Banking Crisis Essay Example | Topics and Well Written Essays - 5000 words

Banking Crisis - Essay Example The crisis is thus perceived to have occurred as the result of exposure to Market Risks due to such risk transfer mechanisms (Banks normally are never exposed to market risks because they reply on internal systems in managing the credits) that caused many loopholes in the Credit Risk Management in management of lending to Sub-Prime customers. These customers are individuals or companies who do not have clean credit history or regular source of income. The Banks & Financial Institutions preferred to lend loans to Sub-Prime customers to avail the benefits of higher interest rates at a perceived calculated exposure of the investment capital to higher risks. To facilitate this in a secured and manageable manner, the banks & financial institutions used the mechanism of "Securitization" that essentially is the mechanism of distributing the risk of the lending to the investors outside the Banking system through a process. The process of "Securitization" resulted in the boom of Credit Deriva tive Market and was used extensively in the US Sub-Prime Mortgage Market by increasing the number of risky products but still reduce the liabilities on their balance sheets (thus shielding the same from external auditors). The money was shown to be flowing through so called "conduits" from investors to the borrowers through the SPV and SIV system. As described by experts the primary drawbacks that occurred in this process are poor valuations of assets acquired against the credit instruments thus resulting in uncertain asset valuation & high credit risk exposure that couldn't detect the imperfections in the Credit Markets. Even the external rating agencies got trapped in this mirage and couldn't predict the Sub-Prime crisis because the Securitization Process was extremely complex and the dependency was upon scattered and unreliable data outside the core banking system. Moreover, the Bank's risk assessment didn't demonstrate due diligence in screening the sub-prime borrowers and infor ming the investors about the associated risks in the so called securitized products. The overall system expanded uncontrollably and the competition became very stringent resulting in loans getting sanctioned at the flash of light and there was no time for adequate risk management. The actual risks ware completely covered under hyped data and analytics about the new credit instruments which, frankly no one understood correctly - not even the external auditors and the statutory & governance