ANATOMY OF GLOBAL

CREDIT CRISIS

Team Members:

Chandan Gundala Ramana Reddy

Shair Mohamed Khan Afridi
Midhat Zahra
 WHAT IS CREDIT CRUNCH?

A credit crunch is a sudden reduction

in the general availability of loans (or
credit), or a sudden increase in the cost
of obtaining loans from banks.
 REASONS FOR CREDIT CRUNCH
 Due to decline in value of the collateral used
by the banks when issuing loans, or even an
increased perception of risk regarding the
solvency of other banks within the banking
system.
 Due to a change in monetary conditions (for
example, where the central bank suddenly
and unexpectedly raises interest rates or
reserve requirements).
 Due to the central government imposing
direct credit controls.
EFFECT OF CREDIT CRISIS ON
INDIA
 The bull run in India was backed by excess FII
liquidity. Considering the worsening situation in
US/Europe, this liquidity will dry up.

 Indian banks with exposure to US/Europe markets

with derivative positions will be forced to book MTM
losses. ICICI Bank is one such example. It will
definitely impact them.
 FDI will slow down. India is dependent on FDI to
grow faster.

 The falling out of global majors affect Indian IT and

ITES industry as definitely 40-50 per cent of India's
revenues for IT sector comes in from Foreign sector
and Banking and eventually it will trigger slow down
of Indian economy too.
 Due to the worsening situation in the West, FIIs are
selling across the world to balance their positions and
pay for redemptions. India doesn’t want to allow
money to move out. Depreciating the rupee would
give lesser dollars as and when they want to exit.
QUESTIONS THAT NEED TO BE
ADDRESSED
But don’t investment banks play advisory
role?

 They do, but slowly over the years, their prop

books have multiplied.
 Investment banks also organize big loans for
their clients for funding acquisitions.
 At times, investment banks take positions,
only to palm off the securities to other clients
and banks.
 In a crisis, they may not get the opportunity
to down-sell such positions. This adds to the
panic.
 Can’t central banks step in to stem the crisis?

 It’s precisely to discourage banks and bond

houses from selling securities to generate
liquidity, Fed has relaxed the rules under
which it lends to institutions against
securities.
 Moreover, if there’s a financial chaos of this
magnitude, banks refrain from lending each
other, fearing that the money would get stuck.
 A liquidity window from the central bank thus
comes handy.
 How does the domino effect play out?

 Suppose Lehman faces a redemption and

has to repay another bank it has borrowed
from. If it sells the mortgage-backed bonds,
whose prices have fallen, it will not raise as
much as was earlier expected.
 So, it sells some of the other good assets or
bonds which may have nothing to do with
mortgages. But since the bank starts
dumping these assets, prices of these bonds
also dip.
How does it impact the balance-sheet?
 Herein lies the strange accounting of bonds and
derivatives like mortgage-backed securities.
 All banks are required to mark-to-market (MTM) their
investments. So, if the price of an instrument falls, the
difference between the price at which it was bought
and the current market price has to be provided —
meaning, it has to be deducted from the earnings.
 So, a drop in price leads to the MTM loss. But there’s
a bigger problem which really has deepened the
crisis.
 An MTM loss can be provided only if there’s a
‘market’. How do you provide when there is no
market?
 LEHMAN BROTHERS
 America's fourth-largest investment bank Lehman
Brothers Holdings Inc filed the biggest bankruptcy
petition known to mankind.
 Lehman Bros, which till June 2008 had not reported a
quarterly loss even once.
 The collapse of the giant investment bank came as a
major shock for the entire world markets that plunged
after Lehman filed a Chapter 11 petition with US
Bankruptcy Court in Manhattan.
Why did Lehman Brothers go bankrupt?
 The giant investment bank succumbed to the sub-
prime mortgage crisis that has rocked the United
States and the global economy. Lehman was
strangled by a massive credit crisis and fast
plummeting real estate prices.

 The gargantuan $60 billion loss in bad real estate

loans forced the bank to file for bankruptcy.

 Refusal of other banks to do business with it because

of its complex and, at times, opaque ways of trading.
 Housing loans made by the bank to people with little
support made these loans very risky, and when
interest rates rose, these borrowers could no more
repay Lehman. Thus other banks stopped trading
with Lehman. This led to it losing almost all business
and triggered its fall.

 The final straw for Lehman was the fact that both
Barclays Plc of the United Kingdom and Bank of
America Corp pulled out of takeover talks.
 CONCLUSIONS
 The ongoing financial sector crisis in the United
States and its repercussions on developed markets
worldwide will result in lower capital inflows into
emerging markets like India, economists and
government officials.
 IT firms to sign any significant contracts in the
banking, financial services and insurance (BFSI)
space in the months to come.
 Huge layoffs in IT and ITES sector both in USA and
INDIA.