Credit Score Calculations and Bank Lending in the Global Financial Cri…
It is now 5 years since the beginning of the global financial crisis and it is interesting to mirror on how the processes of credit risk examination ultimately impacted the global economy. The subprime mortgage crisis in the United States was the beginning of a chain events that had a domino kind effect where the financial viability of some of the largest financial institutions was downgraded which led to a collapse in the stock market and ultimately to a national recession with rising unemployment, lowered tax revenues and indeed a global recession as the economies of the rest of the world were impacted by the events in the United States.
The catalyst for what ultimately turned into a catastrophe was a set of complicate financial instruments which essentially enabled edges to sell the risk of credit default to other players in the economy. In the times when financial institutions placed more emphasis on the credit rating of the consumers applying for their products, the buyers of these instruments which were called collateralised debt obligations could comfortably make a profit on the transaction because the credit risk associated with their buy of the rights to these loans was low enough such that they could profit from the transaction despite lending to the occasional credit defaulter.
However, this led to a behaviour in the edges where they had little or no attention to the credit history of consumers applying for loans. Over time, there was no correction for the risk of credit default factored into these securitisation transactions and both edges and securitisation companies were left without any loans which could be relied upon for repayment. This clearly undermined the financial viability of the edges.
To make matters worse, the edges which had not engaged in this practice of securitisation and were considered to be more financially sound had often lent money to second tier edges and were consequently exposed to these credit rating problems as they began to snowball into one of the worst financial crises in living memory.
Although it may seem inconspicuous, when someone applies for a loan or a credit card they are truly engaging a course of action of examination undertaken by the edges to try to ensure that credit risk does not at a later state undermine the viability of the company. In the time since the global financial crisis, the lending criteria have been significantly restricted so that only borrowers with high levels of credit reliability can access the best market rates in the industry.