Credit crunch is also known as credit squeeze, credit crisis or financial crisis. It is defined as the reduction in availability of loan or rapid tightening of conditions to obtain loans from any financial institution. It is condition, when banks and investors become wary to grant loans or funds to individuals or business houses as the price of debt products goes high.
How does credit crunch occur?
Credit crunch is usually the after effects of recession. A credit crunch nearly makes it impossible for companies to borrow because the lenders usually charge high rate of interest. A credit crunch occurs when there is lack of funds available in the financial market. During this time the lenders have limited fund available to lend to the borrowers.
What are the reasons of credit crunch?
During the period of credit crunch the lending institutions generally suffer huge losses from their previous transactions. This occurs as the defaulters fail to repay debts and thus their properties are foreclosed. Generally the banks gives loan to the borrowers against a mortgage property. If the borrowers default then, those properties are sold off so that, the banks recovers their bad debts.
The bank suffer huge losses if the value of the mortgaged property falls. The banks are required to maintain a certain level of liquidity but due to economic meltdown their capital position is reduced. Therefore, the banks are unable to lend to the borrowers.
Credit crunch can also occur when regulatory bodies increase the capital requirement for financial bodies. Most of the financial institutions are required to maintain set amount of liquidity which is based on risk-weighted level of assets. If this level increases most of the banks need to increase their capital reserves. To comply to this norm, the banks reduce the availability of loans for organizations and individuals.
Another reason for credit crunch is that, if the banks perceive greater risk in the market they will often increase their lending rates to overcome this risk. This increased rate of interest makes it almost impossible for borrowers to avail loans.
Overall, credit crunch has ill effects on economy because it hinders in economic growth through decreased capital liquidity and reduced opportunities to borrow money. Lending or availing credit is part of business, it is way through which most of the financial institutions expand their operations. If a credit crunch is coupled with recession it often leads to bankruptcies for many corporate organizations.
How does credit crunch occur?Credit crunch is usually the after effects of recession. A credit crunch nearly makes it impossible for companies to borrow because the lenders usually charge high rate of interest. A credit crunch occurs when there is lack of funds available in the financial market. During this time the lenders have limited fund available to lend to the borrowers.
What are the reasons of credit crunch?
During the period of credit crunch the lending institutions generally suffer huge losses from their previous transactions. This occurs as the defaulters fail to repay debts and thus their properties are foreclosed. Generally the banks gives loan to the borrowers against a mortgage property. If the borrowers default then, those properties are sold off so that, the banks recovers their bad debts.
The bank suffer huge losses if the value of the mortgaged property falls. The banks are required to maintain a certain level of liquidity but due to economic meltdown their capital position is reduced. Therefore, the banks are unable to lend to the borrowers.
Credit crunch can also occur when regulatory bodies increase the capital requirement for financial bodies. Most of the financial institutions are required to maintain set amount of liquidity which is based on risk-weighted level of assets. If this level increases most of the banks need to increase their capital reserves. To comply to this norm, the banks reduce the availability of loans for organizations and individuals.
Another reason for credit crunch is that, if the banks perceive greater risk in the market they will often increase their lending rates to overcome this risk. This increased rate of interest makes it almost impossible for borrowers to avail loans.
Overall, credit crunch has ill effects on economy because it hinders in economic growth through decreased capital liquidity and reduced opportunities to borrow money. Lending or availing credit is part of business, it is way through which most of the financial institutions expand their operations. If a credit crunch is coupled with recession it often leads to bankruptcies for many corporate organizations.
