The main causes of the bad loan market crisis in recent years

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The dramatic increase in defaults at the world’s largest banks is a matter of concern. The Covid-19 epidemic has affected everyone, whether ordinary people, giant corporations or social safety net systems, and paved the way for another financial crisis.

A majority of well-known financial institutions in the United States, such as JPMorgan Chase, Bank of America and Wells Fargo, are warned by the world’s major banking institutions that they may not meet their loan obligations, which would result in a disastrous loan market. crisis.

According to Federal Reserve Bank of New York, U.S. households are expected to have $ 14 trillion in debt, including over $ 1.3 trillion in auto loans and over $ 900 billion in credit card debt, by the end of the year. ‘last year.

While low global interest rates may have contributed to booming housing markets and speculative excesses, microeconomic distortions and poorly understood innovations in the financial system have played a more fundamental role in creating such havoc. .

Although banks are in much better shape than during the 2008-09 financial crises, the impact of late payments and defaults can be severe and can damage even the most balanced balance sheets. It is still unclear how and when the US market will regain economic momentum, as conditions worsen after the detection of the Omicron variant among US citizens.

In recent years, US policymakers and economists have been very active in providing policy advice to other countries on how to avoid and manage financial crises. But it’s a huge surprise that the country itself is on the brink of a bad debt crisis after the outbreak of the Covid pandemic.

An overview of the main causes of the bad loan market crisis

The precise causes of the bad debt market crisis remain surprisingly controversial. Much of the recent analysis has blamed the pandemic and the role of developments within the US real estate and financial markets for this economic recession.

Understanding the root causes of this terrible situation is critical to overcoming ongoing defaults.

  • Pandemic and subsequent lockouts

The main cause of this crisis is none other than the pandemic and its resulting containment measures. It’s no secret that Covid-19 has hit the global economy hard, and the US market is no exception. While lockdowns and other security concerns restrict the spread of the virus, they automatically put U.S. institutions at alarming risk of default. March 19, Swiss credit warned in a report that “the impact of the pandemic on our financial results is difficult to assess, but we try to determine our credit exposures with caution”.

The CEO of German bank, Christian Sewing, also spoke with the German news publication FAS in a interview the possibility of widespread corporate loan defaults, warning that such a scenario depends primarily on how much and, most importantly, how long the coronavirus weighs on the economy. ”

Undeniably, the Covid-19 pandemic and its various variants have crippled businesses and other financial institutions, leading to such a crisis.

  • Reliance on unstable short-term funding

The reliance of banks on unstable short-term funding has increased gradually in recent years, leading to this situation. The shadow banking system and the world’s largest banks rely on various forms of short-term wholesale funding, including commercial paper, repurchase agreements, conditional funding commitments, certain types of interbank loans, etc. .

The shadow banks’ dependence on uninsured short-term funding made them prone to the race, as did commercial banks and savings institutions. However, he insists that financial companies are putting aside cash by shifting their assets to highly liquid securities.

The supply of highly liquid securities is relatively inelastic in the short term. Moreover, the efforts never increase the liquidity of the financial system as a whole but serve only to increase the price of liquid assets while decreasing the market value of less liquid assets such as loans. Such liquidity pressures will make companies less willing to extend credit to financial and non-financial companies, leading to a bad loan market crisis.

Central banks have also warned that the risk of a temporary liquidity shortage persists as the economic shutdown continues.

  • Gaps in risk management paradigms

Although the vulnerabilities associated with a pandemic or short-term financing can be seen as a structural weakness of the global banking system, we cannot overlook that they are a consequence of the poor system of risk management.

From the significant collapse in underwriting standards for mortgages to weakening underwriting standards for commercial real estate loans to the excessive reliance on credit ratings to the insufficient ability of many large companies to track risk exposures at scale of the company, everything shows the fault of the risk management and control system.

Excessive leverage is often a major cause contributing to the bad loan market crisis. There is no doubt that many households, businesses and financial firms took on more debt from banks than they could manage or repay on time, resulting in credit downgrades and defaults.

However, the worst part is that assessing the debt trends of financial companies is not straightforward, as the statistics available are inadequate. Additionally, leverage can be very difficult to measure in a world of complex financial instruments.

Additionally, this cause tends to be pro-cyclical, increasing in good times, when trust between lenders and borrowers is high, and decreasing in bad times, when confidence turns to caution. This, in turn, increases financial and economic stress during the recession and leads to defaults.

Payment defaults also lead to an increase in unsecured debts and high risk loans. With lower credit scores, households are opting for many payday loans and other unsecured loans to overcome the financial crisis.

Central banks around the world are taking appropriate steps to protect international financial institutions to keep credit in circulation, as economies are deeply affected by the pandemic. They do this by keeping interest rates low and extending the lifelines of the businesses and lenders most affected. A team of analysts at BlackRock Investment Institute wrote a research note claiming that such monetary policy moves will reduce downside risks to the economy and the growing threat of an oversized spike in debt and credit defaults.

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