending. This model was based upon relying on the wholesale markets rather than the more traditional approach of the retail markets to finance the majority of its lending. This method of operating is considered high risk. Therefore, it is fundamental to understand why Northern Rock chose to implement this type of model.
Primarily, reporting to shareholders the responsibility of the bank executives is to maximise the profitability of the bank. Choosing to securitize its loans, they packaged them together and traded on the wholesale markets. By selling these packages to investors they were able to make immediate financial gains whilst also ridding themselves of potential bad debt. Operating in this way, Northern Rock had announced record profits for 2006 and further securitisations during the first six months of 2007 generated even
In the UK, the repercussions of the recent banking crisis affecting the financial sector are now being observed in the wider economy. In January 2009, it was confirmed that the UK is officially in recession as the criteria of two consecutive quarters of negative economic growth has been met. Gross domestic product (GDP) fell by 1.5% in the last three months of 2008 following a 0.6% drop in the previous quarter.
Many events leading to the current situation have stemmed from the managerial decisions made within various financial institutions. The following gives an insight into how the crisis evolved and also explores the two key aspects of why Northern Rock opted for their chosen business model and secondly, the actions of the Bank of England (BoE) as the crisis unfolded.
The Northern Rock Affair
The crisis witnessed at Northern Rock widely demonstrates how poor management can contribute to the failing of a huge financial institution. In pursuit of continuing rapid expansion and growth, the bank adopted a business model they believed would enable them to become one of the market leaders in mortgage lending. This model was based upon relying on the wholesale markets rather than the more traditional approach of the retail markets to finance the majority of its lending. This method of operating is considered high risk. Therefore, it is fundamental to understand why Northern Rock chose to implement this type of model.
Primarily, reporting to shareholders the responsibility of the bank executives is to maximise the profitability of the bank. Choosing to securitize its loans, they packaged them together and traded on the wholesale markets. By selling these packages to investors they were able to make immediate financial gains whilst also ridding themselves of potential bad debt. Operating in this way, Northern Rock had announced record profits for 2006 and further securitisations during the first six months of 2007 generated even
References: The Economist, 2008, Lifelines, The Economist, 09/10/08. The Economist, 2007, Lessons of the fall, The Economist, Vol 385 Issue 8551, p91-93, 20/10/2007.