Pbf-Subprime Crisis

Discuss the nature of asymmetric information on banks providing Collateral Debts Obligations and how this contributes to the sub-prime crisis of 2008-2009.

Asymmetric information refers to an unethical behaviour where the seller takes advantage of the buyer who has lesser knowledge and information during the transactional process. Seller will deliberately withhold information that is disadvantageous to the buyer and they do not share this bad information with the buyer.

In the past, financial institutions like banks operate in an old-fashioned and stringent manner where they follow strictly by the bank policies. Banks were not aggressive back then and would rather do less but safer businesses. Bank managers in the past also provide genuine advices and constantly reminding customers not to get overdrawn. Their philosophy also includes the ‘know your customer’ approach, by making an effort to know the lives of their customers inside out. This also enables them to make decision on loans easier as they are aware of who is or who is not capable of repaying. Opening an account was not easy in the past too as you would need to meet certain criteria and background check on customer’s financial stability will be assessed thoroughly before customers are allow to have an account or taking up loan with the bank.

When individuals apply for loans with the banks, a credit analysis will be made on the individual to assess the risks and the loan amount that individuals can take up. The evaluations are based on the 7Cs of credit; character, capital, capacity, conditions, collateral, customer relationship and competition. Assessing one’s character is the most important but the most difficult factor as bank managers will not be able to tell by one’s character based on their outlook. Capital is being assessed based on customer’s wealth position and regular income determines the capacity of the maximum limit that banks can loan to the customer. Conditions are taken into...