The objective of doing this project was to understand the evolution and causes of U.S.subprime crisis and the repercussions on Indian financial sector specifically Indian banks how much loss they have booked and how in the near future they should gear themselves up so that some thing similar doesn’t happen in India.
Understanding and analyzing the U.S.subprime crisis and repercussions on Indian banking and financial sector.
Type of research
Qualitative in nature
World bank reports
An introduction to U.S.subprime crisis
What is US sub-prime market?
In short, sub-prime (lending market) refers to the home loan market catering to the persons whose credit rating is low due to which they will not get a regular loan at prime lending rate as announced by US Federal Bank. The sub-prime rates are much higher than prime lending rates. Presently for a 30-year loan, prime-lending rate is in the range of 4 to 51/2 percent and sub-prime interest rates are higher by 200 to 300 basis points over the prime-lending rate as the risk is more for the borrower. The lower the credit score and the smaller the down payment, the higher are the interest rates. However, the entire structure of rates and fees is higher at sub-prime lenders to cover the greater risk and higher costs of sub-prime lending. By its nature, a higher percentage of sub-primes than of prime loans go into default. Sub-prime lending costs are also higher because more applications are rejected and marketing costs are higher. A sub-prime lender is one who lends to borrowers who do not qualify for loans from mainstream lenders. The interest rate they charge are are uniformly higher than those quoted by mainstream lenders. A sub prime borrower is one who cannot qualify for prime financing terms but can qualify for sub prime financing terms. The failure to qualify for prime financing is due primarily to low credit scores. In US, every borrower is given credit rating depending on his income levels, past payment history etc. A very low score will disqualify for a softer loan. Some other factors can also influence the decision of the financier, including purpose of loan and property type.
The development of the sub-prime market has made mortgages (and home ownership) available to a segment of the population that otherwise would have been shut out of the market. That’s the good news.
Why sub-prime market is in the news?
In US housing prices have been moving up from the year 2000 onwards till the end of 2005. American housing prices have not seen a similar pace of growth since 1979. During this period, all the borrowers went aggressively into the sub-prime lending market. But, during this period, the US Federal Bank either raised or kept constant the interest rates and most of sub-prime lending is based on floating interest rate mechanism. With the raising interest rates, the repayment amount by the sub-prime lenders has gone up. Coupled with this is the slump in home prices from the end of 2005 to the end of 2006, which was the biggest year over year drop. The banks and mortgage lenders are scrambling for creative ways to keep people in their homes but the sub prime market is already teetering and foreclosures are on the rise. With the rising interest burden, sub prime lenders have lately suffered widespread mortgage defaults in the United States, sparking fears the trend will dampen consumer spending and overall US growth. It is estimated that there are a potential $100bn (£50bn) worth of sub-prime mortgage defaults, from less than credit-worthy borrowers, mainly in the US.
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