The recent global credit crisis leading to a recession has attracted huge attention and initiated a lot of writing as to the root causes of what has been described by many writers as the greatest financial crisis since the great depression (Carmassi, Gros, Micossi, 2009; Lo, 2007; Grigor'ev and Salikhov, 2008; Melvin and Taylor, 2009; Ely, 2009; Crotty, 2009; Berrone, 2008; Avgouleas, 2009; Yandle, 2010).
However, they seem to be a kind of agreement when the issue of subprime mortgage is mentioned as the main cause (Grigor'ev, and Salikhov, 2008; Schmudde, 2009; Crotty, 2009; Suetin, 2009; Brown and Lundblad, 2009, Flitter, 2009). While subprime mortgage is named as the core cause, Acharya et al. (2009) argue that the systematic breakdown was as a result of 'the collapse … of two highly levered Bear Stearns-managed hedge funds that invested in the subprime assets backed securities (ABSs).' It therefore means the financial institutions are at the heart of the recent financial crisis.
'Global savings imbalance', poor judgments on the part of agencies (Weisberg, 2010; Gaffney, 2009) responsible for bond-rating, lack of transparency about the risk borne by banks, over reliance on numerical models and compensation plans which made some executives take unnecessary risk, low interest rate (Carmassi, Gros and Micossi, 2009; Kudrin, 2009), and what has been described as 'savings glut' (Rajan, 2008), credit companies issuing 'easy credit, over spending on the part of consumers Wallice, Avis and Smith (2008), Behavioural factors (Avgouleas, 2009); 'Global macroeconomic' disproportion resulting to large cross-border capital flows (Portes, 2008)
Weisberg (2010) attributes it to failure by the regulatory authorities also see (Lacker, 2009). Suetin, (2009) blamed recent financial crisis on securitization which was invented in the 1970s. This is because the securitization process as well as the rating agencies failed to identify dangerous risk-taking (Carmassi, Gros and Micossi, 2009). While Bruce, (2008), argues that the credit crisis could be traced to the use of fraudulent accounting practices which hide the 'underlying debts', the exposure of which resulted in the failure of markets and lead to the ripple spreading all over the world.
Although financial institutions seem are blamed for most of what has lead to the global financial crisis (Acharya, et al. 2009), noted that financial institutions play a exclusive role in the economy, that they serve as mediators between parities that are seeking to invest and the ones that need to borrow. That without such mediation, business activities would be difficult to conduct. Prominent innovations were made in the banking sector through securitization (Suetin, 2009).
The subprime mortgage: what really happened?
The rise in price of houses, coupled with the financial novelty of easy financing resulted in low-income houses being brought into the housing market (Rajan, 2008). This was logically interpreted to mean that with a vibrant housing market, all that was needed was to get an interested buyer to have the house without adequate consideration of the credit worthiness of the buyer and the risk of default, and with the low interest rate (Quentin, 2009; Lacker,2009) attributed to the mortgage payments, little will be paid at the early months of repayments and by the time the payment becomes significant, the house would have appreciate and equity generated to make future payments by the process of appreciation. Subprime mortgages as they were called were intended that mortgages would follow a short period of refinancing to avoid hike in the mortgage rates (Acharya et al. 2009). It was also expected that the prices of housing will continually increase, leaving the option of repossessing and selling the property very viable (Acharya et al., 2009). These activities continued until when the Federal Reserve started increasing interest rates (Lacker, 2009). The result was that fewer buyers could have the funds to buy. Therefore the lenders had to increase the amount of loans to attract buyers. However, the houses stayed longer in the market without buyers, which culminated in falling prices.
As the rates increased, many buyers defaulted in payments and the houses repossessed from them could not find ready markets for buyers, the credit quality of buyers became now a matter of interest.
The Llyods banking group
Llyods TSB Brief History:
Founded as a private bank in Birmingham by Taylors and Llyods in June 1765, it prospered using just a single office as place of operation. Legislative changes made it attain a joint-stock status in 1865 and resulted in massive expansion.
Shifting focus to London in 1880, it acquired Lambard Street bank of Barnetts, Hoares, Hambury and Llyod in 1884. It started its expansion overseas at the first half of the 20th century to continental Europe, South America, India etc (www.llyodsbankinggroup.com).
However the Llyods Banking group as it is known today, and as one of UK based leading financial services group was formed in January 2009, after the acquisition of HBOS.
The main business activities of the group are retail commercial and corporate banking, general insurance, and life pension and investment provision. Its international banking service has had strong footing in forty countries of the world. The Llyods group is at present the largest of UK retail banks with a well diversified customer base. The group is quoted both in the London and New York stock exchanges and happens to be one of the largest companies within the class of FTSE 100 (www.llyodsbankinggroup.com).
Effects of the Global Financial Crisis on Llyods Banking Group:
Like most other financial institutions, the global financial crisis and thus the effect of the global recession (described as a period of negative growth for two consecutive quarters) has had its toll of the Llyods banking group (http://recession.org/definition).
