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Capital Markets Key Concepts

Banking Crisis

Banking Crisis

In 2008, a combination of past bad lending decisions and too much exposure to badly performing, complex mortgage-backed investments pushed many of the world’s biggest banks to the brink of collapse as heavy losses decimated their capital bases.

As the first symptoms of the global credit crunch began to emerge in 2006 as sub-prime, or higher-risk, US mortgage borrowers increasingly struggled to meet their repayments, the seeds of the global banking crisis were well and truly sown. Investment banks were heavily involved in the repackaging of mortgage-backed securities (also known as MBS), ultimately creating complex, opaque investments fused with complex derivatives to be sold on to other investors. However, as the US property market tumbled and more borrowers defaulted, the value of these mortgage-backed bonds collapsed. With the market in these securities drying up amid a crisis of confidence in the products, many investment banks held massive exposure to bonds which were ultimately backed by the very mortgages which were defaulting. The developing global economic slump further impacted on banks’ capital bases as loans, many also ultimately backed by property assets, turned sour.

The banking crisis peaked in September 2008 in the aftermath of the collapse of investment bank Lehman Brothers. In a climate of fear over which banks could be next to fail, government-backed rescue packages on an unprecedented scale were rushed through to stem the crisis.

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