THE TRUTH OF INTERNATIONAL DEBACLE OF FINANCIAL MARKET
The recent fall of world largest
investment bankers including
Lehman Brothers, Goldman Sach,
Morgan Stanley and Merryil Lynch
followed by failure of a number of
largest American and European
Banks have brought the
international financial market to a
halt. American Insurance Group
(AIG), one of the largest insurance
company of United States of America had to be nationalized by
US Government. This is followed by insolvency of a Japan’s largest insurance company. The G-
7, Group of 7 largest economies of the world, at the highest
level have decided to nationalize a larger number of Banks in
American and European countries to arrest the loss of complete
confidence and also to address liquidity crises. The U.S.
President had to approach the senate and U.S. Congress to
grant relief of about 700 billion US$(Bailout Package) to the
ailing financial system.
The Indian financial market and capital market is witnessing worst period of negative sentiments. The stock markets are on a falling spree with sensex nearing 4 figures (a fall of about 50% since January 2008, whereas some of the blue chip shares loosing 70% to 90% in their market capitalization.
The truth of financial debacle started unfolding about a year ago when sub prime crises hit the U.S. market. The source of problem was indiscriminate lending by US Banks and financial services companies to Real Estate acquisitions and other sub-prime lending, with larger risk and of course decent returns
The credit risk of these high risk - high yield loans were hived off into “credit link notes” derivative instruments. The high risk derivatives were bundled with low risk derivatives and marketed and the credit risk were insured by companies like AIG to further improve the credit rating. The top notch credit rating companies provided investment grade credit rating to these derivative instruments. The top notch investment bankers, largest hedge funds and top bankers in the world invested in these credit risk linked derivatives to substantially improve their earning levels and increased bonus to operating top executives. The investment bankers and international banks were highly leveraged financially with lower capital adequacy than was needed. The sub prime borrowers started defaulting towards end of 2006 and beginning of 2007 resulting into sale of real estate by mortgage financiers. This fueled a substantial fall in real estate prices, the most common underlying security for these loans. The default in sub-prime loans rose aggressively towards the beginning of 2008, in spite of substantial reduction in US federal interest rates by more than 60% to about 2% per annum.
The problem got aggravated when the financial system stopped lending against mortgage-backed securities and banks were unwilling to sell them at a loss. The market price reduction of mortgage backed securities and credit linked derivatives is so substantial that not only liquidity but also solvency of all banks, hedge funds and investment bankers became a matter of serious concern. It is apprehended that this crises will take a further toll much deeper and harder and International Monetary Fund has predicted a world wide recession comparable to 1929 worlds worst recession. The banks are not willing to lend other banks and inter bank financial lending system has came to a halt with LIBOR and EURIBOR ruling at about 200 to 300 basis points over Federal Rates as compared to usual margin of 25 bps to 30 bps. The money is not even available at these rates.
Impact on India?
The Indian Stock Market is already witnessing a selling spree not only by FIIs but also by mutual funds and other domestic institutions and investors. The capital market may see another 20%- 30% fall from current levels. The mutual funds are witnessing indiscriminate withdrawal (redemptions) and Indian Mutual Funds are facing liquidity crisis besides a substantial fall in Net Asset Value (NAV) across the board. There is apprehension of failure of some of Indian private sector banks. RBI and Govt. Of India has announced that there is no such risk. The Indian banking system is also facing severe liquidity crunch with call rates and MIBORC (Mumbai Inter-bank offering rate) touching a high of about 18% to 20%. RBI has recently (during 6th – 11th October week) reduced cash reserve ratio by 1.5 per cent injecting Rs. 60,000 crores in the banking system to address liquidity crisis. In view of a very small exposure (about 450 million $) of Indian banking system to credit link notes and credit derivatives, the Indian banking system appears to be safe. The information technology companies, BPOs, KPOs and other IT enabled services companies are highly dependent on U.S. market and more particularly U.S. financial services corporates, banks and funds. The order book of these IT and IT enabled companies has already taken a substantial hit and top I.T. companies have not only retrenched software engineers on the bench but have also initiated cost reduction exercise including substantial cut in salaries and bonuses. The textile sector and other export dependent industries may also take a hit. However India’s dependence on U.S. and European markets is limited and may at best hit India’s GDP growth rate adversely. The Real Estate market may also witness a severe cut in market price. Indian economy is robust. It may however be very important for Indian Government, Reserve Bank of India, SEBI and other Indian Regulators to strategically move firmly and fast and take necessary corrective actions and regulatory measures.
