Executive Summary The objective of doing this project was to understand the evolution and causes of U. S. subprime crisis and the repercussions on Indian financial sector specifically Indian banks how much loss they have booked and how in the near future they should gear themselves up so that some thing similar doesn’t happen in India. OBJECTIVE Understanding and analyzing the U. S. subprime crisis and repercussions on Indian banking and financial sector. Research Methodology ?Type of research Qualitative in nature ?Data Collection Secondary data ?Internet ?World bank reports Research papers ?Journals An introduction to U. S. subprime crisis What is US sub-prime market? In short, sub-prime (lending market) refers to the home loan market catering to the persons whose credit rating is low due to which they will not get a regular loan at prime lending rate as announced by US Federal Bank. The sub-prime rates are much higher than prime lending rates. Presently for a 30-year loan, prime-lending rate is in the range of 4 to 51/2 percent and sub-prime interest rates are higher by 200 to 300 basis points over the prime-lending rate as the risk is more for the borrower.
The lower the credit score and the smaller the down payment, the higher are the interest rates. However, the entire structure of rates and fees is higher at sub-prime lenders to cover the greater risk and higher costs of sub-prime lending. By its nature, a higher percentage of sub-primes than of prime loans go into default. Sub-prime lending costs are also higher because more applications are rejected and marketing costs are higher. A sub-prime lender is one who lends to borrowers who do not qualify for loans from mainstream lenders. The interest rate they charge are are uniformly higher than those quoted by mainstream lenders.
A sub prime borrower is one who cannot qualify for prime financing terms but can qualify for sub prime financing terms. The failure to qualify for prime financing is due primarily to low credit scores. In US, every borrower is given credit rating depending on his income levels, past payment history etc. A very low score will disqualify for a softer loan. Some other factors can also influence the decision of the financier, including purpose of loan and property type. The development of the sub-prime market has made mortgages (and home ownership) available to a segment of the population that otherwise would have been shut out of the market.
That’s the good news. Why sub-prime market is in the news? In US housing prices have been moving up from the year 2000 onwards till the end of 2005. American housing prices have not seen a similar pace of growth since 1979. During this period, all the borrowers went aggressively into the sub-prime lending market. But, during this period, the US Federal Bank either raised or kept constant the interest rates and most of sub-prime lending is based on floating interest rate mechanism. With the raising interest rates, the repayment amount by the sub-prime lenders has gone up.
Coupled with this is the slump in home prices from the end of 2005 to the end of 2006, which was the biggest year over year drop. The banks and mortgage lenders are scrambling for creative ways to keep people in their homes but the sub prime market is already teetering and foreclosures are on the rise. With the rising interest burden, sub prime lenders have lately suffered widespread mortgage defaults in the United States, sparking fears the trend will dampen consumer spending and overall US growth. It is estimated that there are a potential $100bn (? 0bn) worth of sub-prime mortgage defaults, from less than credit-worthy borrowers, mainly in the US. Why investors in Asian and European markets fear sub-prime crisis in US? 1. Investor Worries Investors are worried about a global credit crunch as more banks and investment funds around the world reveal their exposure to the slumping US sub prime, or high-risk, home loan sector, analysts said. The fear is that banks will suspend normal lending practices as they move to cover their losses, thereby restricting access to credit for investors and companies.
Central banks across the world have since last week pumped tens of billions of dollars into the banking system, offering loans at lower rates to commercial banks to forestall a credit crunch that could damage economic growth. Reportedly, the interest rates are lowest in Japan with cheaper yen loans. Global financial players, who had borrowed in low-interest yen to invest elsewhere, dumped stocks on fear of rise of the yen and reports of trouble in the biggest US mortgage lender, Countrywide Financial Corp. While Countrywide took an $ 11. billion emergency loan, the US Federal Reserve stepped in to pump in $5 billion to prevent liquidity crunch. In fact, US central bank has infused $76 billion into troubled banks till Thursday. 2. Hedge Funds Many say that the main culprits in this crisis are hedge funds and not the banks. Hedge funds typically borrow money to invest (and they’ve often borrowed shares and other securities too). But terms and conditions apply to their loans: lenders tell the hedge funds the debt must not rise above a specified proportion of the total fund.
It would be like your bank telling you that your mortgage can’t rise above 90% of the value of your house. Now what would happen if the value of your house fell? You would have to find some cash to repay some of the mortgage to ensure it was still not above 90% of the new lower value. The losses they’ve endured on some investments trigger the need to repay cash to prevent their loans breaching their terms. One way for hedge funds to find cash is to sell shares. Note that this does not mean the hedge funds are insolvent – they just need cash, and the easiest way to find it is to sell shares, pushing down the prices.
This potentially could make the market getting into a vicious circle of falling prices, cash requirements and more falling prices. 3. Lending dries up All kinds of bank lending have been affected by the failure of the sub-prime market. This is because the whole market in second-hand debt has been paralysed by the sub-prime problems. This affects the banks, which are sitting on debt they’d like to sell on, but can’t. And it affects corporate borrowers; particularly the kind of borrowers who have been using debt to finance highly leveraged takeovers.
Those takeovers have helped prop up the stock market, and if they now evaporate, the stock market will probably fall. 4. The real economy Finally, the tightening of credit conditions in the market Housing-and-China-Policy Sep-07 and beyond may have real economic effects that depress corporate profits. The pace of takeovers using borrowed money may slow down a bit. The world has been very dependent on US consumer spending. If that diminishes as the housing market and stock markets dive, then companies are in a pickle, the world over. A GLIMPSE OF INDIAN ECONOMY THE VARIOUS SECTORS AND THEIR CURRENT STANDING
The economy of India, when measured in USD exchange-rate terms, is the twelfth largest in the world, with a GDP of US $1. 25 trillion (2008). It is the third largest in terms of purchasing power parity. India is the second fastest growing major economy in the world, with a GDP growth rate of 9. 4% for the fiscal year 2006–2007. However, India’s huge population has a per capita income of $4,542 at PPP and $1,089 in nominal terms (revised 2007 estimate). The World Bank classifies India as a low-income economy. India’s economy is diverse, encompassing agriculture, handicrafts, textile, manufacturing, and a multitude of services.
