Introduction
The roles of Commercial Banks have evolved over the decades to adapt to the new economic trend of the world. Peek & Rosengren (1997) notes the demands of the new economy as a result of technological innovation, deregulation and globalization among other reasons has enabled the Commercial Banks to diversify its roles. Thus, most Commercial Banks lead in providing vital functions such as; accepting deposits, granting advances and loans and providing essential information and services which are important in financial decision making (Li Ma & Huang, 2011). Effective management and leadership is ideal for Commercial Banks to carry out its duties and responsibility without fear of failing. The issue of management and leadership combined with other volatile challenges perhaps contributed to fall or rather the collapse of the Northern Rock Plc, in the United Kingdom. Therefore, with close reference to the roles played by the Commercial banks, the writer will explore the reasons which contributed to the fall of the Northern Rock Plc.
Functions of Commercial Banks
According to Westerfield (1921) Commercial bank as a financial institution provides several functions. It provides the financial needs of other important sectors of the economy such as communication, industry, trade and agriculture among others (Ahrendsen et al, 2011). This suggests that they are required in a system of social and economic needs. The functions performed by the commercial banks are evolving with time and consequently of late; they are becoming customer centered and diversifying their functions. The commercial banks functions are distinct, and they can be divided into major categories. The first category is the basic functions. According to Accounting and Finance (2011) one of the primary functions of commercial banks is accepting deposits. Functions and Roles of Commercial Banks in the Economy (2010) also notes that accepting deposits is a significant task played by a commercial bank. The bank mobilizes deposits from the public or its clients. These deposits are usually in the form of fixed, saving and recurring deposits among others. People with extra savings and income find it convenient deposit their money with commercial banks. Basing on the nature of the deposits, the amount deposited with the bank accrues interest.
Second, commercial banks are important in providing advances and loans. According to Accounting and Finance (2011), commercial banks grants advances to businesses and members of the public at significantly higher interest rate than the one allowed by the banks on some deposits accounts. The fee of interest charged on advances and loans differs depending on the cash deposited, method of payment, purpose and duration. Hence, the differences that arise between the rate of interests on deposits and the amount charged on loans provide the bank with a source of income (Harborne, 1985). Commercial banks allow a credit for a specific period of time. However, term loans, that is, a loan that takes more than a year, may be given. The beneficiary may opt to withdraw the entire amount in installments or in a lump sum. However, the rate of interests is charged on the full amount of the loan. Commercial banks grants a loan against the security of certain asserts. According to Sinkey (1998) the advance is a credit facility provided by commercial banks to its clients. It differs from a loan in that; the loan may be dispersed for a longer duration. However, advances are provided for a short period of time.
Third, Peach (1975) notes that commercial banks grants short-term financial relief through various methods. That is, through bill discounting, overdraft and cash credit. In cash credit, the bank facilitates arrangements where a borrower is allowed to draw a given amount of money up to a specified limit. The amount withdrawn is then credited to the account of the customer. Therefore, the customer can withdraw this money at his or her own discretion. However, the bank charges an interest on the amount withdrawn. Besides, the cash credit is granted on agreed terms and conditions between the bank and the customer. Mentre (1984) argues the bank allows an account holder to withdraw more funds than the credit balance in his or her account. This is called an overdraft which is usually a temporal agreement between the two parties. Overdraft facility can be granted on either security of assets, personal security or both. Rose & Hudgins (2010) points out discounting bills are a short-term financial service provided by the commercial banks
Commercial banks also have secondary functions, which are performed, alongside the primary ones. These functions include independent agency functions or general utility functions. Hence, Commerce House (2011) notes the major agency functions of commercial include collecting and clearing cheques, granting dividends and interest’s warrants. Also, they pay insurance premiums and rent and dealing with foreign exchange transactions. Commerce House (2011) adds other extra agency services granted by commercial banks. They include purchasing and selling securities, accepting tax proceeds and returns and acting as an attorney, trustee and correspondent.
