LACK OF REGULATION OF THE BANKING SECTOR

Lack of regulation of the banking sector that led to the financial crisis of 2008-9?

Lack of Regulation of the Banking Sector That Led To the Financial Crisis of 2008-9?

Introduction

The heart and core of this paper is to critically analyze the lack of bank regulation and its role in financial crisis of 2008-09. Many regulatory principles were foremost suppliers to the crisis. To advance without analyzing past principles, especially in the localities of lodgings and bank capital guideline, would preclude discovering the courses of history.

The low interest rate coupled with rising housing prices made banks and similar financial institutions to make the most out of it. They started marketing and offering attractive products to lure investors and borrowers. They came out with enticing instruments such as adjustable rate mortgages which at the face of it looked very attractive to potential borrowers. Banks started lending more and more to borrowers as there was no end to it. The advent of mortgage backed securities or Collateralized Debt Obligations (CDOs) caused the banks to be complacent and careless in lending money to borrowers. The result of which was a dramatic increase in the amount of sub-prime mortgages. Sub-prime mortgages refer to those mortgages which are of inferior quality and which are made available to borrowers who do not possess sound credit history and/or repayment capability.

Mortgage backed securities are complex instruments whereby the risk of the lender is packaged and sold to investors globally. It primarily involves issue of securities by financial institutions whereby the loans or mortgages issued act as collaterals. Thus, there was very little concern for the banks to check the credibility and capability of the borrowers as they had more or less avoided the risk by transferring it to other investors. They were earning profits from high interest rates charged to these investors without taking the necessary risks. The mortgage backed securities, having high interest rates, were taken up by investors enthusiastically as they were labelled investment grade securities by credit rating agencies further emboldening the behaviour of the irresponsible bankers. The subprime loans were as much as 20 percent of the total mortgages in the US in the year 2006 (Arnold, 2007). Another important point about the subprime loans was that most of these loans had adjustable mortgage rates (AMRs) which had low teaser rates before the more expensive market based rates were applied (Economist, 2007). As long as the market interest rates remained low the loans were attractive for the borrowers.

The amount of debt taken by commercial and investment banks increased tremendously leading up to the financial crisis. A change in the legislation in the US allowed investment banks to take increased levels of debt so that they could invest in the lucrative mortgage backed securities (Labaton, 2008).

Many regulatory principles were foremost suppliers to the crisis

The spectacular functional alterations that took location in the economic commerce were not observed by the general public, and obtained little treatment even in the ...