Although two-thirds of the Indian workforce still earns their livelihood directly or indirectly through agriculture, services are a growing sector and play an increasingly important role of India’s economy. The advent of the digital age, and the large number of young and educated populace fluent in English, is gradually transforming India as an important ‘back office’ destination for global outsourcing of customer services and technical support. India is a major exporter of highly skilled workers in software and financial services, and software engineering.
Other sectors like manufacturing, pharmaceuticals, biotechnology, nanotechnology, telecommunication, shipbuilding, aviation and tourism are showing strong potentials with higher growth rates. India followed a socialist-inspired approach for most of its independent history, with strict government control over private sector participation, foreign trade, and foreign direct investment. However, since the early 1990s, India has gradually opened up its markets through economic reforms by reducing government controls on foreign trade and investment.
The privatisation of publicly owned industries and the opening up of certain sectors to private and foreign interests has proceeded slowly amid political debate. India faces a fast-growing population and the challenge of reducing economic and social inequality. Poverty remains a serious problem, although it has declined significantly since independence. Official surveys estimated that in the year 2004-2005, 27% of Indians were poor. CURRENT MARKET SCENARIO Amid a crisis of confidence, the 30-share Sensex plunged 642. 70 points (more than 4%) – the largest single-day fall in over four months – to close at 14,358. 1 on Thursday. The 50-share Nifty tubmled 191. 60 points to finish at 4,178. 60. Key Asian markets were awash with red – the South Korean, Taiwanese and Indonesian indices closed around 5-7% lower. Australian home loan group RAMS said it had failed to roll over $5 bn in debt due to the US credit crunch, sending Sydney stocks down 5%. Seoul, which was closed on Wednesday, plunged 6. 35%. According to the provisional data, FIIs have net sold around Rs. 3,100 crore on Indian bourses. Hedge funds are now being made out to be the root cause of this mayhem in the markets.
Dealers said, as quoted in the Economic Times, the 5-10% decline in frontline stocks like Reliance and Tata Steel indicated distress sales by hedge funds that are facing problems in other markets. As quoted by ET, a Moragn Stanley strategy note issued to the clients said market participants ” do not fully appreciate that India is excessively reliant on external sources of risk capital and that these suppliers of risk capital tend to be indiscriminate in their behaviour in times of turbulence”. The crisis in the US mortgages market won’t pare growth in the Indian economy, according to most economists.
However, there are signs that despite better than expected agricultural gro-wth, the slowdown in industrial growth would mean that the gross domestic product doesn’t rise at last year’s 9. 4%. International Monetary Fund estimate that a 1% slowdown in US consumption growth resulting from the subprime crisis would reduce gross domestic product (GDP) growth in India by 0. 15-0. 25%. But overall, the two say that since India is still relatively insulated from the global economy, it may experience a temporary volatility and finally get away with less damage than China, Singapore or Indonesia.
It is expected that in the event of a 1% drop in US consumption growth, China’s growth will decline from 12. 3% to 10. 9%; Indonesia’s from 5. 9% to 5. 3%; and India’s from 8% to 7. 5%. The banking system is currently unusually flush with liquidity. Domestic banks holding excess deposits at the central bank are putting substantial funds with the central bank in reverse-repo operations as well as making sizable subscriptions to market stabilization bonds. All this suggests that the credit channel is likely to be weaker than normal. However, Citigroup India has retained its forecast for India’s economic growth at 9. %, while rating agency Standard & Poor’s says, “the Asian economies are likely to get a little wet but will not be blown off course. ” The Indian government prepares to release provisional gross domestic product estimates for the first quarter of 2007-08 very soon in the month of feburary. The real issue facing the Indian economy, according to economists, was a slowdown in industrial growth. New Delhi-based economy research institute National Council for Applied Economic Research (NCAER) has already scaled down its projection for industrial growth to 9% from 10%. Industry grew at 11. 5% in 2006-07.
Industry’s capacity expansion plans are already under pressure due to the spike in interest rates. “With the investment side of the story largely intact, we expect an extended pause in policy rates to buoy growth in the latter half (of the year),”. However, any abrupt reversal on the external sector could also deny companies access to cheap source of money from abroad. “Almost 82% of the total $98 billion of capital flows that India has received over the past four years has been in the form of non-FDI flows. As a result, India is more exposed than other emerging countries to a potential sharp reversal in global risk”.
BRIEF HISTORY OF INDIAN BANKING SYSTEM PHASE ONE :- The General Bank of India was set up in the year 1786. Next came Bank of Hindustan and Bengal Bank. The East India Company established Bank of Bengal (1809), Bank of Bombay (1840) and Bank of Madras (1843) as independent units and called it Presidency Banks. These three banks were amalgamated in 1920 and Imperial Bank of India was established which started as private shareholders banks, mostly Europeans shareholders. In 1865 Allahabad Bank was established and first time exclusively by Indians, Punjab National Bank Ltd. was set up in 1894 with headquarters at Lahore.
