Subprime was innovated on the back of de-regulation in US banking. In banking parlance, subprime customers are borrowers with less-than-preferred credit history. I’m convinced with the benefits of Subprime as it has resulted in productive gains and enabled economic activity.
Access to credit helps people to keep them afloat during bad times. On contrary, curtailing access to credit creates disparity and leads to economic divide. Developed nations have highest economic disparity despite having de-regulated banking sector. When India is trying to catch up with developed countries, we will also be exposed to rising economic divide. Will banking de-regulation and bringing in less-stricter lending criteria enable financial inclusion and address financial needs of larger section of the economy?
Financial regulation leads to better governance, protection of capital, reduces volatility and ultimately reduces risk of run on banks. However, we have to agree that this comes with risk of shrinking the economic development and creates greater diversity among people. Invariably, most of the banking regulations commissioned earlier have prevented lesser-privileged people from having access to capital.
Whenever there is a change in regulation the opinion on the new policies have been always divided. Currently, we are experiencing one of the greatest financial crisis, which is exerting huge pressure on the economy. Different parties are putting together various solutions such as $700bn bail-out package. Globally, market pundits are advocating against subprime lending but doing so is nothing but judicially approved financial discrimination.
Subprime is not bad and should not be looked with contempt. Subprime hasn’t created all the havoc, some blame is due to the financial astrologers and fragile financial markets backing these loans. So, the solution lies in developing efficient financial market to support subprime loans. Further, it calls for optimal methods to regulate the subprime market rather than constraining them.
October 6, 2008 at 11:33 am
Writing from mumbai.. the decaying financial capital of india..
Well said prasada..
Subprime by itself is not bad, if the risk is assumed by the FI and appropriate measures taken to assess and guard against it. The problem arises when the subprime loan with a different risk level is combined with a less risky loan and sold to an investor who doesnt know about the subprime risk in the portfolio he is buying. To the investor it is a AAA rated security. This is where credit rating agencies are to blame, having failed to rate the instrument accurately. What action is being taken against these rating agencies?
Many FIs in India do subprime lending, most notably a former stockbroking firm, charging crazy rates for the risk they take (sometimes in excess of 20%). This same firm also securitizes their loans to big lenders like ICICI and HDFC. However, the process is fundamentally different, with the big FI’s being allowed to cherry pick from the portfolio what kind of risk and assets they are comfortable with. While this is not practical in a huge mortgage market like the States, there should have been a process in place to rate the whole instrument accurately, because the whole is larger than the parts..
It is also rumored that this ex-stockbroking firm has underworld connections, thus assuring repayment on bad loans. This is unique to Indian market and may be the reason why we wont have a subprime crisis!
October 6, 2008 at 1:53 pm
Subprime as a word has been shown in a negative light; infact CK Prahalad when he talks about the “Fortune at the bottom of the pyramid” is infact talking about these evry people. Also Mohamad Younus who got a noble prize recently pioneered the concept of lending to the so called Sub prime category.
It is not the poor subprime borrowers who are solely responsible for this mess; much of the blame should be shouldered by the giants of wall stret who fuelled by greed and ROI sliced and diced the loans and created derivatives out of them
Personally this article seems to be the best among the ones you have written so far….. I think you should ask Swamiji to write about philosophy and finance…..Does the world know that you were the CFO of his now defunct company
October 6, 2008 at 5:22 pm
It looks like Free markets / Capitalism is not a perfect economic model. Capitalism has its advantages and disadvantages and so does Socialism. Something in between.. a mixed economy with tight and effective regulation will help ensure that there is growth within mutually accepted limits.
We’ve again revisted what Gordon Gekko has said “Greed is Good”! and what we are seeing is the outcome of that statement.
The villain in this entire mess is the Federal Reserve. Its lackadaisical attitude and inept regulation is a major cause of this mess. If it had done its bit in imposing regulations slowly and steadily.. perhaps.. we might have seen a reduced impact of this crisis. To me, it looks like the Fed has adopted a “It aint broke.. so dont fix it”!