On general utility functions, commercial banks play an important role of providing money transfer service, acting as an advocate and providing support on secure service to their customers. They also accept merchant banking and provide various cards such as smart cards, credit cards and debit cards among others (Cariboni et al, 2008).
Commercial banks provide information and other services related to financial matters. Many commercial banks are sources of useful information’s on international trade. As Rose & Hudgins (2010) note some banks provide annual bulletins on economic conditions and trade at home and overseas, and some reports on markets and commodities. Occasionally, they welcome businesses and individuals wishing to strengthen their foreign trade. They do this by equipping them with relevant information, names of recognized dealers of commodities and advice on choice of reliable agents. Northern Rock Plc
According to Shin (2009) the factors contributing to the collapse of the Northern Rock bank were multifaceted. Although some were predictable, others were not directly connected to the Northern Rock bank.
One of the roles of commercial banks is to provide information and other financial advice. However, for over a year before the collapse of the bank, the Financial Service Authority and the Bank of England had been giving information about the changing trends in the financial market (FSA Internal Audit Division, 2008). This information included an increase in asset growth, systematic under pricing of risks and risk-shifting characteristics of monetary instruments such as the credit derivatives. Also, they provided warning signs of the Northern Rock strategy of embracing mass market funding were likely to face liquidity risks (Dieter, 2011). On a different note, the financial market in the UK had fixed weaknesses in regulation which surged the issues the Northern Rock bank experienced (Hamalainen et al, 2008). These problems included the flaw in the deposit protection plan, unclear bankruptcy policies to help banks, and there were no clear guidelines to preserve or supervise the troubled banks.
The Northern Rock was a mutual building society before it attained the banking authority in 1997 (Reuters, 2011). According to Bank of England (2007) when it attained the banking status, its past activities were stripped under the Building Societies Act. This is because; it had attained new legal authority to perform banking operations. However, the bank opted to protect its business activities of residential mortgage market. From the beginning, the bank embraced the securitization and funding policy which was anchored on protected mass money and capital market funding. During this time, the bank had assets worth more than one hundred billion and a growth percent of twenty. Its rate of mortgage lending surpassed the growth of retail deposits that was available within the funding gap (Reuters, 2011).
The Low-probability- high likelihood impact risk. According to Jones (2011) the Northern Rock had a business model which made it vulnerable to adverse likelihood risk. That is; the liquidity was drying up in the commercial paper market and in the interbank but one that created high impact i.e. the inability to continue funding its business performance. The business model embraced by the Northern Rock was dangerous which was not sufficiently noted and controlled by the supervisory authority. Jones (2011) notes the model embraced by the financial institution to be viable for a long period; it was granted short-term funding using the standard funding terms. Hence, the low risk likelihood – high impact risk in this model was integrating three important micro risks. As noted by FSA (2008) one threat was the Northern Rock or its conduits were not able to roll over maturing funding. The cost of funding rose to the yield on mortgage loans that it recorded on the balance sheet. And lastly, the Northern Rock was not able to securitize the mortgage asserts that it had intended to. On the third case, the bank was compelled to preserve the assets on the balance sheet and invoke non-secularization financial aid. Therefore, the low-probability- high probability impact risk here was the bank was not able to roll-over its short-term funding strategy in times of risky liquidity constrict and the binding roll-over funding could be viable at a higher interest rate. In all these events, the major three wholesale funding markets for the Northern Rock collapsed and effectively closed to it (Lambert, 2011).
HM Treasury (2008) also draws there was a partial credit risk shifting. He asserts that over the previous year’s leading to Northern Rock failure, new instruments had developed to allow banks to transfer credit risks off from their balance sheets and on others. However, during the financial turmoil of 2007, it was clear the risk-shifting characteristics of these new instruments had become less complete. It is affirmed by Jones (2011) bankruptcy remote vehicles that are the conduits; special purpose vehicles were not protecting securitizing banks from the verge of credit risks of securitized assets. This was because banks were concerned on the reputation connected with allowing such vehicles to fail to pay.