Between 1906 and 1913, Bank of India, Central Bank of India, Bank of Baroda, Canara Bank, Indian Bank, and Bank of Mysore were set up. Reserve Bank of India came in 1935. During the first phase the growth was very slow and banks also experienced periodic failures between 1913 and 1948. There were approximately 1100 banks, mostly small. To streamline the functioning and activities of commercial banks, the Government of India came up with The Banking Companies Act, 1949 which was later changed to Banking Regulation Act 1949 as per amending Act of 1965 (Act No. 23 of 1965). Reserve Bank of India was vested ith extensive powers for the supervision of banking in india as the Central Banking Authority. During those days public has lesser confidence in the banks. As an aftermath deposit mobilisation was slow. Abreast of it the savings bank facility provided by the Postal department was comparatively safer. Moreover, funds were largely given to traders. PHASE TWO :- Government took major steps in this Indian Banking Sector Reform after independence. In 1955, it nationalised Imperial Bank of India with extensive banking facilities on a large scale specially in rural and semi-urban areas.
It formed State Bank of india to act as the principal agent of RBI and to handle banking transactions of the Union and State Governments all over the country. Seven banks forming subsidiary of State Bank of India was nationalised in 1960 on 19th July, 1969, major process of nationalisation was carried out. It was the effort of the then Prime Minister of India, Mrs. Indira Gandhi. 14 major commercial banks in the country was nationalised. Second phase of nationalisation Indian Banking Sector Reform was carried out in 1980 with seven more banks. This step brought 80% of the banking segment in India under Government ownership.
The following are the steps taken by the Government of India to Regulate Banking Institutions in the Country: 1949 : Enactment of Banking Regulation Act. 1955 : Nationalisation of State Bank of India. 1959 : Nationalisation of SBI subsidiaries. 1961 : Insurance cover extended to deposits. 1969 : Nationalisation of 14 major banks. 1971 : Creation of credit guarantee corporation. 1975 : Creation of regional rural banks. 1980 : Nationalisation of seven banks with deposits over 200 crore. After the nationalisation of banks, the branches of the public sector bank India rose o approximately 800% in deposits and advances took a huge jump by 11,000%. Banking in the sunshine of Government ownership gave the public implicit faith and immense confidence about the sustainability of these institutions. PHASE THREE :- This phase has introduced many more products and facilities in the banking sector in its reforms measure. In 1991, under the chairmanship of M Narasimham, a committee was set up by his name which worked for the liberalisation of banking practices. The country is flooded with foreign banks and their ATM stations.
Efforts are being put to give a satisfactory service to customers. Phone banking and net banking is introduced. The entire system became more convenient and swift. Time is given more importance than money. The financial system of India has shown a great deal of resilience. It is sheltered from any crisis triggered by any external macroeconomics shock as other East Asian Countries suffered. This is all due to a flexible exchange rate regime, the foreign reserves are high, the capital account is not yet fully convertible, and banks and their customers have limited foreign exchange exposure.
ABOUT SYNDICATE BANK Syndicate Bank was established in 1925 in Udupi, the abode of Lord Krishna in coastal Karnataka with a capital of Rs. 8000/- by three visionaries – Sri Upendra Ananth Pai, a businessman, Sri Vaman Kudva, an engineer and Dr. T M A Pai, a physician – who shared a strong commitment to social welfare. Their objective was primarily to extend financial assistance to the local weavers who were crippled by a crisis in the handloom industry through mobilising small savings from the community.
The bank collected as low as 2 annas daily at the doorsteps of the depositors through its Agents under its Pigmy Deposit Scheme started in 1928. This scheme is the Bank’s brand equity today and the Bank collects around Rs. 2 crore per day under the scheme. The progress of Syndicate Bank has been synonymous with the phase of progressive banking in India. Spanning over 80 years of pioneering expertise, the Bank has created for itself a solid customer base comprising customers of two or three generations. Being firmly rooted in rural India and understanding the grassroot realities, the Bank’s perception had vision of future India.
It has been propagating innovations in Banking and also has been receptive to new ideas, without however getting uprooted from its distinctive socio-economic and cultural ethos. Its philosophy of growth by mutual sustenance of both the Bank and the people has paid rich dividends. The Bank has been operating as a catalyst of development across the country with particular reference to the common man at the individual level and in rural/semi urban centres at the area level. The Bank is well equipped to meet the challenges of the 21st century in the areas of information technology, knowledge and competition.
A comprehensive IT plan is being put in place and the skills and knowledge of the Bank’s personnel are being upgraded through a variety of training programmes to promote customer delight in every sphere of its activity. The Bank has launched an ambitious technology plan called Centralised Banking Solution (CBS) whereby 500 of our strategic branches with their ATMs are being networked nationwide over a 4 year period. ACHIVEMENTS 1925On 10. 11. 1925, the business of the Bank commenced in Udupi with the name “Canara Industrial and Banking Syndicate Ltd. ,” a joint Stock Company with just one employee. 928First branch of the Bank opened at Brahmavar in Dakshina Kannada District 1937Bank became a member of the Clearing House for the first time at Bombay. 194629 branches opened in a single day in rural areas. 1953Took over the assets and liabilities of 2 Local Banks viz. Maharashtra Apex Bank Ltd. and Southern India Apex Bank Ltd. 20 Banks merged with the Bank during the period 1953-1964. 1957100th branch opened at Ilkal in Karnataka 1962Entered Foreign Exchange business by opening Foreign Exchange Department at Bombay. 1963Name of the Bank changed from “Canara Industrial & Banking Syndicate Ltd. ” to “Syndicate Bank Limited”.
