ISB Professors Discuss the Financial Crisis

Oct. 21, 2008 - PRLog -- Choppy stock markets, liquidity crisis, credit squeeze, escalating interest rates, inflation hovering at a 12 percent, the global downturn has indeed left all of us asking for answers and  assurances.  



In such a backdrop, the ISB community recently organised a forum to analyse the genesis of the global financial crisis, to derive lessons that can help avoid or at least reduce the possibility of such circumstances in the future, and also to discuss its implications for India, and finally take lessons for the way forward.



A student-driven initiative organised by the Finance Club from the Class of 2009, the discussion had on its panel Visiting Associate Professor Sumit Agarwal from the Federal Reserve Bank of Chicago, Rajesh Chakrabarti, Assistant Professor of Finance, ISB, who researches the Indian financial sector, and Ramabhadran Thirumalai, Assistant Professor of Finance, who is also the resident expert on derivative instruments.



Professor Agarwal began the session by explaining the benefits of securitisation, and how it went from good to bad to ugly. “The number and share of sub prime mortgages increased rapidly over the last few years. Whether factors like rising house prices, excess liquidity, increased securitisation and lax underwriting standards led to increase in sub prime mortgages, or the increase in sub prime mortgages led to these factors occurring, is a chicken and egg kind of situation, and open to debate,” he said. He went on to explain how ‘Mortgage Backed Securities’ are structured by slicing and dicing mortgages, and how they are packaged and resold to institutions across the financial system. Professor Agarwal pointed out that because of the complex structures of these instruments; the instrument holder had no clue about what underlying asset the instrument represented. “As long as the housing prices remained high, there were no problems. But when the house prices in the US fell and the sub prime borrowers were unable to repay the mortgages, it led to a cascading of delinquencies in the system,” he explained.



Professor Rajesh Chakrabarti started by discussing what does the financial crisis entails for India. “The news is not that bad for India. Being conservative over the years has helped Indian banks to be in better shape than its foreign counterparts,” he noted. Professor Chakrabarti further explained that even 10 years ago, when the Asian financial crisis hit the economy, India was spared from the worst effects as it had limited exposure to the global economy. Indian regulations have resulted in a somewhat insulated Indian economy. However, he noted, that it doesn’t mean that India will not be affected by the current economic downturn. It is in someway connected to the global economy.



Professor Chakrabarti then went on to discuss the Indian banking system. He informed that in India there is very limited exposure to sub-prime. Few banks have some exposure to CDOs though their international units. Many Indian banks held securities linked to Lehman. Amongst Indian banks, 14 banks had exposure to Lehman or its subsidiaries.  Further, Indian banks have a capital adequacy ratio of 13% as against the norm of 8-9% in global banks, and thus Indian banks are stable and strong.



“The current global crisis will hit the financial service sectors the most since it is more connected to the world’s sentiments. Firms that deal in brokerage or trading are the ones likely to be hit the most,” Professor Chakrabarti said. He added that although the falling oil prices are a respite, the rupee depreciation is making the scenario worse. “At the same time, there has been no major macro effect that suggests that Indian economy is doing badly. India has a strong domestic market and is not as market driven as other economies in Asia,” he added.   Professor Chakrabarti suggested that inflation is expected to come down with falling oil prices. Although falling rupee is a concern. “All this suggests that we are not completely insulated and there is a degree of vulnerability,” he concluded.



Professor Thirumalai elaborated on the complex derivatives structures that were involved, which ended up compounding the crisis. Another important aspect was the fact that these derivative exposures were so complex that most institutions did not even realise the true extent of their exposures and this was the reason why remedial action was difficult to implement. Also, the extreme complexity left institutions at a loss on how to fair value these exposures, especially in volatile markets. “At best, the pricing was done on the basis of some remote possibilities of severe defaults, and this was considered remote and hence valuations did not reflect realities, to say the least,” he said.



The panel also discussed extensively on the bailout package. The opinion of the panel was that the bailout package was necessary and in its expanded form more relevant – it is better for the US government to actually acquire stakes in these institutions rather than just buy bad or toxic loans.



The panel agreed that India is well positioned to weather the global storm because institutions are now more risk aware and risk focussed, and both regulators and governments fully realise the extent of the problem and are working towards tackling it. Finally vested interests will ensure global stability and security to prevent extremist elements from taking advantage of turmoil



The Finance Club at the ISB comprises finance and accounting professionals and also those who aspire for a career in the field of finance. The Club organises several such knowledge sharing forums and both formal and informal interactions with eminent business leaders from the finance domain.

About the ISB

The Indian School of Business is a premier management institution established in 2001. In a short span of seven years, the ISB has successfully pioneered several new trends in management education in India and has established itself as a leading B-school across the world. In both its Post Graduate Programme in Management and Executive Education Programmes, the ISB invites high calibre international faculty from reputed B-schools to teach and participate in collaborative research with the strong pool of research oriented, resident faculty. The ISB has academic associations with the Kellogg School of Management, The Wharton School, and the London Business School.

Contact:
Ms. Bhuvana Ramalingam
Senior Director – Communications
Indian School of Business
Tel. : 91 - 9394568016
email : bhuvana_r@isb.edu
         
http://www.isb.edu

# # #

The Indian School of Business is a premier B-school established in 200l, with academic associations with the Kellogg School of Management, The Wharton School, and the London Business School.