imapct of financial crisis and role of financial institutions in this crisis


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imapct of financial crisis and role of financial institutions in this crisis

  1. 1. Created by: RANJITH KUMAR.C Financial crisis 2008
  2. 2. Let’s start with Basics
  4. 4. Bank <ul><li>Operation </li></ul><ul><ul><li>Take money as deposits on which they pay interests </li></ul></ul><ul><ul><li>Lend it to borrowers who use if for investment or consumption </li></ul></ul><ul><ul><li>Borrow money from other banks (inter bank market) </li></ul></ul><ul><ul><li>Make profit on the difference between interest paid and received </li></ul></ul><ul><ul><li>Banks collects deposits from the depositors @ 8-10% and gives to the </li></ul></ul><ul><ul><li>Borrowers @14-18%. </li></ul></ul>Source: The Economist: Making Sense of Modern Economy
  5. 5. Investment Banks <ul><li>Help firms raise money in the capital markets (equity and bonds market) </li></ul><ul><li>Advise firms whether to finance themselves with debt or equity </li></ul><ul><li>Underwrite such issues by agreeing often with other banks in syndicate, to buy any unsold securities </li></ul><ul><li>Paid a commission for this service @ </li></ul><ul><li>0.5% -2% </li></ul><ul><li>Advice on mergers and acquisitions </li></ul><ul><li>(most lucrative work- not during </li></ul><ul><li>sub-prime crisis though!!) </li></ul>Source: The Economist: Making Sense of Modern Economy
  6. 6. Insurance companies <ul><li>Oldest type of institutional investor </li></ul><ul><li>From protection to savings + protection </li></ul><ul><li>Law of large numbers – risk can be managed by pooling individual exposures in large portfolios </li></ul><ul><ul><li>Catch1- law works if risk are not correlated </li></ul></ul><ul><ul><li>Catch2- losses in any 1 year may differ hugely from the long run trend </li></ul></ul>
  7. 7. Mortgage Broker <ul><li>Mainly found in developed economies like US, Western Europe </li></ul><ul><li>Professionals who are paid a fee to bring together lenders and borrowers </li></ul><ul><li>Sells mortgage loans on behalf of businesses (ex. Banks) </li></ul><ul><li>Tasks undertaken: </li></ul><ul><ul><li>Marketing to attract clients </li></ul></ul><ul><ul><li>Assessment of the borrowers circumstances (Mortgage fact find forms interview). This may include assessment of credit history (normally obtained via a credit report) and affordability (verified by income documentation) </li></ul></ul><ul><ul><li>Assessing the market to find a mortgage product that fits the clients needs (Mortgage presentation/recommendations) </li></ul></ul><ul><ul><li>Applying for a lenders agreement in principle (pre-approval) </li></ul></ul><ul><ul><li>Gathering all needed documents (paystubs / payslips, bank statements, etc.), </li></ul></ul><ul><ul><li>Completing a lender application form </li></ul></ul><ul><ul><li>Explaining the legal disclosures </li></ul></ul><ul><ul><li>Submitting all material to the lender </li></ul></ul>Source: Wikipedia
  8. 8. Sub-prime mortgage – What’s that? <ul><li>Home loans made to borrowers with poor credit ratings — a group generally defined by FICO scores below 620 on a scale that ranges from 300 to 850 </li></ul><ul><li>  FICO - a number that is based on a statistical analysis of a person's credit report, and is used to represent the creditworthiness  of that person. </li></ul><ul><li>(FICO is the acronym for Fair Isaac Corporation, a publicly-traded corporation (under the symbol &quot;FIC&quot;) that created the best-known and most widely used credit score model in the US.) </li></ul><ul><li>Creditworthiness —the likelihood that the person will pay his or her debts. Calculated by credit reporting agencies. </li></ul><ul><li>Ex. Equifax, Experian, and TransUnion in US </li></ul>Source: Wikipedia