Head Office was shifted to Manipal on 19. 4. 1964. 1966Economic Research Department set up. One of the first few Banks to emphasise on research in Banking even before nationalisation. 1969Bank had 306 branches at the time of nationalisation of which 66% were in Rural and Semi Urban centres. Opened a branch at Port Blair in Andaman and Nicobar islands 1970First Staff Training College started at Head Office 1971First specialised branch in Foreign Exchange opened at Delhi. 1972Opened a branch at Lakshadweep islands 1976First overseas branch opened at London on 17. 8. 76. 1983Took up management of Al Shabei Finance and Exchange Co. n Doha 1984Took up management of Musandam Exchange Co. in Muscat 19841000th branch opened at Delhi Hauz Khas 19891500th branch opened at Kanakumbi 1991First Specialised Industrial Finance Branch opened at Mumbai. 1995First Specialised Housing Finance Branch opened at Mangalore 1999Bank raised Capital of Rs. 125 Crore in Oct. 1999 from more than 4 lakh shareholders 2000First Specialised Capital Market Services branch opened at Mumbai 2001First branch under CBS (Core Banking Solution) started operation at Bangalore. 2002Centralised Banking Solution under the brand name “Syndicate-e-banking” launched at Delhi, Mumbai, Bangalore and Manipal. 003Bank enters into MOU with Bajaj Allianz for distribution of Life Insurance products. 2003Toll Free Voice Mail System for redressal of grievances introduced. 2004Bank ties up with United India Insurance Co. Ltd. for distribution of Non-Life Insurance products 2004Utility bill payment services through Internet banking introduced. 2005Introduced On-line reservation of Railway Tickets through Indian Railway Catering & Tourism Corporation Ltd. (IRCTC) for Internet banking customers of our Bank. 2005Bank approached the Capital Market with Rs. 5 Crore equity shares at a premium of Rs. 40 through Book building route Bank collected Rs. 50 Crore and the issue was oversubscribed by 29. 275 times. 2005Amalgamation of 4 Regional Rural Banks of Karnataka to form Karnataka Vikas Grameena Bank with Head Office at Dharwad. 2005Implementation of Venture Capital Scheme of SMALL FARMERS AGRI-BUSINESS CONSORTIUM (SFAC) Entered into MOU with SFAC for promoting of investments in Agri-business products. 2006Bank signs MOU with M/s. CMC Ltd. , for making Syndicate Institute of Bank Management (SIBM) a center of excellence of global standards and provide quality management education. 2006500th Branch of SyndicateBank in Karnataka opened at Navnagar, Bagalkot. 0062000th Branch of SyndicateBank opened at Tondiarpet, Chennai on 23. 03. 2006. 2006Inauguration of SyndBank Services Limited, the 1st BPO outfit of a Nationalised Bank, a wholly owned subsidiary of SyndicateBank & 525th CBS Branch by Hon’ble Union Minister of Finance, Sri P Chidambaram on 24. 03. 2006 at Bangalore. 20062006th Branch of SyndicateBank opened at Gangtok, Sikkim on 27. 03. 2006 Pigmy Deposit Scheme – Bank’s Brand Equity ?Launched in 1928 by Dr. T. M. A. Pai, one of the Founders to encourage the habit of thrift and small savings. Pigmy Scheme symbolises the description of the Bank as “a small man’s big Bank” even today. Bank collects as low as Rs. 1 daily for 63 months at the doorsteps of 12. 32 lac depositors through its 3370 Pigmy agents. ?Daily collection under the scheme is over Rs. 2. 66 crore today. ?Pigmy deposits of the Bank crossed Rs. 1457 crore. Nationalisation – Bank’s Catalytic Role 1961Industrial Finance Department was set up to encourage advances to Small Industries and Entrepreneurs in keeping with the policy of assisting the common man. 1968Bank’s commitment to the philosophy of social lending since inception provided the spark for introduction of social control measures in the country . 2% of the Bank’s branches were in rural areas as against 22% for the entire Banking system. 1969Bank was nationalised on 19th July 1969. Bank was acknowledged as a live example of mass banking and as a powerful catalyst of social change. Nationalisation therefore merely meant change of ownerhsip. 1995Established Hi Tech Agriculture Branches Social Lending – Concern For The Underprivileged ?Social lending is the Bank’s strong point since inception. ?Priority Sector Advances as at March 2007 were Rs. 18,441 crore accounting for 39. 90% of the Bank’s net bank. 16. 39 lac borrowers assisted under priority sector. SC/ST advances under priority sector are Rs. 1,070 crore as on 31. 03. 2007 covering 2. 79 lac beneficiaries. ?Bank adopted 13,722 Service Area Villages for extending timely. credit to meet all their genuine credit needs. Total credit to the extent of Rs. 7,941 crore was disbursed under Annual Action Plan in these villages. The agricultural credit disbursed during the financial year 2006-07 was Rs. 4,362 crore. ?1. 66 lakh new farmers were brought into Bank’s fold through 1128 rural/semi-urban branches during the year 2006-07, registering an average of 147 new farmers per branch against the Govt’s stipulation of 100 new farmers per branch. Agricultural credit stood at Rs. 8,050 crore constituting 17. 42% of net bank credit. 11. 19 lakh borrowers assisted under Agriculture, out of which 47% were small and marginal farmers. ?Bank has issued 8 lakh Kisan Credit Cards to the farmers with credit limits of over Rs. 2,955 crore. ?24,304 new Self Help Groups were credit linked with a credit support of Rs. 194. 37 crore during the year 2006-07 benefiting 2. 67 lakh families. The Bank has so far credit linked 87,416 SHGs with a credit exposure of Rs. 496. 47 crore benefiting about 9. 63 lakh families, upto 31. 03. 2007. ?Extended education loan to 52,184 beneficiaries amounting to Rs. 13 crore ? Assisted 1. 34 lakh beneficiaries under housing amounting to Rs. 5,645 crore ? Advances to weaker sections were Rs. 4,667 crore benefiting 6. 