The Credit Crunch

The Credit crunch officially began on 9th August 2007. It was supposed to have been the day the world changed. An economic situation where banks are nervous to lend money to businesses and as a result-shrinking credit supply. The most apposite definition would be that, “It is a reduction in general availability of loans, an economic condition where investment capital is difficult to obtain or it can be considered to be an extension of recessions”. To be precise it occurs when there is lack of funds available in the credit market. It occurs when lenders have too little to lend or have increased the cost of borrowing to a rate unaffordable by most borrowers.

If banks discern about the greater menace, they raise their lending rates to counterpoise this risk. This increases the cost of borrowing and makes it more difficult for borrowers to access financing. There are a number of reasons why banks might suddenly stop or slow their lending activity. It might be due to the exogenous change in monetary conditions, new regulatory constraints on lending being imposed, the government imposing direct credit controls on the banking system or even due to an increased perception of risk regarding the solvency of other banks within the banking system.

How does it affect our economy? Financial institutions may fail, economic growth may slow, unemployment may rise, and social unrest may increase. A Credit Crunch can do a hell lot damage to the economy curbing our economic growth through decreased capital liquidity, thereby leading to the reduced ability to borrow. This might cut-down our ability to extend the company for the better or do financing. When coupled with a recession, a credit crunch can often lead to many corporate bankruptcies. This increases the crunch's economic impact by stifling the economy's ability to recover. 

But why does this matter? Well, cheap debt has been the greatest phenomenon of the financial markets in recent years. Central banks lowered interest rates to help the global economy recover from 9/11 and the dotcom crash. Since then, private equity firms have borrowed cheaply to buy well-known British companies. But now it is getting harder for big corporate to secure financing but it’s not yet impossible. As investors attempted to sell in a market with no buyers, prices fell further. Soon, most risky assets were dropping rapidly in price and panic began to creep into the marketplace.It is also important not to underestimate the economic difference between this period and the previous ones. But it is clear that the financial positions have got increasingly serious since the original crisis in 2007. A series of bank failures, mergers and bailouts across the globe means that the governments across the world are individually and collectively attempting to restore confidence in their national and global banking systems. Various reports urge banks to cut their dividends to preserve their existing capital. Central banks and governments should encourage this action across the globe so that there is no competitive demerit or blemish from the reduction. But the better question is not about when the last financial crisis began, but when the next one will. At the moment it is difficult to tell whether the Crunch crisis is the beginning, the end - or just a temporary blip. But we knew it’s our “Time to trim”.