  9. 10. Details : Private Sub-prime mortgage process 1. Brokers identify borrowers 2. Originator and broker identify a loan for borrower after looking at his credit rating 3. Formal application for loan by borrower 4. Originator transfers the loan to the subsidiary of an investment banking firm ( Seller) 5. Seller(Investment bank) collects a pool of loans and call it as SPE/SIV/SPV. Off balance sheet instrument 6. SPV can be a corporation, partnership or limited liability company. Most often a Trust. It has nothing else except mortgage loans 7. Underwriter purchases all the securities (derivative income streams) 8. In designing SPV and its tranches underwriter works with credit rating agencies 9. Underwriter then sells the securities to the investors 10. High rated tranches might be guaranteed by a 3rd party insurance company 11. Seller also arranges to sell the rights to service the loan pool to a company or sometimes Originator takes these rights 12. MERS – document custodian. Company to keep track of mountains of paper work on loans in the pool. At National level. Source : Subprime Mortgage Market Turmoil , testimony by Christopher L. Peterson
  10. 11. Good days turn bad. Crisis at the door (mid 2006 onwards): <ul><li>Through financial innovations loans issued to borrowers at minimal rate, adjusted rate. By mid 2006 time to pay bigger amounts comes </li></ul><ul><li>Household income did not increase in same proportion as house prices </li></ul><ul><li>Subprime mortgage owners start defaulting </li></ul><ul><li>Rating agencies revise ratings of MBS/CDO as expected number of defaults turn out higher. Many ratings are lowered </li></ul><ul><li>Bewildered investors lost faith in ratings, many stop buying MBS/CDO altogether </li></ul><ul><li>Alarm bell at SIV/SPVs </li></ul><ul><li>Banks find themselves in non-comfortable position , stop making loans </li></ul><ul><li>Housing prices plummet owing to increase in foreclosure , delinquency and stoppage of loans </li></ul>
  11. 12. How Sub prime became Global Financial Crisis? <ul><li>Lets look into it from start again: </li></ul><ul><li>  Industry data suggest that between 2000 and 2006, nominal global issuance of credit instruments (MBS/CDO) rose twelve fold, to $3,000bn a year from $250bn </li></ul><ul><li>Became intense from 2004, partly because investors were searching for ways to boost returns after a long period in which central banks had kept interest rates low. </li></ul><ul><li>“ slicing and dicing” was fuelling a credit bubble, leading to artificially low borrowing costs, spiraling leverage and a collapse in lending standards </li></ul>Source: Financial Times ,,dwp_uuid=698e638e-e39a-11dc-8799-0000779fd2ac.html In billion US $ How could problems with sub prime mortgages, being such a small sector of global financial markets, provoke such dislocation?
  12. 13. Top 10 Largest Bank Failures Sept. 25 failure of Washington Mutual was bar far the largest in US history. Sold to JP Morgan Chase by govt. for $1.9B plus WaMu’s loans and deposits Resurgent bank failures (13 in 2008 as of Oct. 12) are symptomatic of weakness in the financial system. FDIC says many more may fail Failure of Indy Mac was the 4 th largest in history
  13. 14. Sub prime losses by Big Banks Worldwide :US$ 586.2 billion and still counting Source: Financial Times
  14. 15. Stakes Taken by Federal Government in 9 Large US Banks <ul><li>Feds announced a total $125B stake in 9 large banks on Oct. 14. </li></ul><ul><li>Another $125B will be infused in regional and local banks </li></ul><ul><li>Sum comes from $700B in Troubled Asset Relief Program in the Emergency Economic Stabilization Act of 2008 </li></ul>
  15. 16. Investments devalued across the Globe Source: BBC News,
  16. 17. Sub prime impact across globe Source: Financial Times
  17. 18. Impact of Financial crisis-felt across the globe Source: Reuters,
  18. 19. Distribution of $700 Billion in Funds Under Emergency Economic Stabilization Act of 2008 <ul><li>Shifting Emphasis </li></ul><ul><li>Original EESA allocated all $700B to Troubled Asset Relief Program </li></ul><ul><li>View was that TARP would take too long and that liquidity/credit crisis required direct infusion of capital in banks by feds </li></ul>
  19. 20. It is the right time to buy a house in U.S rather than buying a house in Hyderabad. Thank ”u”