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Since 2008, a global financial crisis which was caused by the US subprime mortgage attacked numerous countries all around the world. It is generally accepted that the synergy of several factors, such as high mortgage fraud rate, inefficiency of risk management in US commercial banks and some other mortgage institutions, contributed to the US subprime crisis. Bianco (2008) believes that the main unsuitable action is lending to the subprime borrowers which made the commercial banks face to a higher risk of default. This action led to that many banks failed to sustain being operated in case of housing price falling down when the US housing bubble burst. However, some of these inefficient methods are still being adopted by many commercial banks around the world. For example, Britain's biggest lender Lloyds Banking Group has a large amount of the riskiest kind of mortgages on its books. (Glass, 2011) Many Chinese banks make loans to the housing investors without high enough threshold at present – the moment that the future trend of housing price is very unclear in China. (Ma, 2009) Thus, this essay aims to consider alternative methods of risk management of personal loan to prevent a similar financial crisis happening again. Firstly, it will describe the background of the US subprime mortgage crisis and the inefficient risk management measures or strategies which led to the crisis but have not been ameliorated yet. Secondly, some measures which may be used to take place of inefficient ones to help the banks improve their capability of risk management will be discussed. Finally, the alternative efficient ones will be evaluated.
The subprime mortgage refers to the housing loans which were made to individuals who may have not enough income to keep maintaining the repayment schedule. Thus, when the exploding of the default behaviors of the subprime borrowers in case that the US housing price bubble burst, the lenders who consist of commercial banks and some other mortgage firms suffered a huge loss. In addition, through the securitization practices, some of the risks were transferred to the investors who included some famous investment banks and individual investors. Therefore, series negative impacts were brought by the US subprime mortgage crisis to the global economy. Wignall, Atkinson & lee (2008) pointed out that the main causes of the crisis which were related to the commercial banks are making high risk mortgage without enough risk management actions, securitization practices of the subprime mortgage and the lack of efficient measures to prevent the mortgage fraud. Data from some statistics reports shows the rapid rise of subprime mortgage proportion in US commercial banks’ books: the percentage of Subprime mortgage in the whole mortgage services had arisen from 5% (35 billion US dollars) in 1994 to 20% (600 billion US dollars) in 2006. (MacDonald & Arnold, 2008, 2) Besides, securitization practices and mortgage frauds have heightened the influences of the effects of the defaults of the subprime borrowers.
However, although the improper measures and actions which were taken by the US commercial banks had disproportionately high effects on the global financial crisis, some banks in other countries are still taking the similar actions to manage the risk of mortgage and to operate the mortgage services. For instance, when facing to a unclear trend of housing price in China, many Chinese banks continue to issue the mortgage to borrowers without using a strict risk management systems and the amount of individual housing loan rose rapidly.(Ma, 2009) Besides, high amount of mortgage frauds are still a very serious problem in many countries around world. According to the statistics of the Experian, Mortgage fraud attempts have increased by 14 percent to 32 in every 10,000 applications during 2010 in UK. (Ferranni, 2011) Fortunately, since the crisis happened, the originate-to-distributes market (OTD market) which offers a platform for the mortgage securitization practice has been closed down and remains shutting. (Bernanke, 2009) This measure which transfers the banks’ risk to the investors and helps banks replenish their funds has been abandoned temporarily in reality. However, because of the demand of the fund liquidity and the risk transfer, the OTD market may not remain closed forever. Thus, how can get a balance between the crisis prevention and the operational requirement of commercial banks is still a problem being under discussion.
In order to identify efficient risk management measures to take places of these actions which may cause a financial crisis, several alternative methods will be further discussed. First of all, for the problem of the high-risk mortgage, perhaps there is only one method can be used to solve it. That is to enhance the threshold of the credit requirement or even to stop issuing any high risk mortgage to people whose credit record seems not good or has not credit record at all. Secondly, for the mortgage fraud problem, several methods can be taken to help banks avoid it. At present, the general ways for commercial banks to avoid mortgage fraud is evaluating the borrowers’ abilities of repayment. (The Financial Services Authority, 2011) Therefore, the evaluating system plays a decisive role in risk management of banks. In order to work efficiently, an efficient evaluating system should contain several factors to cover all sorts of risk. To start with, it can evaluate both ability and attitude of repayment of borrowers. Furthermore, the punctual tracking to the each time of repayment regime should be adopted by the banks. It means the bank could establish an efficient monitoring system to remind the borrowers of repayment on time and take actions once the borrowers cannot repay their mortgage. At last, an independent monitoring department should take the duties of the mortgage safety. Finally, for preventing an OTD market bringing threats to the investors again, two methods may be taken to considering by banks. One is to abandon the OTD markets entirely. For example, the central bank could establish a ban to OTD market and mortgage securitization practices. The other one is to modify the OTD market rules or enhances the threshold and requirement of it. For instance, an independent and special department can be set up under the leadership of central bank or authority to play a monitoring role to the OTD market and only approved mortgage instead of all of them can be transferred to the investors in OTD market.
Which measures are with practicability and can be used by bankers in reality easily? The alternative measures which respectively could be adopted for different purposes will be compared as follows. First of all, raising the threshold of the credit requirement of borrowers, which aims to prevent subprime borrowers getting a mortgage, will do lot of influence to the banks if being adopted. It’s no doubt that it will reduce the amount of qualified borrowers, in other words, it reduce the customers of the banks. However, comparing to the loss that the unqualified borrowers brought in the crisis, the gain of the banks when banks reject the applying of the subprime borrowers is much more, because it reduces the percentage of bad loan in the banks’ book. It means that if the banks had not subprime mortgage, it could keep profiting instead of closure. Secondly, the improvement of the evaluating methods to the borrowers’ repayment ability should continue to be made by banks. It’s no doubt that this is an efficient way to enhance banks’ profitability and avoid bad loans. Finally, the amelioration of the securitization practice of mortgage will be discussed. Which is the better one to reduce the threats that the mortgage securitization brings, to ban the OTD market or to modify it? Obviously, a ban cannot meet the demand of liquidity and risk transfer of commercial banks, meanwhile, in the crisis, only the subprime mortgage securitization brought the loss of investors. Thus, to keep the subprime mortgage away from the OTD market is a better way to ensure both the liquidity and risk transfer of banks and the assets safety of investors.
This essay has examined the approaches to the inefficiency problem in risk management in commercial banks. The measures which are focused on the three sorts of threats to the mortgage –high risk mortgage issuing, mortgage securitization, mortgage frauds- were discussed respectively and some efficient ones have been selected out. They are enhancing the requirement of the mortgage pre-investigation and tracking, setting up a special department for monitoring the OTD market and stopping making loans to subprime borrowers. However, some special circumstances in specific countries or regions were not considered in this essay, some measures may not be adopted by those banks. Meanwhile, the influence to the profits of the banks which the anti-risk measures exert were not under discussion in this essay as well. Bankers will need to consider more about the balance of the profitability and the risk management, while combining their banks’ specific situation.