88 lakh customers. ?Bank is actively involved in implementing the schemes for financing Solar Water Heating and Lighting Systems. Bank has financed 3886 Water Heating Systems amounting to Rs. 10. 26 crore and 674 Solar lighting systems amounting to Rs. 0. 83 crore during the year 2006-07. Thus the cumulative number of Solar Water Heating and lighting systems financed by the Bank is 21,323 units with a credit component of Rs. 49. 8 crore and 6367 units with a credit component of Rs. 10. 78 crore respectively. ?As a result of Solar Water Heating and Lighting Systems introduced by the Bank, there is grid power saving to the extent of 5. 89 crore units per annum contributing to a peak load saving of 39. 94 MW. Priority For Women – Towards Greater Empowerment ?Women have occupied pride of place in the Bank in employment as well as in credit dispensation. ?Bank pioneered the concept of “All Women Branch”. The first such branch at Seshadripuram in Bangalore was opened as early as 1962. ?Over 30% of credit outstandings under Govt. ponsored anti poverty schemes benefit women. ?Out of 87,416 Self Help Groups financed by the Bank upto March 2007, 70327 groups with credit assistance amounting to Rs. 378 crore are for women groups. Women groups constitute more than 80% both in terms of number of groups financed and credit assistance extended. ?Out of total 2. 25 lakh unemployed youth trained for taking up self-employment ventures at Syndicate Institute of Rural Development (SIRD) and RUDSETIs sponsored by the Bank, 0. 79 lakh constituting more than 35% are women candidates. Awards Won By The Bank Over The Years 972INDIAN MERCHANTS’ CHAMBER AWARD for outstanding contributions towards welfare of community 1974INDIAN MERCHANTS CHAMBER AWARD for outstanding contribution in promotion of savings 1975FICCI AWARD For outstanding achievements in agriculture 1975LAGHU UDYOG SAHAKARI AWARD by the national alliance of young entrepreneurs for bank’s significant contributions to the development of small scale industries and assistance to the young entreprenueurs through self employment clinics 1975INTERNATIONAL AWARD by JAYCEE INTERNATIONAL for self employment 1975FICCI AWARD in recognition of corporate initiative in industrial relations 1975CERTIFICATE OF MERIT for Bank’s house journal “GIANT” 976INTERNATIONAL AWARD by JAYCEE international for outstanding contribution to the cause of the JAYCEE movement 1977ASSOCHAM AWARD for promotion of rural and agricultural activities of Syndicate Agriculture Foundation sponsored by the bank 1978INDIAN MERCHANTS CHAMBER AWARD for outstanding contribution towards welfare of the community 1978NATIONAL TROPHY For outstanding export performance 1981NATIONAL INVESTMENT AND FINANCE AWARD for Priority Sector lending. 1990CHAUDHARI CHARAN SINGH MEMORIAL NATIONAL AWARD for Rural Development 1999FICCI AWARD for institutional initiative in the field of “Rural Development” to RUDSETI jointly sponsored by Syndicate Bank 001Banking Technology Award for innovative use of Banking Applications on INFINET awarded by IDRBT, Hyderabad 2003Banking Technology Award conferred on SyndicateBank by IDRBT, Hyderabad for 2003 WHAT LEAD TO SUB PRIME CRISIS IN THE UNITED STATES OF AMERICA? Traditionally, banks have financed their mortgage lending through the deposits they receive from their customers. This has limited the amount of mortgage lending they could do. In recent years, banks have moved to a new model where they sell on the mortgages to the bond markets. This has made it much easier to fund additional borrowing, But it has also led to abuses as banks no longer have the incentive to check carefully the mortgages they issue. THE RISE OF THE MORTGAGE BOND MARKET
In the past five years, the private sector has dramatically expanded its role in the mortgage bond market, which had previously been dominated by government-sponsored agencies like Freddie Mac. They specialised in new types of mortgages, such as sub-prime lending to borrowers with poor credit histories and weak documentation of income, who were shunned by the “prime” lenders like Freddie Mac. They also included “jumbo” mortgages for properties over Freddie Mac’s $417,000 (? 202,000) mortgage limit. The business proved extremely profitable for the banks, which earned a fee for each mortgage they sold on. They urged mortgage brokers to sell more and more of these mortgages. Now the mortgage bond market is worth $6 trillion, and is the largest single part of the whole $27 trillion US bond market, bigger even than Treasury
HOW SUB-PRIME LENDING AFFECTED ONE CITY It shall be appropriate to take the example of Cleveland as it has been hit hardest by this crisis. For many years, Cleveland was the sub-prime capital of America. It was a poor, working class city, hit hard by the decline of manufacturing and sharply divided along racial lines. Mortgage brokers focused their efforts by selling sub-prime mortgages in working class black areas where many people had achieved home ownership. They told them that they could get cash by refinancing their homes, but often neglected to properly explain that the new sub-prime mortgages would “reset” after 2 years at double the interest rate.
The result was a wave of repossessions that blighted neighbourhoods across the city and the inner suburbs. By late 2007, one in ten homes in Cleveland had been repossessed and Deutsche Bank Trust, acting on behalf of bondholders, was the largest property owner in the city. THE CRISIS GOES NATIONWIDE Sub-prime lending had spread from inner-city areas right across America by 2005. By then, one in five mortgages were sub-prime, and they were particularly popular among recent immigrants trying to buy a home for the first time in the “hot” housing markets of Southern California, Arizona, Nevada, and the suburbs of Washington, DC and New York City.
