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UK Banking Industry

Effects of recession in the UK: The Current Level of Confidence/Trust in the Banking System
2.0 Introduction
Given the need to satisfy the specific objectives formulated for the report on recession
and its subsequent impact on the levels of trust and confidence in the United Kingdom’s banking
system, it becomes prudent to acknowledge that the literature review is tailored towards
satisfying the purpose of this paper. For instance there is need for emphasis on how consumer
confidence has affected the decision making process among consumers, there is the additional
need of determining the role of banks in the financial crisis, as well as using empirical evidence
to establish the level of consumer confidence exhibited towards banks in the United Kingdom.
The other objective which is elucidated in the literature review is an analysis of the customer
confidence and how it has changed since the onset of the financial crisis while the last objective
revolves around methodologies that can be used by the UK banks to improve the confidence of
the consumers in their current banking system and practices (Demirgu¨c¸-Kunt & Maksimovic,
Therefore this literature review targets to examine current schools of thought surrounding
consumer behavior, the pertinent principles of consumer decision making, trust or confidence as

well as processes involved when consumers make their decisions. Specifically, the 2008-2009
economic recession caused a shock to the global financial system. The effects of 2008 recession
were almost similar to the ones of the Wall Street Crash in the 1930s. The crisis which begun as
a result of a foiled hedge funds by an American property firm known as the Bear Stearns.
Despite the government’s attempts to stabilize the economic situation at that time, the dollar
effect led to the rapid and spontaneous spread of the recession to other countries across the
Overview of the UK Banking Industry
Banking is currently the major financial service sector in Britain. The banking industry in the UK
is the third largest in the world after Japan and the US in terms of the returns on capital,
dynamism and overall efficiency. The city of London is one of the world’s largest financial
centers. Britain currently has five major Banks and financial companies that control its entire
financial market sector. These are JPMorgan Chase and company with a market capitalization of
191.01 Billion British pounds, followed by HSBC Holdings plc with 136.55B, Lloyds Banking
Group plc with 48.21B, Banco Santander, S.A., 42.75B and finally Barclays PLC with 37.88B.
We take HSBC as the Bench mark Bank for comparison purposes concerning the
performance, challenges and the opportunities of the banking industry in the UK financial and
the Banking sector, and the ultimate effect of the 2008 economic recession on the consumers’
confidence in the industry. HSBC is derived from the initials of Hong Kong and Shanghai
banking Corporation which founded HSBC in the year 1865 in Hong Kong and later changed its
headquarters to London in 1991. It’s the second largest listed company in the London Stock
Exchange after the Royal Dutch Shell trading company. It’s also listed in various other stock
exchanges across the world including New York Stock Exchange. (Berger, 2010)

The major challenge of the entire banking sector stems from malpractices in management and
the economic conditions that lead to massive and unprecedented financial meltdown mostly due
to over lending, excessive borrowing and poor regulation. The current system of financial
regulation is either entirely flawed or grossly inefficient to control such incidents from occurring.
The UK banking system was majorly affected to the extent that the government was
forced to intervene and bail out the UK banks that were being affected by credit risks, high
forfeiture of loans and credit losses. Hill, Wayne and Highfield, (2010) observed that
corporations were also affected which led the UK economy into a huge recession evidenced by a
negative growth in their gross national product in the year 2009.
In the year 2008, the British government used 500 Billion British pounds to bail out banks that
were about to collapse in UK due to the effect of the global financial crisis. Had it been allowed
to go on without the intervention of the UK government then it would certainly have had a
catastrophic effect on the UK economy. A year later, the UK government added another 50
billion dollars to the banking industry to stabilize its financial position. The effect of the financial
crisis led to massive drops in the banking industry’s income. HSBC operating income dropped
by a massive 26% in the year 2008 and later by another 65% in the year 2009. Customer
confidence in the banking industry was at its lowest as the banking profits took a nose dive for
the worst. http://banking.about.com/od/businessbanking/a/centralbank.htm %
The same year, unemployment rose to 5.25% and further increased to 8% in the year 2010 as
firms begun to lay-off employees as a cost saving strategy.
The United Kingdom economy had a negative growth in its GDP between the 2008 and 2009.
It was followed by a very good performance between 2010 and the year 2011 when there was a

slight drop in its general performance. (Swann, 2009) The relationship between the rates of
unemployment, inflation and the GDP can be seen from the diagram below that was compiled
with information and data from St.louise research center in the United States. They actually
depict the level of confidence in the entire UK economy as illustrated.
Current UK Economic Indicators