The Indian financial market and capital market is witnessing worst period of negative sentiments. The stock markets are on a falling spree with sensex nearing 4 figures (a fall of about 50% since January 2008, whereas some of the blue chip shares loosing 70% to 90% in their market capitalization.
The truth of financial debacle started unfolding about a year ago when sub prime crises hit the U.S. market. The source of problem was indiscriminate lending by US Banks and financial services companies to Real Estate acquisitions and other sub-prime lending, with larger risk and of course decent returns
The credit risk of these high risk - high yield loans were hived off into “credit link notes” derivative instruments. The high risk derivatives were bundled with low risk derivatives and marketed and the credit risk were insured by companies like AIG to further improve the credit rating. The top notch credit rating companies provided investment grade credit rating to these derivative instruments. The top notch investment bankers, largest hedge funds and top bankers in the world invested in these credit risk linked derivatives to substantially improve their earning levels and increased bonus to operating top executives. The investment bankers and international banks were highly leveraged financially with lower capital adequacy than was needed. The sub prime borrowers started defaulting towards end of 2006 and beginning of 2007 resulting into sale of real estate by mortgage financiers. This fueled a substantial fall in real estate prices, the most common underlying security for these loans. The default in sub-prime loans rose aggressively towards the beginning of 2008, in spite of substantial reduction in US federal interest rates by more than 60% to about 2% per annum.
The problem got aggravated when the financial system stopped lending against mortgage-backed securities and banks were unwilling to sell them at a loss. The market price reduction of mortgage backed securities and credit linked derivatives is so substantial that not only liquidity but also solvency of all banks, hedge funds and investment bankers became a matter of serious concern. It is apprehended that this crises will take a further toll much deeper and harder and International Monetary Fund has predicted a world wide recession comparable to 1929 worlds worst recession. The banks are not willing to lend other banks and inter bank financial lending system has came to a halt with LIBOR and EURIBOR ruling at about 200 to 300 basis points over Federal Rates as compared to usual margin of 25 bps to 30 bps. The money is not even available at these rates.
Impact on India?
The Indian Stock Market is already witnessing a selling spree not only by FIIs but also by mutual funds and other domestic institutions and investors. The capital market may see another 20%- 30% fall from current levels. The mutual funds are witnessing indiscriminate withdrawal (redemptions) and Indian Mutual Funds are facing liquidity crisis besides a substantial fall in Net Asset Value (NAV) across the board. There is apprehension of failure of some of Indian private sector banks. RBI and Govt. Of India has announced that there is no such risk. The Indian banking system is also facing severe liquidity crunch with call rates and MIBORC (Mumbai Inter-bank offering rate) touching a high of about 18% to 20%. RBI has recently (during 6th – 11th October week) reduced cash reserve ratio by 1.5 per cent injecting Rs. 60,000 crores in the banking system to address liquidity crisis. In view of a very small exposure (about 450 million $) of Indian banking system to credit link notes and credit derivatives, the Indian banking system appears to be safe. The information technology companies, BPOs, KPOs and other IT enabled services companies are highly dependent on U.S. market and more particularly U.S. financial services corporates, banks and funds. The order book of these IT and IT enabled companies has already taken a substantial hit and top I.T. companies have not only retrenched software engineers on the bench but have also initiated cost reduction exercise including substantial cut in salaries and bonuses. The textile sector and other export dependent industries may also take a hit. However India’s dependence on U.S. and European markets is limited and may at best hit India’s GDP growth rate adversely. The Real Estate market may also witness a severe cut in market price. Indian economy is robust. It may however be very important for Indian Government, Reserve Bank of India, SEBI and other Indian Regulators to strategically move firmly and fast and take necessary corrective actions and regulatory measures.
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