Credit Crunch

Posted in Finance, Accounting and Economics Terms, Total Reads: 703
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Definition: Credit Crunch

Credit crunch refers to the period when capital becomes difficult to obtain due to banks and financial institutions refraining from lending. This in turn raises the cost of debt (rise in interest rates), making it all the more difficult for borrowing corporations.


Generally when an economy faces recessions, credit crunches occur. Because of this it becomes more difficult for the economy to revive and it faces a period of prolonged recession. Credit crunches may occur due to any of the following situations:

-          Weak economy and recession

-          Decline in value of collaterals

-          Creditworthiness of borrowers unknown or risky

-          Change in monetary regulations or Government regulations

-          After a period of free flowing credit to unworthy debtors by banks, leading to accumulated bad debts


Credit crunches are called necessary evils in certain conditions, to keep a tab on credit flow and liquidity in the system. Credit crunch is also called credit crisis or credit squeeze.


Example:

IN USA, banks gave housing loans to any individual without adequately checking credit worthiness. This led to massive recession in 2008, and financial institutions were very badly affected due to major defaults. Post recession, banks did not lend easily, and checked for credit more than 15-16 times. It also drove up the interest rates in USA


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