There is a fixed rate set by RBI for the advances or loans that it gives to other banks.It is the minimum rate that is to be followed.In India it is called as ‘bank rate’ .The current bank rate is about 6%.In a similar way the US federal reserve sets up a rate which is termed as ‘fed rate’.
Now extending the classical definition of banking which is a buissness of deposits & advances.Thus the bank is an financial institution that accepts money as a deposit at a fixed rate(say 5-6 %).But how will the money grow,the bank advances the same money as a loan at an extended rate say 12-15 %. Thus the difference 7-9 % is ‘spread’, which for a layman is gross profit.
Recently the banks have been on loaning spree, and they extended loans compromising on the security,& hence the term sub prime lending ie lending to borrowers with compromised credit history.Thus the sub prime lending is both risky to borrower and lender due to high interest rate involved poor credit histories. and when the loan goes bad the bank suffers,that is it goes into loss. The same goes for the mortgage loans. It has been a prevalent practice that banks often compromise on mortgage loans based on loaners credit history.A general yardstick is arrived that a certain percentage of mortgage loans is lend at compromised credit history & is termed as sub prime. When these loans go bad sub prime crisis
The same phenomena though not as simple as above stuck US markets, it was more of a sub prime mortgages,In late 2006 the US markets entered the phase called ‘meltdown’.
In subprime mortgage industry.Several subprime lenders failed and filed for bankruptcy due to a steep rise in rates of sub prime defaults. and consequently the meltdown caused a sharp decline in stocks in Dow Jones & NASDAQ.Record lows were observed in Asian markets.Even the Indian NSE & BSE felt the repercussions & went on record low in late january.’Bear Stearns’ went bust & was taken up by JP Morgan Chase on March 16,2008, under the supervision of Federal Reserve,and its share were taken as low as $2 each by JP Morgan Chase .Though it is being said by the experts that the sub prime crisis will have limited effect on Indian economy.
The indians by their inherent nature are conservative & risk averse.The same connotation extends to their buissness mentality. Although there has been a phenomenol increase in the mortgage loans in recent years but due to aforesaid cause the Indians lenders resorted to safe grounds.The Indian banks seemingly did not compromise on their benchmarks and consequently the ratio of sub prime lending was relatively low.The collateral damage to India as a result of the sub prime crisis is extremely limited since Indian banks do not own structured finance instruments yet already the stock markets are down and experts are keeping their fingers crossed.One will see for himself the effect till then experts ponder on cause & effect and derive logics.