Real GDP Growth
Inflation rate
Unemployment rate

Source: http://research.stlouisfed.org/publications/iet/

There was a total economic decline of 4.75% between 2008 and 2009 which apparently impacted
on the banks. In return, the Central Plan Bureau reports that this chain reaction affected the
ability of the banks to perform, issue out loans and even sustain their operations thus the
consumer’s confidence was greatly compromised. Gitman, (2005) reported that the shortage of
credit facilities was the main contributing factor towards financial constraints since the
customers had to cut on their investment spending, marketing, technology and employment as
one measure towards curbing the crisis. The corporations and customers had to find alternative

sources of funds because of the shortage of financial resources. These companies had to raise
more working capital owing to the economic constraints and more so limit their credit terms.

2.1 Consumer Behavior and Decision Making Process
Hutchison, Farris and Anders, (2007) states that consumer behavior is a term borrowed
from economics to illustrate how customers tend to react to the forces of demand and supply
which shapes economic markets. The financial markets have made researchers to be more
interested in this subject of study and as such their studies have intensified over the last decade.
Thus decision making is majorly a reaction accrued from consumer behavior which is an
augmentation of mental or cognitive processes which lead a customer into selecting a certain
product at the expense of the other.
To restore consumer confidence in the banking sector, HSBC offered free overdraft up to 1500
pounds for a year while Barclays offered free overdraft up to 3000 British pounds, for the first
three years and 1000 pounds for another three years. Other forms of benefits were offered to
attract more customers. http://www.which.co.uk/money/bank-accounts/reviews-ns/student-bank-
The decision making process is majorly affected by choice and cost preference which
collectively affect the action of the consumer towards the final decision. According to Bradach &
Eccles, (1989) consumer behavior is defined as an act that motivates individuals into not only
obtaining but also using economic services and goods among them being decision processes
which determine their actions. Understanding consumer behavior is a complex because of the

interplay of social, economic, physical and psychological factors which are hard to ascertain
using statistical measures. Generally, it is assumed that consumer behavior is progressive since
the preference, taste and choice of each and every consumer is varied with their level of
Additionally, consumers continuously evaluate, discuss and talk about the services and
goods provided by the businesses thus the dimension of behavior exhibited by consumers is a
complex integration of interdisciplinary schools of thoughts, theories, attitudes, beliefs and
experiences, sociology, psychology, socio-psychology among other individual factors (Ben-
Horim & Levy, 2008). In order to understand consumer behavior and determinants of the
decision making process, a myriad of buying behavior models have been instigated. The
behavior economic model illustrated by the figure below presents a strong basis upon which the
consumer behavior and decision making will be analyzed.
Figure 1: Katonas behavior economic perspective

The behavior economic model represents an economical model that attempts to explain
the rationality with which people make decisions regarding which products or services to
purchase. The model is applicable to the literature review and into the banking scenario as well.
The model is supported by assumptions drawn from microeconomic theories and assumptions
such as heuristics, framing and market inefficiencies. Heuristics means that customer’s behavior
is basically guided by logic (Baltagi, 2008). On the other hand framing describes a collection of
beliefs and stereotypes that determine either the mental or emotional filters that guide the




response systems. Market inefficiencies describe such factors as pricing and interest rates which
collectively affect decision making on the use of bank services.
From the Katona’s behavioral perspective figure, it is made evident that psychological
processes are influenced by economic conditions. According to the utility index of consumer
sentiment abbreviated as ICS as it was examined by Kajal Lahiri and Ivanova, the behavioral
economic model is pertinent in predicting the possible expenditures to be made by consumers
(McKnight, Choudhury & Kacmar, 2002).
2.2 Consumer Involvement and Decision Making Process
As supported by Leach and Melicher, (2009) the decision making process is a product of
the consumer behavior which in return influences the degree or the level of involvement
exhibited by the consumers when purchasing goods and services. Piet, (2009) therefore concurs
that involvement is a measure of the degree of commitment measured using parameters such as
the quantity of time spend and the devotion of the consumer in terms of searching for a given
good or service. Contrary to these research findings, Reason, (2008) argued that involvement
cannot be ranked as being high or low. This is because consumers tend to concentrate on
selecting certain brands but their psychology plays a major role in influencing their decision
making patterns as elucidated in figure 2 shown below.
Figure 2: Types of consumer purchasing decision situations


