Roles of Deregulation on Banking Sector

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What roles have deregulation, innovation, and globalization played in changing the character of bank management in recent decades? Has the overall outcome of the changes been greater stability in the banking sector? Discuss the respective roles of asset and liability management in modern banking.

Deregulation, innovation and globalisation has changed the way banks run from asset management to liability management, as well as the change from ‘mono’ to ‘multi-tasking’ and the increased competition in the sector as well as risk. The banking system has evolved drastically from the traditional mono-tasking institution to what it is now. This change in roles of asset and liability management could be one of the main reasons behind the global financial crisis of which the aftermath effects are still being felt. In this essay I will analyse these three trends in turn and so to explain the reasons for the change to liability management.

Traditionally, the role of the banks are simple (post war period 1945-60s) there were strict credit controls (or credit rationing) by the state (there were large public sector war debt) to keep repayments obligations on this debt low. The low interest should also be of aid in sustaining a high demand for Gilts (UK government bonds), allowing no competition on the liabilities side of the bank’s balance sheet. The Liabilities side of the bank’s balance sheet is mainly composed of customer deposits (shows passive banking). They take deposits in, and loans out as the main source of income; this is referred to as ‘mono-tasking’. It should be noted that in more theoretical consensus that regulation in banking has tended to be increasingly destabilizing as the economy has become more dynamic.

The process of deregulation changed all this; deregulation came in two forms: first was the removal of self-regulatory restrictions, those were the regulations established in the financial sector to keep away substandard service providers; second was the removal of government restrictions which came in three phases:

1) The ending of the traditional/mono-tasking structure of the sector, which is a decisive blow to the traditional framework. On the asset side, we have the lifting of quantitative controls on bank’s assets (deregulating the use of funds); and on the liabilities side they lifted ceilings on interest rates on deposits (deregulating sources of funds) as to promote more competition. The UK began deregulating much earlier than the US; this is because the US is more tightly regulated than Europe (due to the large amounts of bankruptcy and anti-monopolistic view). The US lifted its “regulation Q” act in 1980 (which limited interest rate payable on deposits) but by that time they deregulated many banks moved to Europe where it has been deregulated for a long time. The UK Heath government (1970s) lifted credit restrictions and enabling banks to expand liabilities competitively. In the 1970s the UK was increasingly allowed to use variable rate lending (e.g. LIBOR) instead of sticking to with an unprofitable loan rate when interest rates were volatile; this endowment gave banks higher profit margins. Later on in 1980s the Thatcher government ended all credit and FX exchange controls. This promoted the change from asset management to liability management, variable rate lending meant stock of loans could be determined by demand, and effective those who want a loan gets a loan. This was explained by the Net interest margins (NIM=interest revenue on assets-interest revenue on liabilitiesinterest earning assets). This differential actually improves the bank’s profitability. Banks therefore actively create liabilities (borrow from other banks) in ‘money markets’ and thus switch to ‘liability management’ trying to maximise sources of funds. The asset management of the past where loans was seen as a ‘person to person’ management no longer existed, as banks greatly expanded their balance sheet they reduced...
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