What is Credit Crunch?
Credit Crunch happens when there is a sudden decrease in the available loans or credit or in other words, a sudden hike in the rate of interests of loans from private or government banks or the central bank. Generally, in this case, the banks increase the interest on loan hence making it difficult for the people to repay the loan hence making borrowing more difficult. This could happen due to the fall in expected collateral which is in use by banks for issuing loans. Another reason could be the increased perception of taking risk about the solvency of subsidiary banks under them. This may also happen due to monetary reasons such as unexpected increase in loan rates or central reserve requirements. Also, direct control of the central authority over the credit policies and limits may lead the bank not to lend loan to any entity leading to a credit crunch.
Inappropriate or careless lending by banks over a sustained period may lead to losses for banks and other individuals in debt hence leading to credit crunch. When loan is not paid ( when the loan turns bad ), the banks or other lending institutions tend to reduce the availability of loans and increase the rates of accessing credit. There are some cases when debtors are not able to extend their loans as result of earlier losses.
Another major reason for credit crunch is the fall in market prices of the previously over-inflated assets and the financial crises that has happened due to the steep fall in price. When an organization is unable to gather finance to expand or carry out its cash flow transactions, a liquidity crisis is put in motion. In such case, it’s better for the business to access additional credit sources to make sure the business is out of the problem maintaining its viability and solvency. It’s very difficult in such crises to guess that whether the business is going through a permanent mishap or a temporary financial liquidity crises.
If the money involved in the business affected by credit crunch is not enough to get through the post phase of credit crisis, it is always better to go into liquidation, that is to dissolve the business. It is always preferred to check out other lines of credit before going to liquidation as still the opportunities of advancement exist after the crisis is over.
It is said that credit crunch for a prolonged period is opposite of cheap, easy and plentiful lending practices which is referred to as loose credit or easy money. But after such loose lending, the banks generally suffer from credit crunch. To avoid this, the banks should curb the practices of loose lending of funds to entities. In most of the countries, the whole country suffers due to such crisis and the government has to step in and pour some liquidity into the markets to save them from crashing.
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