Subprime Crisis and Impact on Banking in India Finance Essay

Subprime crisis, the turmoil on mortgage markets has claimed several causalities. Banks have transferred risks to special entities SIVs and SPVs. This practice has given the impression that the credit risk has been transferred from banks to investors. In traditional banking loans were kept in on bankA´s balance sheets. Now the complete process of originates and distribute model involves borrowers, originators, arrangers, credit risk agencies and investors. This process means credit market imperfections. The banks have less incentive to monitor the quality of borrowers and the quality on original loans. As a result of originate and distribute model of subprime loans there is a capital shortage on financial markets. Market participant do not rely on each other. Banks have lost money on mortgage-backed securities on two ways; Prices went down on the trading books and defaults went up in the banking books. It is estimated that the total write-downs on subprime asset backed securities will reach 285 billion US Dollars. In the case of the subprime crisis, the situation is based on an accumulation of several risks; market risks, credit risks and also strategic risks. So the crisis poses real challenges for financial markets regulation process. In the case of the subprime crisis, the situation is based on a collection of several risks: market risks, credit risks and also strategic risks. Originate and distribute strategy has generated a situation, where banks have lost money on mortgage backed securities in two different ways, prices went down on the trading books and defaults went up in the banking books. Subprime crisis, the turmoil on mortgage markets has claimed several causalities. Banks have transferred risks to special entities SIVs and SPVs. This practice has given the impression that the credit risk has been transferred from banks to investors. In traditional banking loans were kept in on bankA´s balance sheets. Now the complete process of originates and distribute model involves borrowers, originators, arrangers, credit risk agencies and investors. This process means credit market imperfections. The banks have less incentive to monitor the quality of borrowers and the quality on original loans. As a result of originate and distribute model of subprime loans there is a capital shortage on financial markets. Market participant do not rely on each other. Banks have lost money on mortgage backed securities on two ways, Prices went down on the trading books and defaults went up in the banking books. It is estimated that the total write downs on subprime asset backed securities will reach 285 billion US Dollars. In the case of the subprime crisis, the situation is based on an accumulation of several risks; market risks, credit risks and also strategic risks. So the crisis poses real challenges for financial markets regulation process.

Subprime crisis:

The main tasks of financial institutions are there allocation of resources, division of risks and sustaining the general payment system. (1994, 19-20) From an operational point of view, it is possible to divide the functions into three key elements: payment system, loans and deposits. Payment system refers to a service provided for the customer, where a cash transaction can be deposited to a bank. This task is shifting from manual, over the counter transactions to electronic and internet-based formats. Modern banking is facing various new challenges, such as continuous need for creating innovations and improving operations in the banking industry. A bank is defined generally as a financial intermediary. There is also another way of thinking the concept. One example is Prosper, an online community for lending and borrowing money without the intervention of banks. Prosper is an online auction platform. It generates revenue by collecting one-time fees on funded loans from borrowers and assessing loan service fees to lenders. Still the traditional banking is operating on the 6 traditional ways. A financial intermediary participates to the payment system and finances customer entities in financial deficit using the funds of customer entities in financial surplus. At the macroeconomic level, banks finance each other through interbank operations. Among the financial intermediaries, the specificity of banks is to issue money, broadly defined as demand deposits and short-term deposits. Taking deposits is therefore the main task of a bank. Customers are accustomed to rely on banks and this is the main reason for giving money to a bank depository account. If a customer needs a loan, the primary commodity is naturally the money, in other words capital. You can see also the secondary advantage: saving time. The loan, given by a financial institution, makes it possible for the customer to purchase items of significant value or invest the capital, whenever the need arises. From the bank point of view, credit always involves handling risks. In the market economy, the banks are competing with loans and credit risk.

Subprime Crisis and the Impact on India:

As interest rates started falling due to excess liquidity, house prices rose rapidly, creating a pool of wealth in the hands of Americans, which they unlocked by contracting mortgage loans. It benefited them in two ways - they got huge liquidity at inflated housing prices and interest rates that were practically lowest in the last twenty years. This became a virtuous cycle, which resulted in very high consumer spending, obviously fuelling global growth. As interest rates started rising in the US due to inflation concerns, this virtuous cycle came to a standstill and the demand for houses started tapering. This resulted in lower prices for houses and many were unable to cover the mortgage loans. It has now hit the entireA bankingA industry in the US and the virtuous cycle is becoming a vicious cycle. Perhaps a similar story will unfold in the next couple of months for these lenders who have lent big money into the subprime markets. One or more banks will fold, just like Enron did, resulting in a huge crisis of confidence. It would be naive to wish away this major problem inflicting the global markets and to presume that the Indian market is decoupled. If the global super-tanker US, which has a 25 per cent share of global GDP, slows down it will definitely have an impact on the Indian economy. Only time can decide which policy becomes successful. More importantly, no one can predict a change of plans in the Oval office. The Impact of US subprime crisis on India may not be very large according to economists. It is being anticipated that the developing countries might be spared for a year or two and neither of the countries would be affected either by economic recession in the USA or the prevailing US subprime crisis. This notion was put forward by the leading economist of the World Bank. Effect of US Subprime Mortgage Crisis on the Banking Sector: Effect of US subprime mortgage crisis on the banking sector has been immense. This is evident from the fact that banks as well as stock markets were affected in every nook and corner of the world. The European Central Bank or the ECB came to the rescue of many. The amount injected by the ECB to rescue the other banking institutions was AsA 95 billion. The rate of interest was 4%. This was the first rescue operation, the second and the third followed with a cash assistance of AsA 61 billion as well as AsA 47.67 billion respectively. The approach taken by the authorities of other Central Banks were also varied. Central Bank of Japan's contributions to the financial markets comprised injection of 600 billion yen or AsA 3.6 billion. The price of stocks fell in Frankfurt, Tokyo and New York. In fact, the financial assistance, which the ECB had shelled out, exceeded the amount it shelled out after terrorist attacks on the World Trade Center on 11th September. Effect of US subprime mortgage crisis on the banking sector did not spare IKB Deutsche Industry bank in Germany (Europe). The bank had to be bailed out by a payment of USD11.1 billion. It has investments in the United States mortgage market. A bank in France, known by the name BNP Paribas halted all withdrawals. This step was taken by the bank as the actual value of the assets was not being ascertained. Another bank, which was about to declare bankruptcy was West LB. Deutsche Post bank as a measure to combat the effects of US subprime mortgage crisis on the banking sector redirected or re routed Euros worth hundred million of the bank's funds. Baffin, a federal agency in Germany is responsible for the regulation of the industry dealing with financial services. Other effects of the crisis include rise in rates of interest. As a result of this, lending business got stalled. The signals started from the money market. In the money markets there is liquidity and the banks carry out several transactions to keep the system functioning. If the functioning of the money markets gets distorted, the whole system gets upset. Indian Banking sector challenged by domestic, not global, factors: October 14, 2008: CRISIL believes that the Indian banking system is relatively insulated from the factors leading to the turmoil in the global banking industry. Further, the recent tight liquidity in the Indian market is also qualitatively different from the global liquidity crunch, which was caused by a crisis of confidence in banks lending to each other. Says Roopa Kudva Managing Director and Chief Executive Officer, CRISIL, "While the main causes of global stress are less relevant here, Indian banks do face increased challenges due to domestic factors. The banking sector faces profitability pressures due to higher funding costs, mark-to-market requirements on investment portfolios, and asset quality pressures due to a slowing economy." CRISIL views the strong capitalization of Indian banks as a positive feature in the current environment.A Indian banks' global exposure is relatively small, with international assets at about 6 per cent of the total assets. Even banks with international operations have less than 11 per cent of their total assets outside India. The reported investment exposure of Indian banks to distressed international financial institutions of about USD1 billion is also very small. The mark-to-market losses on this investment portfolio, will, therefore, have only a limited financial impact. Indian banks' dependence on international funding is also low.A Subprime crisis impact on Indian economy: The Impact of US subprime crisis on India may not be very large according to economists. It is being anticipated that the developing countries might be spared for a year or two and neither of the countries would be affected either by economic recession in the USA or the prevailing US subprime crisis. This notion was put forward by the leading economist of the World Bank.A Further, it is being fathomed that even if there is an impact of US subprime crisis on India, it will not be taking place earlier than two years. However, it will be wrongly said if the developing nations like India would be entirely untouched by the ripple effect. The prevailing economic condition in these countries are so strong that it may not feel the upheaval as it would have felt had the economy of these countries been sluggish.A During the East Asian crisis, the Indian economy was in the regime of limited convertibility (current account and capital account) thanks to the careful and gradual move towards globalization decreed by the RBI and GOI, which worked as a blessing in disguise and we were not particularly affected. Things have changed since and owing to various international obligations and the understanding that capital is important for the overall growth of the economy, the RBI and GOI have liberalized a lot on both the current and capital accounts. Integration of the Indian economy into the world economy has brought about many disadvantages too. The question is how to continue as an integral part of the world and also remain unaffected by the crisis happening in other parts of the world? This question may not be so pertinent to a developed economy but for an emerging economy like ours, if we are affected to a great extent by a crisis arising in another part of the world, this will imply one step forward and two steps backward.A The present crisis in US may not have such an impact on the world economy because it is confined to one sector of the economy, viz., mortgage and housing but one cannot deny that housing is a sector with large-scale implications. Then what do we learn from this housing crisis?A 1. Sound banking practices: The root cause of the subprime mortgage (even prime mortgage loans are in trouble in US; e.g., trouble in Countrywide, America's biggest home loan lender) crisis is the unsound credit practices that emerged in the US market. Fake certification, which helps an ineligible person to raise a home loan, cannot be ruled out in India. Housing loan frauds are not uncommon in the cities of India and the aggressiveness with which housing loans are being sold by banks and financial companies in violation of sound credit practices cannot be ignored. Personal loans and overdue credit cards are the other sectors which the regulators and bankers should handle carefully because they have the potential to plunge the Indian banking sector into a crisis. 2. Controlled Derivatives market: Derivatives are financial instruments, which can spread the default risk attaching to loans. All the same, indiscriminate use of such derivatives can lead to havoc as in US. Derivatives lead to such a chain reaction that it will be nearly impossible to quantify the risk of exposure to bad loans and advances subsequently. RBI and GOI should prohibit indiscriminate use of such derivatives if they intend to introduce such products in India.A 3. Limited investment by Indian companies abroad: Prudent investment abroad should be the order of the day. Reckless investment in the derivatives market abroad by banks and financial institutions has to be controlled. In the recent crisis, BNP Paribas of France and Macquarie Bank of Australia have been affected because of such overseas investments. The exposure of Indian banks to the subprime crisis of US is minimal. 4. Quality Inward Investment: FDI should be given priority over FIIs as history has shown that flight of capital in case of FDI is low compared to that in respect of FIIs. Due to their stable nature, FDI can help in the growth of the country's infrastructure.

