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The Credit Crunch Causes
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by: stickystebee
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A credit crunch is a situation wherein supply of money in the economy becomes extremely diminished. The availability of loans and other types of credit become difficult & banks tend to tighten their monetary policies to regulate the flow of money due to which bank loans become a hassle.
Generally there is an inverse relation between availability of credit & the rates of interest as more money is borrowed at lower rates of interest & less money is borrowed at higher rates of interest. However this relationship does not hold true in times of credit crunch because the credit ceases to be available at the interest rate which is determined by the authorities. In such times people like to play at lower levels of risk & therefore are not willing to borrow even if the rates of interest are high.
The reasons why banks all of a sudden reduce the offering of loans could be many. If banks anticipate that the value of collateral securities such as property against which loans are secured, will fall in the near future, they will refuse to give out loans. Even if the central authority or the government starts to establish direct & stringent control over the lending policies of retail banks & start regulating the debt management norms, the banks would go in for lesser lending. Any changes in the monetary policies of an economy can lead to credit tightening by the banks. For instance if the rates of interest fluctuate or if reserve requirements change , like an increase in the mandatory reserve amount that needs to be maintained with the central bank, this will effect the credit giving ability of the banks.
Usually a credit crunch follows when there has been careless & reckless lending by the financial institutions. When the credit checks are not performed by the banks before giving out loans to customers, the disclosure norms are not followed. Because of this there happen to be lots of bad debts & loans turn bad. This leads to enormous losses for the financial institutions. It results in a situation where the banks ability to give out more credit is tarnished. The economy suffers from a credit crunch due to the accumulation of such factors.
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The reasons why banks all of a sudden reduce the offering of loans could be many. If banks anticipate that the value of collateral securities such as property against which loans are secured, will fall in the near future, they will refuse to give out loans. Even if the central authority or the government starts to establish direct & stringent control over the lending policies of retail banks & start regulating the debt management norms, the banks would go in for lesser lending. Any changes in the monetary policies of an economy can lead to credit tightening by the banks. For instance if the rates of interest fluctuate or if reserve requirements change , like an increase in the mandatory reserve amount that needs to be maintained with the central bank, this will effect the credit giving ability of the banks.
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