From the diagrammatic representation, it is made clear that low involvement among
customers often determine the perception of manufacturers. For instance, research showed that
products with a low customer involvement index were less costly while high involvement
products are costly. Among the high involvement products are financial services and products
which according to Alfayoumi and Abuzayed, (2009) were among the highly searched on the
internet search engines. The reason for the high search and involvement shown by the customers
is spiked by cognitive dissonance.
2.3 Factors Influencing Brand Preference and Selection
A brand is any patented product or service, which is provided on the market for sale. It
represents the actual product which forces the individual consumers to make a choice on which
the brands to purchase. Branding is a tool that is often utilized to position the product by
designing its packaging or branding the service in a way that attracts clients and actually creates
customer loyalty for a perceived need. For any communication to be effective, the customers
must form a picture mentally about his perception of the product which eventually influences the
price they are willingly or a ready to pay for the product. Brand equity occurs where customers

are willing to pay much more for a product because of its position. Understanding the relevant
factors in this context are essential in determining why financial services provided by some
banks in the U.K have come under criticism especially after the 2008 economic recession
(Ruben, 2012). The most dominant factor influencing selection of banking services and brand
selection among customers in the United Kingdom is the level of risk associated with the
financial services. Additionally there it the cost of the service which is established and measured
on the scale of interest rates demanded by the banks while issuing the loans. In particular the
interest rates increased during the recession as a counter reaction towards the high demands
versus the low supply of cash among the banks in the U.K. these factors are analyzed in depth
under the following subheadings.
2.3.1 Perceived Risk
Perceived risk was described by Gefen and Straub, (2003) and Lamb, (2012) as being a
key factor that influences the customers involvement levels as well as their preferences during
the decision making process. The two authors separately defined the various dimensions of risks.
In this paper, only six risks are analyzed among them being; financial risks which are perils
associated with the loss of money on bad or unplanned purchases. Secondly, performance risk is
related to the perils associated with the functionality of the products. Psychological risk refers to
the post purchase dissonance which is a feeling of disappointment when a product fails to
achieve the desired objective. Physical risks are perils associated with the health and safety of the
product of services. (Ralf, 2009)
There are social risks which is an indicator of the disappointment as perceived by the
customer to the friends and lastly, time risk which is the loss of time spend searching and
purchasing a product (William & Marlene, 2009).


2.3.2 Social Influences
Social influences also affect selection and brand preference. This is because social
influences aggregate towards creating awareness among the customers. The buying behavior of
customers is highly dependent on their social class and grouping. These groupings come a long
way into influencing the buying behavior and lifestyles of the people in the same class thus it is
highly likely for people in the same class to use certain goods and services. In the U.K the
banking system was affected by the negative word of mouth that was being spread among the
business class (Harold & Lee, 2004). Apparently this affected the trust and confidence of the
people of U.K in the banking system especially after the risks that were presented by the 2008
Global economic recession.
2.3.3 Availability of Capital
The third influencing factor is the availability of the capital. The United Kingdoms’
financial system was among most affected owing to the volatility of their financial system which
was equally hit by the scourge of sub-prime loans. These loans are very risky to the banking
system because they quickly accrue to bad debts and non-performing loans. As a result, the
government was forced to salvage the British Bank Northern Rock from imminent collapse
through a bail out process facilitated by the Central Bank’s intervention of Fenny Mea, AIG and
Freddy Mac (Harold & Lee, 2004). One year into the global recession, the Lehmann Brothers
operational in the United States collapsed and this came as a huge shock to the world banking
system, which was still reeling from the effects of recession.


