Can the current financial crisis affect you?
The financial turmoil happening in international markets seems to have no end. In the recent communiqué from the G7 meeting in Washington it was acknowledged that the global economy continues to face a difficult period and that near-term prospects have...
The financial turmoil happening in international markets seems to have no end. In the recent communiqué from the G7 meeting in Washington it was acknowledged that the global economy continues to face a difficult period and that near-term prospects have weakened. The International Monetary Fund estimated total losses and write-offs would reach some $1 trillion (€640 billion) with half the losses suffered by banks. However, as more financial problems are disclosed and woes revealed, the amount could be even higher as economic growth is stifled.
Many people think the present financial crisis has no effect on them. However, in today's globalised world where markets are easily accessible and highly inter-connected and financial products more sophisticated, the problems may be closer than one thinks. The Times Business spoke to analysts and financial operators to see what the situation is like.
Origins: The rising defaults
The prevailing credit crisis began in early 2007 with rising defaults in the US sub-prime mortgage market. Sub-prime lending is the practice of making loans to borrowers who would not normally qualify for the best market interest rates because of their deficient credit history.
It is unfortunate that these so-called sub-prime mortgages were securitised, pooled and sold to other financial institutions around the world. When the property bubble burst, the value of properties linked to sub-prime were substantially lower than the mortgages.
Problems were exacerbated when world renowned financial institutions did not immediately disclose the full impact of impaired asset backed securities they held. It was HSBC that first highlighted this problem early last year and took immediate action to curb the risk. While HSBC was criticised at the time for such a move, financial analysts are today commending HSBC for its actions. HSBC has maintained a focused strategy and has been rewarded for its efforts by being named as the world's most valuable banking brand in The Banker magazine and it has topped the Forbes list of world's largest companies, the first non-US company to do so.
Presently, the US is facing a recession with consumer spending slowing down and unemployment ticking up. Credit markets remain in distress despite interest rate cuts and the credit crunch is now moving to other areas of consumer finance. Two of the largest and world-renowned US financial institutions have just announced yet further write-downs due to eroding values of mortgage-backed securities and leveraged loan portfolios. Home equity loans have become a source of trouble for banks as housing prices continue to spiral lower. Hence, the possibility of the rest of the world being affected and entering a downturn cannot be disregarded.
More and more banks are having to set aside money for potential loan losses and being asked to boost their capital levels to restore confidence in the financial sector. It is a costly exercise for banks to increase their capital requirements as they will have to curtail their funds available for lending. This makes the situation of a slowing economy even worse.
Go for quality
In these challenging times, it is in the investor's interest to check and know where funds are being placed and how secure these are. Capital security is what should be sought and not promises of high returns. If a bank offers a much higher return than the market, then it is possible that it needs to raise capital quickly to fund current operations or riskier projects.
One should make a distinction between those financial organisations, such as HSBC, which in the main raise funding from deposits and employ them in assets (loans), as opposed to institutions that have an over-reliance on markets for monies and then place this in assets of other companies. The latter situation could easily lead to liquidity problems in times of crisis.
What is certain is that the credit crunch has led to a flight to quality. Waiting in queues to withdraw funds desperately from a hard hit financial institution or hoping that the depositor protection scheme is enough to secure your money is not a risk worth taking. Always ask questions and seek information about where your money is going.
It does pay to ensure that hard-earned cash is placed with a strong financial institution one can trust!
Many people think the present financial crisis has no effect on them. However, in today's globalised world where markets are easily accessible and highly inter-connected and financial products more sophisticated, the problems may be closer than one thinks. The Times Business spoke to analysts and financial operators to see what the situation is like.
Origins: The rising defaults
The prevailing credit crisis began in early 2007 with rising defaults in the US sub-prime mortgage market. Sub-prime lending is the practice of making loans to borrowers who would not normally qualify for the best market interest rates because of their deficient credit history.
It is unfortunate that these so-called sub-prime mortgages were securitised, pooled and sold to other financial institutions around the world. When the property bubble burst, the value of properties linked to sub-prime were substantially lower than the mortgages.
Problems were exacerbated when world renowned financial institutions did not immediately disclose the full impact of impaired asset backed securities they held. It was HSBC that first highlighted this problem early last year and took immediate action to curb the risk. While HSBC was criticised at the time for such a move, financial analysts are today commending HSBC for its actions. HSBC has maintained a focused strategy and has been rewarded for its efforts by being named as the world's most valuable banking brand in The Banker magazine and it has topped the Forbes list of world's largest companies, the first non-US company to do so.
Presently, the US is facing a recession with consumer spending slowing down and unemployment ticking up. Credit markets remain in distress despite interest rate cuts and the credit crunch is now moving to other areas of consumer finance. Two of the largest and world-renowned US financial institutions have just announced yet further write-downs due to eroding values of mortgage-backed securities and leveraged loan portfolios. Home equity loans have become a source of trouble for banks as housing prices continue to spiral lower. Hence, the possibility of the rest of the world being affected and entering a downturn cannot be disregarded.
More and more banks are having to set aside money for potential loan losses and being asked to boost their capital levels to restore confidence in the financial sector. It is a costly exercise for banks to increase their capital requirements as they will have to curtail their funds available for lending. This makes the situation of a slowing economy even worse.
Go for quality
In these challenging times, it is in the investor's interest to check and know where funds are being placed and how secure these are. Capital security is what should be sought and not promises of high returns. If a bank offers a much higher return than the market, then it is possible that it needs to raise capital quickly to fund current operations or riskier projects.
One should make a distinction between those financial organisations, such as HSBC, which in the main raise funding from deposits and employ them in assets (loans), as opposed to institutions that have an over-reliance on markets for monies and then place this in assets of other companies. The latter situation could easily lead to liquidity problems in times of crisis.
What is certain is that the credit crunch has led to a flight to quality. Waiting in queues to withdraw funds desperately from a hard hit financial institution or hoping that the depositor protection scheme is enough to secure your money is not a risk worth taking. Always ask questions and seek information about where your money is going.
It does pay to ensure that hard-earned cash is placed with a strong financial institution one can trust!