Articles:

Abstract:

Indian economy would be less adversely affected by the global economic crisis

Link - https://cje.oxfordjournals.org/content/33/4/725.full

By: Jayati Ghosh

The view that the Indian economy would be less adversely affected by the global economic crisis because of limited integration and other inherent strengths has proved to be wrong. The economic boom in India that preceded the current downturn was dependent upon greater global integration in three ways: greater reliance on exports particularly of services; increased dependence on capital inflows, especially of the short-term variety; and the role these played in underpinning a domestic credit-fuelled consumption and investment boom. These in turn made the growth process more vulnerable to internally and externally generated crises, as is now becoming clear. Abstract:

Link - https://ssrn.com/abstract=1273487

By : William B. and Sanders, Anthony B.

The Sub Prime Crisis: Implications for Emerging Markets

This paper discusses some of the key characteristics of the U.S. subprime mortgage boom and bust, contrasts them with characteristics of emerging mortgage markets, and makes recommendations for emerging market policy makers. The crisis has raised questions in the minds of many as to the wisdom of extending mortgage lending to low and moderate income households. It is important to note, however, that prior to the growth of subprime lending in the 1990s, U.S. mortgage markets already reached low and moderate-income households without taking large risks or suffering large losses. In contrast, in most emerging markets, mortgage finance is a luxury good, restricted to upper income households. As policy makers in emerging market seek to move lenders down market, they should adopt policies that include a variety of financing methods and should allow for rental or purchase as a function of the financial capacity of the household. Securitization remains a useful tool when developed in the context of well-aligned incentives and oversight. It is possible to extend mortgage lending down market without repeating the mistakes of the subprime boom and bust. Abstract: A A A A

Link - https://ssrn.com/abstract=1124961

The Subprime Mortgage Crisis and the Social Capital Response

By: Raymond H. Brescia

This article explores the extent to which social capital theory can respond to the crisis in the subprime mortgage markets. Building on the groundbreaking theories of Robert Putnam in his book BOWLING ALONE: THE COLLAPSE AND REVIVAL OF AMERICAN COMMUNITY, this article seeks to explore the role of trust and social capital in micro-economic transactions, specifically those involving homeownership in general and the subprime mortgage crisis in particular. The article posits that asymmetries of information, the lack of fiduciary obligations between the mortgage broker and the subprime borrower, the incentives built into the subprime mortgage market as a result of mortgage securitization that promote abusive lending practices, deregulation that led to the influx of subprime mortgage products into communities of color, the limits of anti-discrimination laws to address this influx adequately, and restrictions on refinancing built into securitization agreements have all led to the current crisis. In response to these causes of the current crisis, this article suggests changes to the broker-borrower relationship, the promotion of greater consumer education and the creation of problem-solving courts to address the looming foreclosure crisis