House prices were high, and it was difficult to become an owner-occupier without moving to the very edge of the metropolitan area. House prices were high, and it was difficult to become an owner-occupier without moving to the very edge of the metropolitan area. But these mortgages had a much higher rate of repossession than conventional mortgages because they were adjustable rate mortgages (ARMs). The payments were fixed for two years, and then became both higher and dependent on the level of Fed intereset rates, which also rose substantially. Consequently, a wave of repossessions is sweeping America as many of these mortgages reset to higher rates in the next two years.
And it is likely that as many as two million families will be evicted from their homes as their cases make their way through the courts. The Bush administration is pushing the industry to renegotiate rather than repossess where possible, but mortgage companies are being overwhelmed by a tidal wave of cases. THE HOUSING PRICE CRASH The wave of repossessions is having a dramatic effect on house prices, reversing the housing boom of the last few years and causing the first national decline in house prices since the 1930s. There is a glut of four million unsold homes that is depressing prices, as builders have also been forced to lower prices to get rid of unsold properties. And house prices, which are currently declining at an annual rate of 4. %, are expected to fall by at least 10% by next year – and more in areas like California and Florida which had the biggest boom. HOUSING AND THE ECONOMY The property crash is also affecting the broader economy, with the building industry expected to cut its output by half, with the loss of between one and two million jobs. Many smaller builders will go out of business, and the larger firms are all suffering huge losses. The building industry makes up 15% of the US economy, but a slowdown in the property market also hits many other industries, for instance makers of durable goods, such as washing machines, and DIY stores, such as Home Depot.
Economists expect the US economy to slow in the last three months of 2007 to an annual rate of 1% to 1. 5%, compared with growth of 3. 9% now. But no one is sure how long the slowdown will last. Many US consumers have spent beyond their current income by borrowing on credit, and the fall in the value of their homes may make them reluctant to continue this pattern in the future. CREDIT CRUNCH One reason the economic slowdown could get worse is that banks and other lenders are cutting back on how much credit they will make available. They are rejecting more people who apply for credit cards, insisting on bigger deposits for house purchase, and looking more closely at applications for personal loans.
The mortgage market has been particularly badly affected, with individuals finding it very difficult to get non-traditional mortgages, both sub-prime and “jumbo” (over the limit guaranteed by government-sponsored agencies). The banks have been forced to do this by the drying up of the wholesale bond markets and by the effect of the crisis on their own balance sheets. BANK LOSSES The banking industry is facing huge losses as a result of the sub-prime crisis. Already banks have announced $60bn worth of losses as many of the mortgage bonds backed by sub-prime mortgages have fallen in value. The losses could be much greater, as many banks have concealed their holdings of sub-prime mortgages in exotic, off-balance sheet instruments such as “structured investment vehicles” or SIVs. Although the banks say hey do not own these SIVs, and therefore are not liable for their losses, they may be forced to cover any bad debts that they accrue. BOND MARKET COLLAPSE Also suffering huge losses are the bondholders, such as pension funds, who bought sub-prime mortgage bonds. These have fallen sharply in value in the last few months, and are now worth between 20% and 40% of their original value for most asset classes, even those considered safe by the ratings agencies. If the banks are forced to reveal their losses based on current prices, they will be even bigger. It is estimated that ultimately losses suffered by financial institutions could be between $220bn and $450bn, as the $1 trillion in sub-prime mortgage bonds is revalued. EFFECT ON INDIAN BANKING AND FINANCIAL SECTOR
The true and correct effects are yet to come out openly as there are various balance sheet factors that are used by banks and financial institutions that hide the correct figures of losses it also possible that what may be the losses would actually appear by the second quarter of the FY 08-09 but the present reported losses are disclosed by indians 2nd largest bank ICICI BANK LTD which has foreign operations in the us as well has raised money from us capital markets in form of ADR’s the current reported loss is of US dollar 212million and the hedging and other losses and expenses are yet to be disclosed . the other bank that has reported a loss is INDIAS LARGEST BANK ie THE STATE BANK GROUP the bank has lost about 250million us dollars and operations of both the banks have been effect .
Other than the disclosuers it was very evident reading the RBI’S TREAND REPORT OF INDIAN BANKS that loans given to non residents have increased from 2005-07 from 4,103crores in 2005 to 6,270crores in 2006 to 7,122 in 2007 this rise in the lending would certainly increase the risk of banks in the current prevailing conditions. The bad credit habits of the us residents have caused this slow down in the us economy and the relatively much poor methods of loan disbursement and appraisal system caused such an international wave that has hit nearly all the growing and emerging economies. Indian banks are certainly going to face troubled waters and so would our financial markets. We have already witnessed a dropping dollar rate v/s rupee causing serous losses to our exporters.
