What is a Credit Crunch?

Credit crunch is something that most of us would have heard of during the last five years. While some of us would have a clear understanding of it, many would only have experienced the impact of the crunch without any clear understanding of what it is.

What is credit crunch? Why does it happen? These are questions worth looking at. Also it may be a good idea to do some stocktaking of what we have learnt and where we stand now, five years after the financial crisis.

Credit crunch in very simple terms is a situation where the banks find it difficult to lend and potential borrowers find it difficult to borrow whether for personal loans, mortgage credit or for business purposes. This situation could arise for a variety of reasons:

• A bank finds itself in a situation of tardy growth of deposits and inability to borrow or raise resources from other sources thus making it necessary for them to hold up fresh loans / credit growth.
• Sometimes large scale withdrawal by depositors can bring about a resource crunch for banks
• Sharp unexpected deterioration in the quality of the loan portfolio as happened during the sub-prime crisis can compel a bank to put further credit growth on hold.
• The bank may take a conscious decision to upgrade the quality of assets and this may result in more stringent credit norms that may make credit unavailable to some who may have otherwise been eligible.
• In extreme situations, major international developments may adversely affect industry and trade resulting in impairment of the banks assets, forcing them to halt all lending until the damage is assessed and repair carried out.

Well for those of us who have lived through a credit crunch, the impact is obvious:

1. Getting a personal loan or a mortgage will not be that easy. The credit standards will be far more stringent. Therefore as an individual I will have to do a lot of belt tightening to manage my repayments to maintain a good credit record and cannot tap into easy credit to meet requirements.

2. People who want to borrow for their business will find credit that much harder to access and this in turn can hamper their growth prospects.

3. If you are setting up a new business, this may not be the best time as credit availability could thwart your attempts or stymie growth.

4. Existing business will be forced to cut costs to stay afloat and this may translate into job-cuts.

5. There could be an overall contraction effect felt by the economy as a whole.

It may be very relevant for all of us to see where we are now in terms of the financial crisis that hit us five years ago. That will have pointers to the way things could unfold from here.

While there could be different points of view on what we have learnt or done so far and how much remains to be achieved, the overall consensus seems to be that we are definitely not out of the woods.

The video below presents a thought provoking perspective.