Before discussing the structure, conduct and recent performance of the UK banking sector, it is useful to provide an insight in the recent global financial crisis caused by the sub-prime mortgage crisis initiated in the US and underline its effects on the banking industry in the UK. It all started with the collapse of the housing bubble in the US, as borrowers were no longer able to meet their financial obligations and as consequence many of these subprime mortgages became default and the market became illiquid while banks were struggling to obtain funds which resulted into devastating losses for banks and mortgage lenders. Through securitization many of these loans were initially transferred into asset backed securities and were sold to third parties using complex structured financial instruments. In fact, the risks were actually passed on to other large institutional investors. This spillover effect became soon evident in the rest of the world due to the high integration of global markets as well as its financial sector linkages worldwide.
In order to better assess the structure of the UK Banking sector, it is important to understand the difference before and after the crisis. Hence, the main question here should follow as: what has changed in the financial system and what are the characteristics?
In the years prior to the crisis, the use of financial markets to generate revenues, obtain funding for lending and hedge credit risk by major banks is greater than before. This indicates that it’s more vulnerable to credit risk in the case of deterioration of the market. Remarkably, the ‘originate and distribute’ business model where banks can originate loans and sell them off to investors who is willing to expose such risk is growing rapidly and generating high revenues. Due to their leading role as providers of such leveraged loans, the eventual credit risk retained on balance sheet would appear to be relatively modest. However, there has been...
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