The effect has been significant on the Llyods TSB corporate markets business. But relatively low compared to other players in the industry, this has been attributed to the strategy adopted by the group. Thus a reduction in profit for the year 31st December 2008, to £845 million (Appendix 1).
Another division of the group that was significantly impacted is the bank shares which fell considerably. An article on the acquisition of HBOS by Llyods TSB reported a fall of close to 50% in the share price of Llyods TSB on the news of HBOS losing about £10 billion in 2008 and shattered the initial anticipation of £1.5billion annual cost saving expected from the takeover.
The effect of the financial crisis on the basis of the different divisions of the group showed the wholesale and international banking recording losses. However the UK retail Banking and the Insurance and Investment divisions recorded some increases in profit, compared to the previous year ended 2007. The changes recorded were 4% and 22% respectively (Appendix 2).
The overall profit before tax (statutory) dropped from £4000 million to £807 million, a change of 80%. The earnings per share were not spared as it dropped from 58.3p in 2007 to 14.3p in 2008, a percentage change of 75% (Appendix 2).
Impairment losses; the group was adversely affected by an overall losses on impairment of about 68%, which amounted to £3,012 million. Impairment on loans and advances taken as a percentage of the average lending was 1.13%, the impact of the market disorder not included. This is compared to 0.82% recorded in 2007. Impairment on assets increased by 64% to the tune of £8700 million and stands at 3.5% of the total lending, this is an increments from 2.5% recorded as at December 2007 (Appendix 3).
Strategic adjustments employed by the Llyods group to protect its financial performance against problems caused by the recent credit crisis:
The Lloyds group cushioned itself from the immediate effect of the financial crisis as well as put measures in place against the future occurrence of such events. Thus we may say short-run and long-term strategies. These strategies may also be looked from the point of view of structural and financial strategies.
Structural remedies; The Llyods group has a business risk committee as well as a group assets and liability committee which encompasses the Chief executive and all members of the group executive committee. This enables them to have an agreement on the nature and level of risk the group will allow without letting the risk adverseness or otherwise of a manager of a business unit affect the overall performance of the group (i.e. they must act within the confines of agreed level of risk while trying to maximize performance.
This is enhanced by giving the Chief risk officer (a newly created position) direct access to the Chief executive officer, the Chairman and the 'risk oversight committee'. The officer must also be a full member of the group executive committee (appendix 5)
Other structural decisions aimed at the long-term include putting into more effective use of non-financial measures by introducing the balanced scorecard as a measure of the long-term incentive plan directed at HBOS incorporation
Another structural adjustment that was made related to a reduction of staff strength.
Financial remedies:
In the interim at the heat of the financial crisis with the high instability and volatility rate in the market, the UK government decided to 'inject liquidity into the financial system' so as to restore confidence to investors and thus the market. The Llyods group took advantage of this to reposition itself and had the government take a stake of 43.4% of its shareholding.(Llyods group annual report, 2008) (Appendix 6). Funds were also raised by selling new shares worth £21 billion, of which the government was to support with a provision of £5.7billion (Werdigier, 2009)
There was also a review of the remuneration of serving directors by the remuneration committee which agreed that no bonuses were to be awarded to executive directors for the year 2008, directors' base salaries were to be frozen at 2008 level and that a reduction of incentive level of 175% of salary is implemented. The plan and adjustments also included:
Strengthening the role of risk-adjusted economic profit through its introduction as a measure in the long-term incentive plan and its immediate use in yearly incentive.
The incentive plan was also adjusted so that payment could be deferred over a period of three years and could be withdrawn if act on which the incentive is based is unsustainable.
It was also asserted that executive directors will no more take part in the 'final salary pension' starting from the year 2012, by April precisely.
Since the overall result of the group despite the crisis showed statutory profit before tax of £807 million and economic profit of £731 million and not a lose, one may say the strategies adopted were effective. It could also be argued that most of the strategies adopted would yield better results in the long-run as there are directed.
The arbitrage pricing theory (APT) which was adopted by Clare, (1995) in a similar situation during the recession of the early 1990s will fit into the evaluation of the recent financial crisis. The theory takes into consideration the economic factors that are systematic in nature as well as non-systematic risk factors that are likened to a firm. Clare, (1995) is of the opinion that this model would be good since the comparative risk related with each circumstance is reflected in the prices of common stock. Behavioural theory of finance could also give a useful explanation (Avgouleas, 2009; Ely, 2009).
Conclusion:
Although the subprime mortgage saga stands at the centre of causes to the global financial crisis, many other factors have been blamed. The Llyods group as a global player suffered significantly from the effects of the global financial crisis leading to a recession in 2008. However, strategies adopted (financial and structural) helped reduced the overall effect. Financial theories that have been employed to explain the results of the crisis include the Arbitrage pricing theory which was employed by Clare (1995) in a similar situation as well as Behavioural Finance theory which analyzed the cause of the crisis from human behaviour perspective (Avgouleas, 2009).