Why is the Fed not strictly forcing US banks to implement Basel 2 norms like the RBI has on Indian banks and foreign banks operating in India?
Why has RBI been effective in regulation is becoz they’ve been blessed with Governors who have been Administrators (S. Venkitaraman; Bimal Jalan, Y.V Reddy) whereas Bernanke is an Academic. (A contentious point but I’m willing to takeup the challenge to prove me wrong)
Though the RBI has been accused of micro management of banks… RBI needs to be commended for handling this situation very well.. they’ve stepped in the moment they’ve received bad news and quelled rumours and forced banks to embrace transparency, enforce adequate risk management through increasing risk weightages for exposures to real estate so as to prevent an asset bubble and good governance.
The winners in this financial crisis is the credit rating companies and financial analysts of Investment Management companies. They have got away with blood through successful lobbying with Joker of 21st Century – George Bush and Runner Up – Hank Paulson!
While Pauslon should be trying to make lives of American people better, he is busy kissing the voluptuous ass of Wall Street.
As Scudie pointed out, the issue is poor assessment of risk and inability of American banks to price and implement efficient risk management systems for the various loans issued.
Why should CEO’s of companies alone be prosecuted for this mess? I’m of the opinion that these financial analysts who give recommendations should also be hauled to the courts for influencing investors into buying worthless bonds.
When the US Senate could come out and close Arthur Anderson for its role in Enron and implement a SOX, it’s time for the US Senate to break-up the power of these credit rating companies and implement a more effective and transparent law which can disclose: -
A) The remuneration earned by the rating company for the financial instrument
B) The mode and method of arriving at the credit rating.
The second point can be disputed and can cause a brouhaha by the rating agency.. as this will reveal their “copyrighted method of rating” so, the solution I can think of is… any potential investor would need to enter into a confidential agreement with the rating agency for arriving at the rating.
The financial markets in the US is in shambles because the foundations are weak and there is no political will to strengthen the same.
October 6, 2008 at 5:46 pm
Venkatesh,
I head the financial operations of a fund management company which manages India’s largest Microfinance focused PE fund – Bellwether Microfinance Fund.
There is a difference between sub-prime lending and microfinance. And lets get the fact straight… about what Prahalad and Mohd Younus have been trying to state.
Prahalad has been talking about the Bottom of Pyramid which is the section of people who are not part of main stream business. Microfinance is basically lending to people who dont have access to organized form of credit.
Sub-prime is basically that section of people who are not “prime” according to their FICO (Fair Issac Credit Score) Sub-prime borrowers are borrowers who have a score of less than 600 on a scale of 800. Prime Borrowers have a score upwards of 700 and above.
Sub-prime indicates borrowers whose credit is of question.. this could be for a variety of reasons – delinquency in cards / loans, inadequate credit balances in bank accounts, debt servicing ratio more than 65-70% of net income, living in a place remotely accessible to collection agencies etc..
You can also become a sub-prime borrower if you do any or all of the above! But, you’ll never be a microfinance customer. Most MFI customer’s dont have a bank A/c!
Regds
Lakshmikant
October 6, 2008 at 6:22 pm
Thanks for the clarity….U needn’t have cited ur credentials for me to see the light of your statements
….I work for the same company you used to work for earlier (CTS) ….anyway thanks a ton for clearing a wrong notion
October 16, 2008 at 9:46 pm
regulation is always backward looking. it never prevents crisis. Effective regulation is necessary to avoid speculation. subprime is not bad but it should be targeted at teh right segment. Option arm originated for sections like wall street people who have high variable pay so that they can pay off their loans when they get the bonus . it has designed for people who get huge lumpsum payment and not for tom , dick and harry. Please read the article written by Swaminathan (ET) on effect of extending inclusive loans. it should be useful.
regds
Uppili
October 16, 2008 at 9:49 pm
sub prime is good………………..agreed………but catering to the sub prime consumers’ speculative needs is not good……………i guess that is one of the causes of the present crisis.
btw lakshmikant…………….u are writing a blog within a blog da!!!!!!!!!