4. Global Financial Crisis -Timeline of Crisis 2007/08âŚ.
The recent financial crisis is categorized as the worst since the Great Depression. Some of
the major events related to the crisis are mapped to the Dow Jones Industrial Average
4
5. The turmoil was not merely another
turn of the business cycle but a
restructuring of the economic order.
5
6. Causes: US Housing Market Collapse
Many expertsbelievethat theglobal crisiswastriggeredbytheUS housingmarket collapse
Easyaccessto credit: Falling interest rates and rising availability of mortgages, combined with rising
housing prices encouraged consumersto buy homes
Relaxed lending standards: To cater to the growing number of mortgage seekers, lenders relaxed
standards and issuedalarge number of sub-primeloans
Inadequate regulations: Regulations did not keep pace with innovations in US financial
products,leading to much higher complexity, poor transparency and greater risk
Complex credit derivatives: The invention and use of complex debt derivatives such as CDOs1
madeit difficult to identify and contain the sub-prime lending problem, oncedefault ratesbegan to
Rise
Market collapse: The property boom led an over-supply of housing and prices could no longer be
supported. Just like the self-perpetuating behaviour that led to the rise, the crash was also self-
perpetuating. As pricesfell, more foreclosuresstarted taking place, increasing the supply of homeson the
market. Lenders started to tighten their standards and fewer consumers could qualify for mortgages and
help reducethe supply
6
8. Historically low global interest rates after the bursting of the dot-
com bubble sparked greater global liquidityâŚ
0
1977 87
Sources: Federal Reserve System; ECB statistics
5
10
15
20
FF
ECB
Japan
97 00 07
Global interest rates %
Global rates hit
historic lows in
aftermath of dot-com
bubble burst
03
Fed and ECB
monetary easing
created greater
liquidity and
helped global
rebound after the
tech-bubble burst
8
9. A vicious cycle completed to drive further illiquidity
Risk aversion
of investors
Falling
asset
prices
Announce-
ment
of losses
Banks reduce
funding to
other banks
Banks pay
inflated price for
liquidity
Investors
avoid lending
to banks
Banks/
hedge
funds
need to
liquidate
positions
Rising losses in
subprime market
9
10. Genesis of a Crisis
Scant Regulatory
Oversight
Originate-and-
Distribute Model
Deterioration of
Underwriting
Standards
Mortgage
Securitization
Mispricing of
Risk
Credit
Default
Swaps
Excess
Global
Liquidity
CrisisExcessive
Financial
Leverage
Low
Interest
Rates
Driveto Increase
Investment Returns
Rising Real
EstatePrices
10
11. Regulatory Balkanization â Failure of Oversight
Officeof
Thrift
Supervision
Federal
Deposit
Insurance
Corporation
Individual
States
Department
of Labor
Officeof the
Comptroller of
theCurrency
Federal
Reserve
National Credit
Union
Administration
Securitiesand Exchange
Commission
Commodity Futures
Trading Commission
Commercial
Banks
Thrifts
Insurance
Companies
Securities
and
Exchanges
Futures
Credit
Unions
Industrial
Loan
Companies
Bank
Holding
Companies
11
12. Global Financial Crisis
ď Proximatecauses
ď Sub-prime lending
ď Originate and distribute model
ď Financial engineering, derivatives
ď Credit rating agencies
ď Lax regulation
ď Largeglobal imbalances
ď Fundamental cause
ď Excessively accommodative
monetary policy in the USand
other advancedeconomies(2002-
04)
10
8
6
4
2
0
12
Jan-90
Dec-90
Nov-91
Oct-92
Sep-93
Aug-94
Jul-95
Jun-96
May-97
Apr-98
Mar-99
Feb-00
Jan-01
Dec-01
Nov-02
Oct-03
Sep-04
Aug-05
Jul-06
Jun-07
May-08
Percent
Effective Federal Fund Rate in the US
US Monetary policy too loose during 2002-04; aggregate
demand exceeded output; large current a/c deficit;
mirrored in large surpluses in China and elsewhere.
13. ⢠Lowinterest rates
⢠Excessivefinancial leverage
⢠Complexity of financial products
⢠Lack of effective risk managementat largeinstitutions
⢠Inadequateappreciation/regulation of derivatives risk
⢠Conflicts of interest at rating agencies
⢠Mark-to-market accounting
⢠Lackof accessto liquidity
⢠Poor corporate governancepractices
How Did We Get in the crisis?
