Readers Question: Creating a post recession; what steps should the EU take to reform the banking sector?
I have looked at this important issue in this essay: - Steps to Avoid Financial Crisis
Reforms To The Banking Sector Could Include:
Regulation of Mortgage Products
Unconventional Mortgages like 100% mortgages, self-certification, interest only, mortgages several times income, contributed to the boom in housing markets and the asset bubble. Also, these mortgage products make mortgage default more likely when circumstances change. The real problem with mortgage default was in America which had the least regulated mortgage sector.
Counter Cyclical Mortgage Products
When House prices rises, this encourages housing equity withdrawal and people to take on bigger mortgages. This effect is known as a financial accelerator because one rising economic indicator encourages more risky lending and spending. Similarly – When house prices fall there is a rise in negative equity. A counter cyclical mortgage product would make homeowners pay more capital back during rising house prices leaving them less to pay when the housing market turns.
The aim of this policy is to restrain bank lending during a boom, and also make the banking sector build up reserves in good times so that if money markets deteriorate they can use their own savings rather than rely on government bailouts.
Greater Use of Fixed Rate mortgages. – hopefully encourage greater stability by making homeowners less subject to changing interest rates. (though this was not really a problem in UK during 2007-09 crisis) but was in US 05-606
A prominent feature of the boom years was falling capital ratios of banks. Banks like of Northern Rock took a risky approach to lending. They funded an increasing percentage of their loans / mortgages through short term borrowing – rather than the traditional model of lending their own savings. This business model of borrowing short to lend long was fine until money markets froze up then banks were stranded with no access to necessary liquidity.
Limiting Dividends and Pay.
A startling statistic – In 2008, global banks made losses totalling $60 billion, but on average still made dividend payouts of over $60 billion (1).
See also – The problem of Bank Bonuses – Outcry over bank bonuses is not just populist criticism. Bonuses encouraged a climate of risk taking without responsibility.