Q.30 Write a short note on the sub-prime crisis and point out the lessons for India.

Ans. The sub-prime crisis is related to the US mortgage market which first surfaced in July 2007. Simply said, this is a financial crisis generating from the default of the borrowers. It means that it is like the non-performing assets (NPAs) crisis of banks in India. But the analyses of the situation and the mode of financing involved make it highly complex. Let us have a look on

the whole matter in the following steps:

Step 1: Borrowers with poor or less than standard (that is why ‘sub-prime’) credit records were encouraged (to borrow by some of the world’s leading banks and financial institutions).

Step 2: These ‘sub-prime loans’ were then sold to other investment banks by the original lending banks and institutions.

Step 3: The investment banks (who purchased the sub-prime loans from the original lenders) in turn converted them (the loan papers) into marketable, complex financial instruments to spread risks and manage liquidity (i.e., fund).

Step 4: When the sub-prime borrowers defaulted in their repayment of mortgaged loans, the financial crisis originated—today known as the ‘sub- prime crisis’ around the world.

Basically, in the name of financial innovation and cut-throat competition in the financial world, there is always a risk that banks start adopting/promoting highly risky, complex and questionable financial practices. Two long-term measures will help to prevent such crises to occur again:

(i) The financial instruments should be made transparent enough and easily communicated to the buyers, and

(ii) The buyers should have at least basic knowledge of how these instruments work and the risk involved.

We find some similar actions among the Indian banking industry, too—for example, the SBI offering the ‘teaser loans’ (a bit cheaper interest rate on home loans for the first 2 years) to attract customers. During this period, the some substandard borrowers too got loans (as per the Economic Survey 2008–09). But soon after the sub-prime crisis in the USA, the RBI got more vigilant to such banking norms. By March 2017, the banking regulatory norms have been tweaked by the RBI several times. Today, India’s banking industry being regulated by highly prudential norms and is getting compliant to the Basel III norms to in a time-bound way.