13
14. Differences Between Financial Crisis in US/Europe and India
What hasnot happenedhere
ď§ No subprime
ď§ No toxic derivatives
ď§ No bank lossesthreatening capital
ď§ No bank credit crunch
ď§ No mistrust between banks
Our Problems
ď§ Reduction in capital flows
⢠Pressure on BoP
⢠Stock markets
⢠Monetary and liquidity impact
⢠Temporary impact on MFs/NBFCs(Sept-Oct)
⢠Reduction in flow from non-banks
⢠Perceptionsof credit crunch
14
15. But do we really understand the real reason for crisis ?
The conventional wisdom used to be that the basic cause of the crisis was bad incentives in the mortgage
industry , while itâs tempting to blame what happened on just a few greedy bankers who took
irrational risks
But isthat the real reason....
The largeglobal impact of the crisissuggeststhat the problems with subprimemortgageswere asymptom
rather than the cause
The main causesare:
-Flawed global financial order in which the incentives to take on risk are incrediblyout
of step with thedangersthoseriskspose.
-System where growing inequality and thin social safety net createstremendous political
pressure to encourage easy credit and keep job creation robust, no matter what the
consequencesto theeconomyâslong-term health
-Unequal access to education and health care in the united states and other countries
(includingIndia) puts everyone in deeper financial peril.
15
17. Global banking trends after the crisis
The near-term prospects for US and European banks are decidedly grim. The
global financial crisis will bring about the most significant changes to their operating framework banks have seen in
decades. There will be fundamental re-regulation of the industry, ownership structures are shifting towards heavier state
involvement and investor scrutiny is rising strongly. Equity ratios will be substantially higher. As a result, growth and
profitabilityof thebanking sector asawhole arelikely to decline.
Lean years lie ahead for US banks. Performanceimprovementsduring thelast 15 yearshaveoften been
due to strong lending growth and low credit losses. As private households reduce their indebtedness, revenue growth in
some European countries but especially the US may remain depressed for several years. With weak loan growth and a
return of higher loan losses as well as a fundamentally diminished importance of trading income and modern capital
market activitiessuchassecuritisation,banksmaybelacking major growth drivers.
Consolidation to continue but with a different focus. Whiletherewill still be aconsiderable
number of deals, transaction volumes are likely to decline and restructuring stories rather than strategic M&A may
dominate.Theprobability of domesticdealshasincreased,while that of cross-bordermergershasdeclined.
Internationalisation of banks likely to slow. Uncertainty about the future prospects especially of
foreign markets and strictly national banking sector stabilisation programmes are triggering a re-orientation towards
domestic markets. This is more relevant for European banks that have greatly expanded into other European countries
recently, whileAmericanbanksoverall maycontinueto target thenational market ratherthangoing abroad.
17
18. expanding price-to-earnings multiples during the long
economic expansion.
Over the past decade, PE rode a credit bubble
inflated by low interest rates to record deal values.
That boom, of course, came to an abrupt end with the
mortgage-led debt crisis that froze credit markets in
2008 and triggered a global recession affecting nearly
every industry.
Private Equity is a cyclical business
Global Private Equity
From private equityâs heyday a few years ago when deal makers were riding high, to the gut-
wrenching drop in deal making through last yearâs recession, this industry knows what itâs like to
ride the roller coaster. Private equity has always been a cyclical industry, and signs of a nascent
rebound in 2010 underscore that fact.
Since it emerged as a major asset class in the 1980s, PE has experienced three major booms.
In the 1980s, the PE industry capitalised on the sale of many poorly run public companies and
corporate divestitures available at low cost and largely financed with junk bonds.
During the 1990s, debt financing
prominent role. PE industry returns
mainly by gross domestic product
played a less
were driven
growth and
18
19. ďIndiaâs economy has experienced a robust and broad-
based recovery from last yearâs financial slowdown
ďFund-raising has been on the rise
again, particularly, from the domestic fund houses.
ďWhile the core infrastructure sector and the
telecommunications sector continued to attract PE
investment, we are experiencing the revival of the real
estate sector. Other sectors like consumer products and
retail, financial services and technology are also showing
signsof improved deal activity.
ďThere were 11 PE-backed IPOs thus far in 2010 â
compared to seven total in 2009 â as the companies
leveraged the rising stock market to raisecapital.
ďMore PE-backed IPOs in the comingmonthsif the stock
market remainsfavourable.
ďLookingahead, valuations are an expected
concern, accentuated by the fact that stock markets
continue to soar.
Top deals see global funds
participate; emerging
consumer-driven sectors
Private Equity - India
19
20. â˘Private equityâs âgolden ageâ of low interest rates, abundant leverage, mega-deal making and effortless
returns is over, and will not soon return. Global PE investments sank to a level not seen since the last
downturn. All regions and industry sectors suffered.
â˘The dynamics underlying the decline differed by region. In North America and Europe, economic
uncertainty and frosty debt conditions constrained deal making. In emerging markets, the massive
dislocation of value brought about by declining economic growth and tumbling equity markets led to a
mismatch of buyer and seller expectations. In both regions, the rapid rebound of equity markets did not
give valuation anddeal multiples achanceto reset.
