Defining margin lending
Financial institutions have in the recent past been engaging on numerous lending practices to investors hence the economical growth we are experiencing today globally. Without investments an economy can not thrive and investments are made possible by financial support (Makay 2005). The ability for individuals to borrow money from financial institutions so as to engage in further investments has enabled the global economy to rise. Borrowing money from financial institutions is of different types but this paper will be dealing with margin lending.
Margin lending by definition is a loan taken by an individual with the aim of buying shares, securities and bonds. It can be used for other purposes but normally it is taken for the former reason. For one to access a margin loan, security in form of investment collateral is required. In this case, the collateral is in the investor’s shares and securities as well. Under normal circumstances, an investor is allowed to provide his or her other investments to stand as collateral for securing a loan. Margin loans have interests attached to them and are referred to as margin rates.
This is the amount of interest charged above the call rate. The margin interest is influenced by a number of factors which include; the investor’s account balance and interest rates which impact and determine the level of inflation. Marginal loans are mostly used by investors who lack enough money to purchase securities.
Causes of the storm financial company collapse
Storm financial company was a financial planning group in Townsville, Queensland, Australia. Going by the records of Thompson (2009), the company had an estimated 4000 investors. The company exposed its investors to the worst experience ever in its history of existence. Immediately at the final stages of the global economical crisis, the company was placed under insolvency status. This caused big loses to the investors as they hoped to recover from the previous economic crisis.
Investors flocked unaware of the dangers into the storm’s offices for financial advice and did exactly as they were told. One would ask him or herself the reason as to why storm’s clients never gave a second thought on the deals offered. But this was backed by the fact that the firm was fully licensed by the ASIC. In the financial planning, ASIC is the regulatory body that is responsible for formulating rules and regulations governing the industry.
Storm financing having been licensed by the national governing body gave the clients more confidence in the firm hence the huge investor base. Before it collapsed the company was one of the major financial planning systems in Australia as Barry (2011) articulates. Many interviewed clients were submitting the same concerns that loans processing paper work was inauthentic. Storm financial was accused of lending money by going against the law.
These saw its collapse, as the firm was lending money to clients who in most cases were not in a position to repay the loans (Barry, 2011). Barry (2011) noted that “It could be construed that income and ongoing commitments may have been manipulated to achieve approval.” The process of investigation was far much delayed as the firm was defended by the Bank of Queensland. In the defense of the storm financial planning firm, BOQ submitted to the authorities that in view of banking regulatory policies, storm had not contravened any of the policies and this is the reason why the company was able to get cover its careless dealings.
Storm clients received special treatment from allied banks to the firm like the Macquarie bank which offered lower interest rates on loans and extended time for an applicant to respond to the margin calls (Barry, 2011). The mistake the clients made was to borrow money even with the market fall. Guided by their financial advisors who happened to be the storm financial planners, they unknowingly put their finances into risky ventures.
Suspicion on the firms unlawful dealings were not easily detected since the firm was fully licensed by the government’s licensing body. The ASIC received complains about the storm’s financial dealings but still did not take any legal actions against the firm. This was reported several times. This lead to storm investors loosing their shares and houses and other investments as pointed out by Barry (2011).
Aspects of margin lending
Margin lending is basically money lend to borrowers for specifically further investing purposes. This is typically meant to increase an investor’s power to invest more than he she can, using his or her own money. Finances are availed to an investor so that he or she can purchase more shares and manage funds hence increasing the chances of a higher returns margin (Kupiec & Sharpe 1999). One is able to purchase shares and securities with a 20 – 50 percent deposit of the borrowed loan.
Borrowing money by marginal lending, one is charged an interest rate by the lender normally not more than 10 percent per annum (Kupiec & Sharpe 1999). As margin lending increases the chances of an investor to increase his or her returns, it also increases the chances of making losses. It is therefore a win-win situation. In margin lending, the most important characteristic is the aspect of a margin call where an investor is required to deposit more money as a cover for losses caused by price variations.
The benefits accrued to margin lending is that one has a chance to increase his or her investments in the stock and securities market using a small amount of one’s own money. This diversifies investors’ chances of making more money. By margin loans, one has a chance to boost his or her returns while margin call ensures that investors do not loose everything they have invested (Makay 2005). Margin lending is typically facilitated by the banks or stock brokers with a credit limit used incase of a margin call as described above.
In Australia, standard margin loans and protected margin loans are the two main types of margin lending processes used. The standard margin loan is subjected to a 40-80 percent credit limit where a margin call can be effected in the event that the value of the collateral declines (Kim 2006). These are the mostly borrowed loans accounting to more than 80 percent of the total margin loans in Australia. On the other hand, protected margin loans have a credit limit of 100 percent and unlike the standard margin loan they have no margin calls.
Risks of margin lending with share market falls
Borrowing money for the purposes of re-investing the same is a wise way of putting money into use. This can ultimately give one high chances of good returns hence increasing individuals financial portfolio (Kupiec & Sharpe 1999). However, the same is true with regards to losses and decreased financial capability if it all goes wrong with the money markets. The risk of margin lending is attached to the fact that it is limited to investors who wish to invest in the shares and securities markets.
This prompts the concern especially when the market is on its downfall. When the market is in a falling situation, the ultimate results will be that the price value of shares and securities will decline considerably. This will call for reduced value of investors initial credit reserves hence margin calls (Kim 2006). Market fall translates to an investment value fall. This means that an investor has to pay more money to the lender to cover for the decline in value in the investment or alternatively, the investor can sell some of his or shares to get the money needed.