2.4 Variables that Shape Decision-Making
Decision-making is influenced by a number of determinants and factors. Harold and Lee,
(2004) classifies these factors into three groups which include environmental influences,
individual differences and psychological processes. On the other hand, Lamb (2012) established
two major factors which are psychological and individual factors. The two factors are supported
by cultural and social influences which collectively form the variables that shape the decision
making process.
2.4.1 Environmental influences: Situation
Environmental influences such as in the case of the 2008-2009 Global economic
recession have been attributed towards shaping the behavior of consumers. The environmental
influences are reflected in the recent economic recession when the GDP of U.K declined with
sharp margins being reported in the industrial production sector. These factors further affected
trade flows and the overall ability of the banks to issue loans and maintain their credit
worthiness. As compared to previous recessions, the severity of the recent recession was shown
by the shrinking of trade by 12% which shows that the business environment was greatly
affected (William & Marlene, 2009). The fall in output affected the banking system as customers
as their decision making process was barred by the fear of potential high risk loss.
2.4.2 Individual differences: Attitudes (confidence/trust)
Altman, (2008) supports that attitude is determined by an individual’s definition of value
and as well as their value systems. Attitude is dynamic hence it keeps changing with the rise in
the social class or with the development of new values which are possibly influenced depending
on the availability of information. Attitude therefore brings about the individual differences
which in the case of financial decisions can be described as risk averseness, risk neutrality and

risk seekers (Wells & Foxall, 2012).. The same effect trickles down into affecting the U.K
banking system eroding the customer confidence in the industry.
2.5 Consumer Confidence/Trust
At least 90% of the researchers have identified that trust is directly proportional to the
quantity of sales made. In fact relationship selling is purely pegged on trust. According to
Springford, (2011) trust is the process of depending on an agent to conduct a business in the best
of your interest according to the agreement or contract made and signed by both parties. This is
because trust instills a feeling of security and belief into both parties thus facilitates their
interaction. The lack of competence in the banking system caused by recession is one such
incidence where trust could lead to lack of confidence.
Other variables such as uncertainty, vulnerability and dependability are the main barriers
to confidentiality and trust (Altman, 2008).
2.6 Benefits of Consumer Confidence/Trust
Trust just like the pricing of financial services is paramount in the determination of a
good or services. For instance the banking system has been affected because of the decline in
trust which makes the customers to prefer other forms of lending and keeping of their money.
Confidence or trust can be blamed for the complexity of relationships especially when it is
lacking but when trust is present then customer decision making process is highly enhanced
(Springford, 2011).


2.6.1 Trust and customer loyalty
In the descriptive study conducted by Soureli and Lewis in the year 2006, it was
established that the banking system is most affected with trust (Springford, 2011). An
aggregation of integrity and reliability are two variables that are so vital in determining consumer
loyalty. The research further established that there is a great correlation between the trust held by
consumers and customer loyalty. The two are further related to inertia especially in the banking
sector thus it is made evident that trust contributes towards customer loyalty.
2.6.2 Competitive performance long term relationship building
The concept of relationship building is supported by relationship marketing theories such
as the network theory and the inter-firm relationship marketing theory. These theories are
supported by sociologists where research established that relationships built on trust last longer.
In a research conducted by Piet, (2009) on 120 couples, it was established that nearly 56% of the
relationships based on trust were stable as compared to relationships where partners hide
information from their spouses. The research is vital in emphasizing that competitive
performance is equally influential in promoting competitive performance in the long term among
financial service providers in the U.K.
2.6.3 Brand Building
The building of a brand takes a long time whose essence if driven by the need to augment
the various factors identified as variables that shape decision making. According to Piet, (2009)
trust can influence the consumer’s attitude, perception and decision towards a certain brand. The
brand building process should therefore be treated with a lot of patience which is the same
scenario as that exhibited by the banks in U.K.