â˘PE firms readjusted their investment focus to the opportunities 2009 presented, favoring carve-
outs, growth equity, acquisition finance, balance-sheet restructuringsand distressed debt investments.
â˘Fund-raising declined across all major PE asset classes and was weak in every region. Despite their
continued commitment to PE, the âdenominator effectâ and the paucity of PE distributions squeezed LPsâ
liquidity and impaired their ability to commit to new funds.
â˘The downturn forced significant markdowns in portfolio valuations, causing short-term PE returns to
declineby double digits; recent vintageswere hit hardest.
â˘Leading PE firms that laid the groundwork during the downturn should be positioned well for market
conditionsin 2010 and beyond.
Key takeaways from Private Equity Industry
20
21. Countriesin the fire zonearelikely to facesevereeconomic pressures asthey increasepublic
debt to greater than 90% over the next few years, which will in turn stall growth
Imagine earning $100 to pay $90-110 rupees as interest on debtâŚ.
BIG SHIFTS: Increase in Public debt might trigger another crisis
21
23. The spectre of deleveraging has been haunting the global economy since the credit crunch reached crisis
proportions in 2008.
The fear: an unwinding of unsustainable debt burdens will drag down growth rates for years to
come. Sofar, reality hasbeen more benign, with economic growth recovering sooner than expected in some
countries, even though the financial sector is still cleaning up its balance sheets and consumer demand
remainsweak.
The deleveraging process may just be
getting under way and is likely to exert a
significant drag on GDP
Whatâs more, analysis of deleveraging
episodes since 1930 shows that virtually
every major financial crisisafter World War
II was followed by a prolonged period in
which the ratio of total debt to GDP
declined significantly. The one exception
was Japan, whose bursting asset bubbles in
the early 1990stouched off afinancial crisis
followed by many years...
BIG SHIFTS: Debt and Deleveraging (1/3)
23
26. China
Hong Kong
India
Indonesia
Philippines
Korea
Malaysia
Thailand
Singapore
Taiwan
0 2,000 4,000 11,000 13,000 19,000 22,000
* Assessment including key product penetration (credit card, life insurance), openness to foreign banks, market consolidation, financial stock perâŹcapita
** Financial stock includes bank deposits, government and corporate debt and equity
Sources: MGI; WMM;
maturity*
GDP per capita, 2009
Medium
Low Vietnam
Mature market with high
penetration of banking and
insurance products
different
Size of 2009
financial stock**
Degree of market
High Emerging fast-growing markets
with under-developedbanking
sectors; growth driven by
product penetration and
increase of bankable population
Transition markets with fast
maturingmarket structure and
fast growth
Asia is not a homogeneous region; it consists of markets at
stages of development
Consumer Credit Markets- ASIA
26
27. 27
Asiaâs population(Some countries) is aging rapidly âŚ
200
1
202
1
205
1
10 working
adults*
support
1 retiree**
6 working
adults*
support
1 retiree**
3 working
adults*
support
1 retiree**
* Working adults are adults from 15 to 64 years old
** Retirees are adults 65 years old and above
Sources: Data up to 2021 from Asian Demographics; data for 2051 from Firm estimates
Population over 65 years old %
20
16
7
20
15
7
14
5
9
10
14
20
2021E2001
Singapore
Need for retirement investment
increases with time
Hong Kong
India
Taiwan
Korea
China
which will create pension-related wealth management opportunities
28. Important banking trends for Asia (1/2)
1. Asia is fragmented, and markets have distinct characteristics: Asia is not one homogeneous
market, but rather afragmented region of independent markets at different stagesof development.
2. The bulk of Asiaâs growth will come from a few large markets, though selected smaller markets
have high growth rates: China, India, Korea, and Taiwan account for 80% of the financial assets in Asia
(excluding Japan) and will be key growth drivers. However, smaller markets such as Vietnam and
Indonesia areexpected to grow rapidly.
3. Consolidation is happening at varying paces across the region: Malaysia, Korea, and Thailand have
madegood progressin banking consolidation, while countries likeTaiwan arestill highly fragmented.
4. Persistent boom-bust cycles have been observed in the capital markets: Historically, the growth of
Asiaâscapital markets hasnot been linear; the region islikely to faceboom-bust cycles in the future.
5. Large and profitable pan-Asian foreign franchises have emerged: Citibank, HSBC, Standard
Chartered, and GE Capital have created material Asian franchiseswith a median share of 1.7% in active
Asian markets and 40%-50% PBT marginsin 2009.
6. New local âempoweredâ players are seeking regional and global growth: Many local market leaders
aregoing beyond their homemarkets (e.g., DBS,ICBC, CCB, Chinatrust, Kookmin, CIMB, OCBC).
7. Rapid influx of new bankable customers in large markets (China, Indonesia, and India):
Approximately 600mn newâbankableâ customerswill enter the market in the next 5-10 years.