ABSTRACT:

Accounting in and for the Subprime Crisis

Link - https://link.aip.org/link/ACRVAS/v83/i6/p1605/s1

By: C. P. Chandrasekhar*

This essay describes implications of the subprime crisis for accounting. First, I overview the institutional and market aspects of subprime lending with the greatest accounting relevance. Second, I discuss the critical aspects of FAS No. 157's fair value definition and measurement guidance and explain the practical difficulties that have arisen in applying this definition and guidance to subprime positions during the crisis. I also raise a potential issue regarding the application of FAS No. 159's fair value option. Third, I discuss issues that have arisen regarding sale accounting for subprime mortgage securitizations under FAS No. 140 and consolidation of securitization entities under FIN No. 46(R) associated with mortgage foreclosures and modifications. Fourth, I indicate ways that accounting academics can address the implications of the subprime crisis in their research.

Abstract:

Understanding the Subprime Mortgage Crisis

https://rfs.oxfordjournals.org/content/early/2009/05/04/rfs.hhp033

By: James W. Kolari

Using loan-level data, we analyze the quality of subprime mortgage loans by adjusting their performance for differences in borrower characteristics, loan characteristics, and macroeconomic conditions. We find that the quality of loans deteriorated for six consecutive years before the crisis and that securitizes were, to some extent, aware of it. We provide evidence that the rise and fall of the subprime mortgage market follows a classic lending boom-bust scenario, in which unsustainable growth leads to the collapse of the market. Problems could have been detected long before the crisis, but they were masked by high house price appreciation between 2003 and 2005.

Objectives

To find out the reason of subprime crisis. To know the affect of subprime crisis on banking sector. To know that how the Subprime crisis rising. Affect of subprime crisis on Indian economy and financial institutions. To know that how the subprime crisis affect the Banking sector. Research Methodology: RESEARCH Research is a Purposeful investigation. It is a scientific and systematic search for knowledge and information on a specific topic. Research is useful and Research objective can be achieved if it is done in Propose Process. METHODOLOGY The word "Methodology" spells the meaning itself i.e. the method used by the researches in obtaining information. The data (Information can be collected from the Primary sources and Secondary sources.) Definition of Market Research:- Market research is "the constant search for and analysis of fact." It is defined as diligent investigation.

By Charles F. Kellering.

"A researcher looks forward to see what industry may do when it can go longer do what it is doing. He further says that "research is done in man's minds are not in laboratories may be necessary". Data collocation method: There are two types of data collocation method-

1. Primary

2. Secondary

Primary data- Primary data are those which are collected a fresh and for the first time, and thus happen to be original in character. Method of Primary data collection: Observation method Interview method Questionnaire method Schedule method Secondary Data: Secondary data means data that are already available, they refer to the data which have already been collected and analyzed by someone else. In this case he is certainly not conformed to the problems that are usually associated with the collection of originals data. Secondary data may either be published data or unpublished data. My data collection in primary source was questionnaire and schedule. In secondary source of data collection I have use internet, magazine, books, and Indian journal of marketing. Researcher must be very careful in using secondary data. He must make a minute scrutiny because it is just possible that the secondary data may be unsuitable or may be inadequate in the context of the problem which the researcher wants to study. Source of Secondary data: The secondary source of data collection is the Books, Internet, News paper, etc. These are the secondary source of data collocation. Research methodology: We use the research methodology to find out the hidden truth and research the problems. I have chosen secondary data for this term paper. Secondary Data: Secondary data was collected through various publications of books and journals, websites. CONCLUSION: The subprime crisis arised from the USA and then this affects the whole countries of the world. One of the country is India which had bad affect of this. And then in India various sectors were affected by this crisis private sector and public sector also. Many banks were affecting by this crisis and they were insolvent. In the case of Insolvency the banks were can't be able to payment to the creditors. The mail function of the bank is to provide loan and get profit by this but in the rotation the banks are insolvent and can't be able to return money. The subprime crisis had bad affect to the banking sector of the India and it is also harmful for the Indian economy.

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