David T. Llewellyn

An analysis of the causes of recent banking crises

The incidence of systemic banking crises has risen over the past twenty years and the costs have been high. Although each countrys experience has country-specific factors, several common elements appear in most crisis countries: (1) volatility in the macro economy; (2) the inheritance of structural weaknesses in the economy and financial system; (3) hazardous banking practices; (4) hazardous incentive structures and moral hazard within the financial system; (5) ineffective regulation; (6) weak monitoring and supervision by official agencies; (7) the absence of effective market discipline on banks, and (8) structurally unsound corporate governance mechanisms within banks and their borrowing customers. Causes of such crises are complex and a myopic focus on single factors (e. g. instability in the macro economy, weak regulation, etc.) misses the essential feature of interrelated and multidimensional causal factors. Although macro-instability has been a common feature, and may often have been the proximate cause, banking crises usually emerge because instability in the economy reveals existing weaknesses within the banking system.

The Role of Market Discipline in Handling Problem Banks

This paper considers the conditions that are necessary for market discipline to complement prompt corrective action (PCA) by the authorities in handling problem banks. We initially consider precisely what market discipline means in this context, who exercises it and the preconditions that are necessary for it to operate effectively. We explore the incentives that are necessary for PCA and market discipline to reinforce rather than cancel each other and in particular consider the limits to market discipline in this context from corporate governance and from difficulties in valuation. While our analysis is primarily aimed at advanced countries, we also examine problems in emerging markets and how deposit insurance arrangements might conflict with the aims of both PCA and market discipline.

Trust and confidence in financial services: a strategic challenge

The purpose of the paper is to offer an analytical framework for the Treating Customers Fairly initiative of the Financial Services Authority. The TCF agenda is set in the context of theory of consumer behaviour. The central theme is that retail financial transactions are fundamentally different from most other economic transactions made by retail consumers and to an extent that means the consumer needs to have Trust and Confidence in the products purchased and the suppliers of financial products and services. A distinction is made between different types of products and also between the degree of need for Trust and the extent to which the consumer actually does have Trust and Confidence when making decisions. The inculcation of Trust and Confidence needs to become a central strategic issue in financial firms and can be addressed by initiatives of collective self regulation rather than more prescriptive regulation.

The Northern Rock crisis: a multi‐dimensional problem waiting to happen

In August 2007, the UK experienced its first bank run since 1866. Northern Rock had adopted a business model (heavy reliance on securitization and wholesale market funding) that exposed itself to a low-probability-highimpact (LPHI) risk. The chapter argues that it was an accident waiting to happen in that there were fundamental fault lines in the institutional architecture for dealing with failing banks in the UK. In particular, there was an inconsistency in the deposit protection scheme, no special insolvency arrangements for dealing with failing banks, and no ex-ante Resolution procedure. There were also serious failings in the supervision of Northern Rock, and in the split of responsibilities between the Treasury, Bank of England, and the Financial Services Authority (FSA).

Competition and Profitability in European Banking: Why are British Banks so Profitable?

Substantial differences remain between the profitability of banks in different European countries. This article considers the relationship between competition and profitability in European banking focussing on the experience of the UK where two issues are considered: why British banks have been earning excess returns for more than a decade and why British banks seem to be more profitable than their Continental counterparts. A paradigm is offered to explain this. A distinction is made between shareholder value (SHV) and stakeholder value (STV) banks whose business objectives are often different. Significant differences exist between European countries in the balance of SHV and STV banks. The UK is almost unique in Europe in having almost exclusively SHV-based banks. Pressures will intensify for all European banks to adopt SHV strategies, which will imply substantial changes in bank strategies and business operations. Copyright Banca Monte dei Paschi di Siena SpA, 2005

Aligning financial supervisory structures with country needs

this book is the result of a World Bank conference on regulatory structure organized to give policymakers an opportunity to reflect on the worldwide trend toward structural change and, in particular, the amalgamation of regulatory agencies. Within this trend, a number of competing models of regulatory structure have emerged, each with its group of proponents. These models range from an institutional structure in which each regulatory agency is assigned to a group of industry participants, through varying degrees of regulatory integration, to a unified structure in which all key regulatory responsibilities are combined within one agency. Rather than highlight one-or more-model as necessarily superior to the others, the conference sought to take an objective and balanced approach to the topic. This objective is reflected in a number of the presentations gathered here, including chapter 2, which, by providing a balanced overview of the alternatives, outlines the spectrum of possibilities and the range of issues that might influence the decision to choose a particular structure in a given situation. The conference was structured around three themes: the choice of an appropriate structure for regulation, problems relating to management of the transition to a new structure, and issues involved in implementing the new regime effectively.

Converting Failed Financial Institutions into Mutual Organisations

Abstract There are three reasons for promoting mutual building societies: they are less prone than banks to pursue risky speculative activity; a mixed system produces a more stable financial sector; and a stronger mutual sector enhances competition within the financial system. The banking crisis highlighted the importance of retaining diverse models of financial service providers, and while mutuals were affected by the recession, they were not themselves responsible for causing the recession, as were private banks. The UK Government needs to secure a financial return for the failed financial institutions it nationalised and a low level of overall economic risk for the taxpayer. Given a trade-off, the long-run benefits of financial sustainability and reduced risk, plus enhanced competition, need to be given proper weighting compared with any short run gain through a trade sale and the repayment of the governments support. This paper focuses on the case of Northern Rock as the most suitable candidate for remutualisation, and whose disposal is under current consideration, but the analysis applies more widely.

Islamic Banking and Finance

Islamic Banking and Finance discusses Islamic financial theory and practice, and focuses on the opportunities offered by Islamic finance as an alternative method of financial intermediation. Key features of profit-sharing (as opposed to debt-based) contracts are highlighted, and the ways in which they can facilitate improved efficiency and stability of a financial system are explored.

Financial Innovation and the Economics of Banking and the Financial System

This valuable book discusses in detail, through a blend of theory and empirical research, the processes of innovation and the diffusion of new financial instruments.

Financial Regulation: A Perspective from the United Kingdom

Many of the papers at this conference focus on regulation and its impact on the structure of the financial system. The objective of this paper is to offer a discussion of some of these, and related, issues from the perspective of the United Kingdom, where the structure and content of regulation is in many important respects in stark contrast to that of the United States. A British perspective on financial regulation might be particularly interesting, given the historical differences in the regulatory regimes in the United Kingdom and the United States as well as the changes occurring in the structure and approach to regulation in the United Kingdom.