The curse of toxic assets
Tuesday, 1 December 2009
Fahim Salek
The financial world has gone through a severe shakeout due to the severity of the global economic recession that is still on going. Though the economic experts have predicted the recovery of the economies in the near future, there is still not much convincing signs. Economies all over the world, particularly in the developed countries, have been seriously affected by the recession, resulting in layoffs, import-export discrepancies, bankruptcies, global unemployment and equity market crashes.
The 'Credit Market' is to be blamed first for the economic crisis. When Northern Rock, a British bank, and Lehmann Brothers, an American financial services firm, plummeted due to subprime mortgage crisis near the end of 2007, this was all due to the trouble in the credit market. It all started from there and since then the markets began to tumble, resulting in the collapse of colossal banks, financial institutions, industries and equity markets. We are quite aware of this big picture regarding the global economic downturn, but quite remarkably miss the concept of 'unregulated credit' and its atrocity.
'Toxic assets' originate from the cost of unregulated credit in the financial markets. These are assets for which there are no buyers, and as a result, these have no clear value. These assets do not reflect the real cost and become a burden for the organisation. In plain words, if a bank sanctions a loan to someone retaining some assets as security but after a period of time the market price of the assets falls and the person becomes unable to pay off the loan and the interest, the assets held as security become illiquid and the bank will only be able to recover a portion of their money through the process of acquiring and selling these assets. Eventually, the receivables in the bank's books get transformed to 'toxic assets' from 'assets'.
In this global economic crisis, toxic assets became an issue of major concern. It was this unregulated credit sanctions that made the banks and financial institutions globally victims of the recession. Sanctioning loans and offering credits without proper and thorough credit checks worked as a catalyst for this situation. Nevertheless, banks and financial organisations are the heart of the financial world. Their consistency is so important that their business relies heavily on trust, which has a tendency to evaporate in such unsound situations and in extreme cases the organisation would soon be left scrambling for cash. If the government loses faith, the organisations might not have a business worth saving. This leads to nationalisation and takeover which have been the way-out in several cases around the world. But the curse of the toxic assets remains. The biggest losers, of course, are the shareholders, who get wiped out as creditors take the equity in the new company.
If we take a glance at Bangladesh, the government banks, especially the Sonali Bank and Agrani Bank, have exempted interests of three thousand six hundred & forty four crore BDT in the last eight years. This amount has surely been written off the books or categorised as toxic assets.
Since the world financial markets began to tumble in 2008, governments around the world have spent almost $11 trillion, bailing out failing banks and trying to repair the financial system. We have been quite fortunate that, even during the recession none of our banks went broke or was struggling severely that needed to be nationalised or bailed out. But the matter to regret is that the interests out of the sanctioned loans in the past might not be ever recovered which is a colossal loss to our economy. To address credit problems, the banks need to strictly renegotiate the terms of loan facilities but at the same time help keep the credit flowing securely which is essential for investments.
The writer is an International MBA, Anglia Ruskin University, UK. He can be reached at: fahim032003@yahoo.com
The financial world has gone through a severe shakeout due to the severity of the global economic recession that is still on going. Though the economic experts have predicted the recovery of the economies in the near future, there is still not much convincing signs. Economies all over the world, particularly in the developed countries, have been seriously affected by the recession, resulting in layoffs, import-export discrepancies, bankruptcies, global unemployment and equity market crashes.
The 'Credit Market' is to be blamed first for the economic crisis. When Northern Rock, a British bank, and Lehmann Brothers, an American financial services firm, plummeted due to subprime mortgage crisis near the end of 2007, this was all due to the trouble in the credit market. It all started from there and since then the markets began to tumble, resulting in the collapse of colossal banks, financial institutions, industries and equity markets. We are quite aware of this big picture regarding the global economic downturn, but quite remarkably miss the concept of 'unregulated credit' and its atrocity.
'Toxic assets' originate from the cost of unregulated credit in the financial markets. These are assets for which there are no buyers, and as a result, these have no clear value. These assets do not reflect the real cost and become a burden for the organisation. In plain words, if a bank sanctions a loan to someone retaining some assets as security but after a period of time the market price of the assets falls and the person becomes unable to pay off the loan and the interest, the assets held as security become illiquid and the bank will only be able to recover a portion of their money through the process of acquiring and selling these assets. Eventually, the receivables in the bank's books get transformed to 'toxic assets' from 'assets'.
In this global economic crisis, toxic assets became an issue of major concern. It was this unregulated credit sanctions that made the banks and financial institutions globally victims of the recession. Sanctioning loans and offering credits without proper and thorough credit checks worked as a catalyst for this situation. Nevertheless, banks and financial organisations are the heart of the financial world. Their consistency is so important that their business relies heavily on trust, which has a tendency to evaporate in such unsound situations and in extreme cases the organisation would soon be left scrambling for cash. If the government loses faith, the organisations might not have a business worth saving. This leads to nationalisation and takeover which have been the way-out in several cases around the world. But the curse of the toxic assets remains. The biggest losers, of course, are the shareholders, who get wiped out as creditors take the equity in the new company.
If we take a glance at Bangladesh, the government banks, especially the Sonali Bank and Agrani Bank, have exempted interests of three thousand six hundred & forty four crore BDT in the last eight years. This amount has surely been written off the books or categorised as toxic assets.
Since the world financial markets began to tumble in 2008, governments around the world have spent almost $11 trillion, bailing out failing banks and trying to repair the financial system. We have been quite fortunate that, even during the recession none of our banks went broke or was struggling severely that needed to be nationalised or bailed out. But the matter to regret is that the interests out of the sanctioned loans in the past might not be ever recovered which is a colossal loss to our economy. To address credit problems, the banks need to strictly renegotiate the terms of loan facilities but at the same time help keep the credit flowing securely which is essential for investments.
The writer is an International MBA, Anglia Ruskin University, UK. He can be reached at: fahim032003@yahoo.com