The lender in most cases can also be willing to buy the securities from an investor who may have margin calls to cover. A twenty four hour deadline is normally given for an investor to respond to a margin call. With a falling market, it may be very difficult to meet such a deadline and the possibilities of a margin call are very high. This means that the investors run the risk of having to pay more money or lose their shares in an attempt to cover for depreciating market value of their investments.
Storm financial relationship with the banks
The storm financial enjoyed a privileged relationship with most of the banks especially the bank of Queensland that even stood up for the firm with the question on whether or not the firm was acting within the banking regulatory policies. The financial advisor was a fully licensed financial institution recognized by government’s banking regulators such as the Australian Securities and Investments Commission. No bank had any reason to doubt or undermine storm’s financial advisory services since it seemed to operate within he stipulated banking laws.
However, as provided by the managing director of the bank of Queensland, the bank had no official relationship with storm financial and it was working within its mandate with the firm (Fraser 2010). The bank denies involvement in the provision of margin loans or managing geared equities. The management maintains the bank only issued standard equity loans to borrowers who needed to invest in other firms. The three financial institutions that is; the bank of Queensland, the Commonwealth bank and the Macquarie bank are collectively facing legal action against their role in facilitating the collapse of the storm securities hence leading to loses that caused clients a life time savings.
The Australian securities and investments commission has served the banks with legal warnings (Kupiec & Sharpe 1999). However, the banks are denying any violation of banking laws with each redefining its relationship with the storm financial. Macquarie in its defense said that “There is a fundamental difference between the role of a margin lender and that of Storm, a financial adviser licensed by ASIC,” (Fraser 2010). But as Washington (2010) finds out in his research, the banks had an official relationship with the fallen financial advisor.
In his article, Washington reveals that emails and secret documents show that the bank of Macquarie had a relationship with the storm (2010). This relationship was based on clear knowledge of the firm’s operations as opposed to the claim that the bank did not know of its operations. Evidence given by Washington suggests otherwise with regards to the banks denial.
The role of ASIC
The Australian securities and investments commission is a government’s governing body that regulates the money and financial market. The commission was formed on 1st January 1991. The commission is mandated to making sure that the Australian market is fair and transparent. The constitution requires the commission to live up to specific standards. The commission is constitutionally obliged to improve and influence effective and productive financial systems.
It is the commission’s prerogative to maintain consumer confidence in the market operations with provision of informative policies to inform the consumer on the procedures of the market. The commission is the solemn financial law enforcer ad is responsible in making sure that the financial laws are adhered to by financial players (Makay 2005). This ensures a level playing ground for all the players in the market. The commission regulates Australian companies and financial players as well as individuals engaging in investment advisory services.
Such companies include the fallen storm financial. The commission also does license and standardize players in the consumer credit business ensuring that required standards are met. The commission has powers to license and supervise investment systems. In the event a company or a player contravenes the code of conduct as set by the law, the commission is mandated to administer the appropriate penalty to the company (Makay 2005). This may include even withdrawing the company’s operation license. The most important mandate of the commission is to ensure fair and cordial relationships in the market.
It is important for financial institutions and players in all levels to be regulated to avert the devastating possibilities of exploitation. This is done by the commission with the authority vested in them by the government. The ASCI provides guidance to the financial players to help the investors to manage their resources and avoid possibilities of making losses. With regard to these functions, the ASCI is under all circumstances responsible for protecting the storm’s financial investors. The commission is responsible for licensing the company that saw investors loose billions of dollars collectively.
The commission’s mandates are to ensure that companies and financial market players obey the regulations as given by the commission. It is the commission’s responsibility to monitor the operations of all firms and ensure that they align to the regulations (Kupiec & Sharpe 1999). Besides, complains were leveled against the storm financial but the commission gave the matter a blind eye. In my opinion, that would be classified as neglect of duty. The investors should not suffer for a mistake they did not have a hand in. The fact that they had faith in the commission and trusted the Storm financial led them to have faith in the firm since it was a fully licensed company by the government regulatory agency.
So the agency is to blame for the losses made under their watch and with their knowledge. The agency however will not be held responsible for future failure of companies if it provides the public with proper information regarding the market practices. If this is not rectified, then the commission bears the responsibility since it is the sole regulatory body in charge of the market regulations. If the commission did their work competently then there will be less cases of fraud or business malpractices hence no losses will be experienced.
References
Barry, P, 2011, In the Eye of the Storm: The Collapse of Storm Financial, the Monthly.
Fraser, A, 2010, “Bank hits out at ASIC’s action over Storm Financial.” The Wall Street Journal. 1, 1-2
Kim, J 2006, “Margin loans make a comeback.” Wall Street Pushes Investors to Borrow against Portfolios to Buy Cars, Homes; Weighing Risks. 2, 11-12
Kupiec, P & Sharpe, S 1991, “Animal spirits, margin requirements, and stock price volatility,” Journal of Finance, American Finance Association, 46 (2), 717.
Makay, J 2005, “Margin Lending in Today’s Environment,” Australian Journal of Financial Planning. 1, 56-60
Thomson, J, 2009, Five lessons from the collapse of Storm Financial. Smart company.
Washington, S, 2010 “Macquarie and Storm Financial’s secret formal alliance,” the business daily journal. 62, 62-63