28
29. Important banking trends for Asia (1/2)
8. Extremely high wealth concentration: Lessthan 1.5% ofAsianhouseholdscontrol about 50% of
personal financial assets (PFA); this privileged segment is growing rapidly, and its wealth could match
that of thesegmentâs Continental Europeancounterpartsby 2010.
9. âFlippedâ risk-return perception of financial investments: 40%-60% of AsianPFA is still held in
low-interest-earning deposits dueto âflippedâ risk-return perception; this perception isdriven by afear
of investment risk, perpetuated by poor historical performance of theunderlying capital markets. Asa
result, consumersarestuck at theawarenessstageof thesalesfunnel for most investment products.
10.Many billion-dollar product marketshaveemerged: Significant revenue and profit pools acrossmany
markets havecreated anopportunity for selective players to createlargeand profitable nichebusinesses.
11.Demand hasincreased for borrowing among consumers; consumer financeis still highly
underpenetratedin Asian markets (except for Taiwanand Korea): The younger generation is more
open to borrowing and believesthat borrowing can improvelifestyle. This belief, coupled with existing
low penetration of credit products, suggests that consumercreditwill experienceexponential growth in
theAsianbanking sector.
12. Rapidly aging populations haveincreasing retirement needs: Asiaâspopulations areaging rapidly.
Concerns about meeting retirement needswill drive thedevelopment of innovative pension
products,subject to conducive regulatory environments.
29
31. Key take away from this session
ďąThe Global Financial System is still not out of the woods (European
crisis, consumer credit, public debt etc ): the hidden fractures still threaten the world
economy⌠theFAULT LINESare to be fixed.
ďąGlobal Debt and leverage reduction will result in slow growth.
ďąTheEconomic Wealth shift happeningto East
ďąPrivate equityâs âgolden ageâ of low interest rates, abundant leverage, mega-deal
making and effortlessreturnsisover, and will not soonreturn.
ďą Technology (Internet and Mobile) isreshaping theworld of financial services.
ďąThe Asian financial marketsare projected to grow very fast.
31
33. How Did We Get Here?
ď§Federal Reserve underAlanGreenspan (EasyMoney)
ď§Fannie Mae, FreddieMac& Congress: GSEssupporting affordable housing â increased demand
for subprimeandAlt-A loans
ď§Borrowers at best wereuninformed; at worse, lied about their financial condition
ď§Mortgage Brokers,Appraisers, Realtors: Overvalued propertiesand pushed borrowers into
gimmick or complex mortgages
ď§Rating Agenciesmisrepresented security/asset values
ď§LargeCommercial and Investment Banks demonstrated poor risk management practices
ď§Regulators (Banking & SEC) allowed excessiveleverageand failed to criticize the large
institutionsâbusinessmodels; no regulation of derivatives
ď§Separation of Ownership from Origination:
ď§Securitization allowed loan originatorsto carelessabout the quality of the loansthey
originated
ď§ Mark-to-Market Accounting forcedunreasonable
ď§valuations of securitieswhen there wasno liquidity
33
34. How the story unraveledâŚ
⢠In theaftermath of the dot-com bubble burst, growth of liquidity and easy credit
availabilities, combined with novel structuring of financial assets droveadramatic expansion of structured
credit; investors chased yield and bet on real asset performance in residential real estateand didnât
properly understand true credit risk
⢠Even whiletheeconomy remained strong, housing pricesceased to rise, and many subprimeborrowers
began to struggle to service their debt
⢠Default ratesof RMBSand CDO began to risedramatically, and financial asset valuations were strongly
impacted by market reaction against in-transparencyand complexity in theinstruments, and afailure of
trust in their credit ranges
⢠Downgradesin financial asset valueshelped spur areduction in market liquidity. A reinforcing
cycle, based on lossof confidenceand transparency, drovefurther deterioration in financial asset value as
well asacrisisin funding liquidities
⢠The devaluation of financial asset values, combined with afunding liquidity crisis, hit thecapital market
participants in various ways. Many players exited themarkets
⢠Central banksinjected capital to secure theavailability of funding liquidity, and held or reduced interest
ratesto support thecapital market. The side effect wasto exposethereal economyloop to therisk of
inflation
⢠Regardlessof thescenario, there will besome winners and manylosers asthecycle continuesto unravel.
34
35. What caused the bubble?
The monetary policies of central banks particularly the US Federal Reserve and the ECB in some
countries were too loose â they focused too much on consumer price inflation and ignored asset
priceinflation
Global imbalances â the Asian crisis of 1997 and the policies of the IMF led to a desire among
Asian governments to savefunds
35
36. Growing Importance of Finance
Note: Financial services and insurance accounted for 7.8% of U.S. GDP in 2009.
36