2.6.4 Encouragement of purchase intention
Confidence has been proved by empirical research as being a factor in directing the
intention of customers towards making purchases. In fact relationship marketing which is
associated with the making of repeat sales is basically pegged on confidentiality its ability to
influence the purchase intent of the customers.
2.7 Trust/Confidence in the Financial Products
2.7.1 Nature of the relationship
Springford (2011) states that trust and confidence towards financial products stem from
the following factors. The nature of the relationship between the service provider and the
customer build by the provision of quality services because the customers purchase expertise and
uniqueness of the service. In this context communication and feedback are important. Secondly,
the relationships are ongoing or progressive which means that the nature of relationship and the
period of interaction lead to escalation of the confidence in the financial services and products
being offered.
2.7.2 Distrust and inertia
Survey by the SMF established that loss of trust is the sole cause of inertia as compared
to exit costs. Inertia is often weighted according to the costs of exiting thus the lower the cost of
exiting from one service provider to the other, the lower the inertia and vice versa (Beranek,


2.8 Role of Banks in the 2007 Financial Crisis
The banks in both the United States and the United Kingdoms contributed towards the 2007
financial crisis in the following ways. Increase in bad loans. The willingness of the banks to lend
out in spite of the credit worthiness of the customers and the agents led to the credit crunch.
Mortgage companies and the banks loosened their credit issuing criteria because of the increased
competition. Most of the customers were issued with loans with limited checks thus the ability of
the customers to pay was limited. Repackaging and reselling of bad loans (Accountability, 2009).
The bad loans were being sold to other financial institutions across the global financial markets.
United Kingdom was among the biggest buyer of the mortgage bundles from United States and
this exposed them to financial risks. On 15 th September the year 2008, one of the largest
investments Banks in America’s history filed for bankruptcy. Lehman Brothers had assets worth
slightly over $639 billion and debts worth $619 billion and over 25000 employees worldwide.
Lehman Brothers was the largest producer of subprime securities between the years 2005 and

  1. By the end of the year 2007, it was facing a myriad of cases on grounds that it made
    borrowers to take more loans than they could service or afford. Lehman’s collapse led to a
    massive erosion of almost $10 trillion in gross market capitalization in the global equity market.
    (Bernanke, 2010) The collapse of the housing market in the U.S resulted into loss of finances in
    the banking sector while at the same time making it impossible for them to borrow from money
    2.8.1 Effects of Recession on household finances in the UK

The UK banking industry was hit hard by the 2008 global recession which resulted in the
closures of a number of large multinational corporations which led to massive job losses.
The UK was significantly affected with the reduction in the lending rates by the banks which
reduced the household finances. This is because the banks reacted to the losses by reducing their
mortgages and loans (Andy, Alan, Anna & Isobel, 2009). The chances of getting credit was
limited which forced the government in UK to bail out some of the banks but the reality that the
banks were unreliable harmed the confidence that had earlier been exhibited by the customers in
the UK. The loss of trust and confidence led to reduced investment and spending among the
households. The major advantage or strength of the banking sector in the UK economy is that it
touches every sphere of the economy and also on every kind of business or trading activity. The
failure of the Banking system in the UK led to the near collapse of the entire UK economy where
thousands of jobs and economic life line of many British people were affected
The excessive weaknesses and the collapse of many banks during the crisis have had a negative
effect in the foreign markets. The interbank market is still reeling from the effects of the crisis
and they are still to recover fully. The LIBOR (London Interbank Offered Rate) is still very high.
LIBOR is the actual rate banks are willing and able to lend to each other. The higher the
uncertainty of loan repayment the higher the rate of loan. These high LIBOR rates have greatly
affected the steady free and steady flow of money to very small drops. The major effect of the
financial crisis is the entire erosion of confidence in the market, between banks, insurance and
brokerage companies, pension funds, individual investors and other financial firms. Most
markets are very distrustful and are not willing to either invest or even to lend their spare capital.
( www.ise.com ). The 2008 financial credit crisis was like an earthquake in financial spheres.

Investors were affected all over the world. From money centers in Tokyo, Sydney, Frankfurt,
London and New York.
The most effective and the best way to minimize risks is diversification. It involves portfolio
spreading over well researched and promising investment opportunities. You can diversify asset
classes, or move and diversify globally or by sector or style. Minimization of risks can also take
the form of combination of different stocks and bonds from different industries and avoiding
single investing. Others are short term investments.


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