Most fii’s have started booking profits in the stock markets and an drop of 5000points can be seen in Bombay stock exchange showing not very healthy financial signs. The various property rates of past two years in the cities that are high in demand due to the employment factor and presence ITES industry causing a sharp rise in prices of residential property as compared to commercial property PROPERTY RATES IN MUMBAI( WESTERN SUBURBS): LOCATIONRESIDENTIALCOMMERCIAL 2006200720062007 Vashi 2100-35002100-55002800-48002800-6800 Koparkhairaine 1100-15001800-31002000-34002000-5400 Airoli 1100-18002100-31001600-39001600-5900 Sanpada 1100-14002100-34001500-34001500-5400 Nerul 1100-44003100-44001500-32001500-5200
Konkan Bhavan (CBD) 1000-13002100-33001200-36001200-4600 Kharghar 900-26001900-26001200-32001200-4200 Kalamboli 700-11001700-3100900-24002900-4400 Kamothe——1725-31002900-3400 Panvel 750-21001750-31001200-32002900-4200 Property Rates-Delhi LOCATIONRESIDENTIALCOMMERCIAL 2006200720062007 Karol Bagh7000-90007000-110009000-2300013000-31000 Rajendra Nagar7000-90007500-105009000-1400011000-24000 Gole Market5000-110006500-950010000-3200013000-28000 Chanakyapuri5000-90006500-85007000-120009000-11000 South extension5000-80004500-85007000-110008000-13000 Defence Colony5500-85006500-90007000-90008000-13000 Lodi Colony5000-80006000-90007000-90007500-11000 Greater Kailash2800-40004400-65004000-80005500-9500
Hauz Khas3200-41004000-70006000-80006500-7500 Kalkaji2400-32003200-34003000-50004000-6500 Saket2500-28003200-42003000-45003500-5500 Vasant Vihar2200-40003200-55003000-50004500-7000 Mayur Vihar2400-55003000-60004000-70004000-8500 Malvia Nagar2200-30003000-45003200-45004200-5400 Noida1700-28002200-32002400-70003000-8000 Shastri Nagar1800-24002200-32003000-40004000-6000 Sadar Bazar2000-24003000-40003000-40004000-7000 Kamla Nagar1400-28002000-30002000-30003000-5500 Vaishali 2800-41003000-42003500-65004000-6500 IFCI Colony1800-24002200-32003000-50003500-6500 Rajouri Garden1800-24002200-44003000-40003500-5500 Janakpuri2200-36002400-45003500-45004000-6000
Dwarka1600-24002200-32002500-45003000-6000 Suryavihar1200-18001700-38002000-32002800-4000 Palam Gurgaon1900-23002200-43003000-55004000-7000 Gurgaon (Smaller)1800-32002200-42004000-60005500-8000 Property Rates-Bangalore Arearea Residential Commercial 2006200720062007 M. G. Road 2800-40003000-42004000-90005500-11000 Cunningham Road 2800-5500 3200-52004500-60005500-13000 Jayanagar 1800-2200 2200-2700 3000-45003800-8000 Basavangudi 2100-3200 2100-3600 3000-40003800-8500 Koramangala 1800-2800 2200-3400 2500-45003500-7600 Ulsoor 1800-3000 2200-4200 2000-30003800-8400 Langford road 1600-2800 2100-3200 2000-30004000-7600 Richmond road 1600-2800 2100-3200 2000-30003800-8500
Palace cross road 1200-2200 1600-2400 2400-32004000-9000 Levelle Road 2500-4000 3200-4200 3000-40004500-11000 Domlur 1500-1800 1800-2200 2000-30003300-7400 Bannerghetta road 1100-1600 1200-2400 2000-30003300-5500 Nagarbhavi 1200-1600 1400-1800 1800-28002200-3200 R. T. Nagar 1500-1800 1600-21002000-32002200-5400 Cooks town 1800-2500 2100-2700 2800-40003200-4500 Yelahanka 1150-1600 1400-2100 2000-30002500-4000 J. P. Nagar 1500-2100 1900-3200 2000-30002200-4000 Augodi 1200-1400 1600-3400 2000-25002000-4400 Maker Circle 1400-2200 2400-3300 2000-27003000-3300 Dollars colony 1600-1800 2100-3800 2000-30002000-4200 Brigade Road 3000-4500 4200-6500 5500-75006500-8500
IN THE ABOVE MENTIONED CITIES THERE ARE 9 LOCATIONS THAT ARE INHABITATED BY ITES EMPLOYEES AND ON AN BROAD PERSPECTIVE THE GROWTH IN PROPERTY PRICES ON AN AVERAGE IS ABOVE 45% ( REFFERCE TO CALCULATIONS BELOW) YEAR——->2006 MID PRICE2007 MID PRICE% CHANGE S. NOL1L2 L1L2 VASHI21003500280021005500380035. 7142857 KOPARKHARINE11001500130018003100245088. 4615385 NOIDA17002800225022003200270020 PALM GURGAON19002300210022004300325054. 7619048 GURGAON (SMALLER)18003200250022004200320028 RICHMOND ROAD16002800220021003200265020. 4545455 PALACE ROAD12002200170016002400200017. 6470588 DOLLAR COLONY16001800170021003800295073. 5294118 PANVEL7502100142517503100242570. 1754386 408. 744184 NET AVERAGE % CHANGE45. 416 •THE LOCATION CHOOSEN FOR CALCULATIONS ARE ALL AREAS WHERE THE ITES INDUSTRY IS PRESENT NAMELY BPO’S, KPO’S ETC. ALL THE LOCATIONS ARE DENSLY POPULATED WITH MIDDLE INCOME GROUP THAT IS JOB DEPENDENT •ALL THE PROPERTY OWNERSHIP IS WITH PEOPLE FROM OTHER PARTS OF THE COUNTRY THAT HAD COME TO WORK AND EVENTUALLY PURCHASED THE PROPERTY •MORE THAN 75% OF THE PROPERTY IS FINANCED BY BANKS AND FINANCIAL INSTITUTIONS. One of the primary cause of U. S. sub prime crisis was housing mortgage loans that were provided on inflated property prices to customers with slightly bad credit track record. The areas were the places were employment rate was strong and percapita income high. The problem arouse due to unemployment that caused loan default and the property prices crashed hence the banks went into a situation of over finance causing them a loss.
