Advanced Credit Risk Analysis and Management

25

2008 Credit Crisis

The growing importance of credit in the modern world and increasing debt in the economic systems in various countries highlights the need for robust credit risk analysis and management. As we discussed earlier, the banking and monetary system depends upon confidence. Billions of dollars are transferred in the inter-bank market every day as the banks and financial institutions adjust their liquidity requirements and positions. If there is any worry about the strength of financial intermediaries, it will cause enormous problems, resulting in risk averse behaviour and consequently a flight to quality. The collapse of confidence in the system is equivalent to a financial earthquake.

On 15 September 2008, the financial giant Lehman Brothers, which had existed for over 160 years, filed for bankruptcy and this resulted in a financial earthquake, the consequences of which reverberated across the world. Let us examine in detail how the 2008 US Credit Crisis unfolded, the contribution of US housing market and how it became a global credit crisis.

25.1 CREDIT ASSET – PRIME VS. SUB-PRIME

Prime credit means giving loans to creditworthy customers. As we have discussed in earlier chapters, banks and FIs commit considerable resources to study and identify creditworthy borrowers. A creditworthy customer is one with a sound financial position and good cash flows which ensures timely repayment of credit facilities. Sub-prime credit refers to the credit exposure to customers ...