Skip to main content

Sub-Prime and implications on the financial world- a small understanding of mine.....

These days the talk of the town……. oops talk of the whole globe is failure of several banks in US.
 
But I would say it is not the failure of the financial institutions but due the business model they were having.
 
But before getting to know what the model is, its better to know a few terms which is being on air for a while…….. (or at least the way I have understood thoseJJJJ)
 
1. Sub prime lending:
That is nothing but lending to some one whom u know so well that he/she will have problems in repaying the loan.
Sub-prime works in a very simple way:
1. Give a loan to some one who doesn’t have a credit rating worth a loan.
2. The loan period will be usually for a very long period. Say 30 yrs.
3. The person taking the loan will be taking the loan under the impression that after some time he will be able to make some money and settle the loan.
4. The lending terms usually will be like interest fixed for first 2 yrs. (for selling the loan to the poor borrower)
5. After the fixed rate period the lender starts charging at the premium rate from the borrower.
6. When the borrower turns bad most of the lenders sell the receivables to some financial institutions at a discount.
7. The financial institutions finance these sub prime receivable from the deposits accepted at a lower rate and purchasing the receivables of the sub prime lenders.
8. The money of the Banks, Hedge Funds, Insurance companies and Pension funds is invested in the financial institutions.
9. Thus the money deposited with a financial institution at notion that it is of low risk is indirectly finding a way into highly risky Sub prime market.
 
» Subprime lending, also called "B-Paper", "near-prime" or "second chance" lending, is a general term that refers to the practice of making loans to borrowers who do not qualify for market interest rates because of their patchy credit history or poor income records
» Subprime lending encompasses a variety of credit instruments, including subprime mortgages, subprime car loans, and subprime credit cards, among others.
» There is nothing called as Savings Bank Account in USA. They live in a world where plastic money takes care of things (credit cards).
 
2. Rating Agencies:
» These agencies are nothing but a agency similar to our ISI (ISI - Bureau of Indian Standards) who rate to a financial instrument.
» These agencies are supposed to be independent from the financial institutions and Banks.
» But being the investment banks like Goldman Sachs having business in Equity research they have their own ratings.
» Thus the game begins, the corporate houses bargain for a good rating for merchant banking and other businesses with the Investment banks.
» Forget not Lehman Brothers paid 1.2 billion in fine


Comments

Popular posts from this blog

GST; What Changes would make it work

After several red flags in the way the GSTN functions, finally the Officials from the finance ministry have indicated that indeed these issues are being reviewed at the highest level. As a Chartered Accountant with my experience from Fortune 500 company wherein the end users were all highly qualified people, the systems need to be simple. In case of GSTN, the system was pretty simple in paper. However when we got to use it, the complications came out. The system is highly illogical or rather not tweaked to match the practical requirements of the stakeholders. Be it the registration or the backend access to the tax department officials. Changes that would make the system workable. 1. No Matching of Invoices. Currently the buyer and the seller has to match the sales and purchases. Though a very simple process it is highly resource consuming. Just imagine a single paise difference in invoice will lead to manually matching the invoice with at least 2-3 minutes of time being sp...

History of Income Tax in India

When we look at the Income tax history in India, we realise how progressive we were long back even before the british. There are references found in the works of Manu Smirthi and Arthasastra apart from our own Thirukural. As we stand today we have an Act of 1961 which has in origins from 1860. To have a better perspective we need to know about a British Statesman by name, Henry Addington, 1st Viscount Sidmouth who was the Prime Minister from 1801 to 1804. The tax was initially levied on Land which was used for agriculture and the collection was in kind. Income tax was thought to be a government instruction into the private matters. To overcome this in 1707, when the Kingdom of Great Britain came into being, a Window tax, wherein the tax was collected basis the number of Windows a property had was introduced.                             ...