We can take example of four cities Banglore, Mumbai, Gurgaon, Noida. The areas that are referred to are major hubs of ITES many BPO’s , KPO’s and other IT related services are provided here and these destinations are also high employment zones where people are nearly 100%employed and percapita income is also high. Let us take a middle income group earning Rs. 30,000 to 48,000 who can afford property of 1000sqft at a price range of Rs. 1700 to 3500 per sqft builtup and find correlation. The banking norms specify that maximum 50% of the monthly income is only disposable. XY SalaryProperty Pricex’y’x’y'(x’. x’)(y’. y’) 300001700-9000-900810000081000000810000 10001800-8000-800640000064000000640000 320001900-7000-700490000049000000490000 330002000-6000-600360000036000000360000 340002100-5000-500250000025000000250000 350002200-4000-400160000016000000160000 360002300-3000-300900000900000090000 370002400-2000-200400000400000040000 380002500-1000-100100000100000010000 39000260000000 4000027001000100100000100000010000 4100028002000200400000400000040000 4200029003000300900000900000090000 4300030004000400160000016000000160000 4400031005000500250000025000000250000 4500032006000600360000036000000360000 4600033007000700490000049000000490000 4700034008000800640000064000000640000 4800035009000900810000081000000810000 4100049400046800570000005700000005700000 •PROPERTY PRICES ARE AVERAGE PRICES THAT PREVALE IN ALL THE ABOVE COLLECTED DATA •SIMILAR CONDITIONS DO PREVALE IN THE AREA AS COMMON EMPLOYMENT CONDITIONS PREVALE By applying karlpearsons coefficient of correlation we get a +0. 032 positive correlation. The correlation coefficient r (also called Pearson’s product moment correlation after Karl Pearson) is calculated by The correlation coefficient may take any value between -1. 0 and +1. 0. Assumptions: •linear relationship between x and y •continuous random variables •both variables must be normally distributed •x and y must be independent of each other
Please note, that the equation above can be replaced by an equivalent formula which avoids to use the means and is therefore much faster to calculate: That proves that whenever salary is higher the property prices shall be higher due to demand concentration. Now if we take a case where the U. S economy goes into a recession our ITES industry will suffer most causing lot of job cuts and that may lead to housing loan defaults and crash in property prices this shall cause a situation that is similar to us sub prime crisis. PREVALING RATE OF INTEREST ON HOUSING LOANS FROM THE YEAR 1988TO 2008 IN INDIA YEARRATE OF INTEREST 1988-8916. 25 1989-9016. 25 1990-9116. 25 1991-9217 1992-9319 1993-9419 1994-9519 1995-9614. 25 1996-9716 1997-9814 1998-9913. 75 1999-0012 2000-0112 2001-0211. 75 2002-0311. 5 2003-0410. 25 2004-0510 2005-0610. 25 006-0711 2007-0811. 25 THE ABOVE MENTIONED RATES ARE FIXED RATE OF INTERESTS IN FARIOUS YEARS AS PRESCRIBED BY NATIONAL HOUSING BANK AND FOLLOWED BY NEARLY ALL BANKING AND HOUSING FINANCE COMPANIES IN THE ABOVE MENTIONED PERIOD. THE HOUSING LOAN DISBURSEMENTS TREND FROM THE YEAR 1999 TO 2008 ARE AS FOLLOWS: *THE DISBURSEMENT FIGURES MENTIONED ARE IN Rs. CRORES. YEARTOTAL DISBURSEMENTSGROWTH 1999-0019723. 38 2000-0122425. 0913. 69800714 2001-0229359. 2930. 92161503 2002-0351672. 776. 00119076 2003-472341. 7840 2004-5101278. 49240 2005-06141789. 888840 2006-07155968. 877710 2007-08171565. 765410 GRAPHICAL REPRESENTATION OF YEAR ON YEAR DISBURSEMENTS
LESSONS FROM THE SUBPRIME CRISIS LESSON 1 : Distorted Incentives without Accountability can spell Disaster The subprime crisis has been the result of individual incentives and the lack of accountability which has caused the present dilemma. The market for MBS created by subprime loans is like leman markets because of the information asymmetry between the key players and in this situation only low quality lemons would be traded. Under the extreme scenario, such a market should cease to exist however low tranches are backed by multi class MBS and thus the players have managed to service which has spilled disaster for the US economy and the economies world over.
LESSON II ; Central Banks faced Moral Hazard which needs to be resisted Under the conditions that are prevailing now the Fed has to consider the moral hazards inherent in any bailout. The Fed has already pumped $31. 25 billion in temporary reserves to the banking system via system repurchase agreements and the Fed has also slashed the interest rate by 50 basis points again. But such actions will only further the tendency to default. LESSON III : Risk Allocation does not mean Risk Elimination Spreading risk does not eliminate it and eventually these risks expose themselves. As risk is spreading globally it becomes difficult to assess the impact of loss and its ripple effects show up in the most unlikely places. LESSON IV : Complex Mathematical Models can also fail
FICO scores which have been used to judge the consumer’s ability to pay back seems to have failed as the number of foreclosures have exceeded a lot with the increase in the interest rate over the last year. Moreover if the interest rate changes, the valuation of different tranches of CDO’s would change and hedge funds have made bets on the correlation of the actual change to their models which has spiked off illiquidity at least in the short run. LESSON V : True Risk Assessment of Securities is Crucial Rating agencies are typically paid by issuers and only for initial ratings thus true assessment of the risk of securities by re-rating need to be ensured.
LESSON VI : Credit History Analysis of Borrowers is Essential In the wake of failure of models and even FICO to calculate the credit lending capability, it has become all the more important to ensure stricter lending practices. There has to be greater check on the background of borrowers to curtail the increasing foreclosures. LESSON VII : Greater Need for Consumer Protection With lending standards tightening the appropriate policy response needs to balance improving consumer protection with maintaining the viability of the securitization model that has successfully dispersed credit risk away from systemically important financial institutions.