There was also an issue of solvency verse liquidity. A major difference is predictably made between solvency and liquidity of a bank. This difference is more challenging to achieve in practice than in hypothesis (Keasey & Veronesi, 2008). The Northern Rock remained lawfully bankrupt, and yet it was reliant on the Bank of England support because it could not afford to fund its activities in the markets.
Deposit insurance was also a major bug that contributed to the Northern Rock bank collapse. According to Treasury Committee (2008) a critical fault-line was detected in the British deposit protection scheme, which was a piece of the Financial Services Compensation Schemes (FSCS). The co-insurance code where the protection was less than the whole; at the time, about the first two thousands sterling pounds of a deposit were protected, and the about ninety percent of the value of the deposits to a maximum of thirty three thousands suggested the FSCS would do little to prevent what it was supposed to prevent. This is to say the withdrawal of deposits when misgivings ensured about the security of a particular bank. This was a contributory factor leading towards the fall of the Northern Rock bank.
Lastra (2008) contend that structural weakness of the Northern Rock bank contributed to its downfall. Besides the inconsistency, in deposits in the deposit plans, the United Kingdom experienced two major structural weaknesses in its financial operations. Rodgers (2011) explains the UK was the only country among the G7 countries which didn’t have a special bank insolvency system (Lastra, 2008). Also in the UK, there was the lack of a clear defined ex ante decision model in situations where a bank fails. With the latter, instability problem is fixed, and in occasions where bids are invited to “salvage” a collapsing bank, the likely bidders are vulnerable to bid for financial rents rather than the interests of the taxpayer. This was a major happening in the Northern Rock state. The drawn up system the government embraced eventually contributed to the rejections of all the bids attempted and the temporal nationalization of the bank.
When the Labour government assumed power, it announced a significant fix of the institutional measures for financial supervision and regulation (Chambers, 2011). This caused a crisis in the institutional structure of supervision. Since 2000, the Financial Services and Markets Act, the United Kingdom has embraced a unified supervisory framework. Specifically, supervising banks were hived from the Bank of England and supervision and regulation of major financial institutions and markets was granted to the newly fixed Financial Services Authority. According to Chambers (2011) many financial analysts marked that this situation could be a challenging in circumstances of crisis. Whereas the duty for effective stability and the necessity of market liquidity remained the task of the Bank of England, it had no obligations of supervising the institutions in the banking hierarchy. Although, the government established the emergency management committee, the Tripartite Committee, the committee did not resolve the crisis that was engulfing the Northern Rock bank.
Simona (2011) assigns the emergency lending and standing facilities by the Bank of England as a contributory cause to the collapse of the Northern Rock bank. He explains that different elements granted by the Bank of England did not perform properly as expected. The intention of the Bank of England was fine; however, the aim to support the Northern Rock precipitated a retail experience instead of stopping it. The FSA’s efforts that the Northern Rock was solvent and the Bank of England willingness to support it through lending against the collateral though at a fine rate of interest, should have been sufficient. Rather, willing to embrace the Bank of England was viewed as movement of failure.
Conclusion
Commercial Banks have contributed to the growth of the economy of many countries across the world. This is explained through the multiple roles it succeeds. As noted earlier, the commercial banks receive deposits from the public. Besides protecting these deposits, it helps in simplifying fund transfer by cheques or undertakes responsibility to repay funds in legal tender money. Commercial banks provide loans and advances to its customers. These facilities are important because it encourage businesses and individuals to improve their business growth and development
The Northern Rock had a distinctive business model. Securitization was a core part of the bank’s general business strategy. Whereas many banks securitize their assets at a margin, the distinctiveness of the Northern Rock was dependence on the short-term market funding and securitization. Hence, a core features of its business strategy.
Also, the inherent assets of the Northern Rock bank model are that it exposes it to the LPHI risk. The bank became reliant on short-term funding in the financial markets. No one predicted the liquidity in the markets would suddenly disperse on a large-scale. Although the business strategy was viable for some few years, the LPHI risk suddenly emerged in the form of global financial crisis largely on subprime mortgage lending in the United States. Northern Rock had no part to play in this, thus; it became an innocent victim.
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