Financial institutions facing losses can then reduce the availability of credit and increase the cost of accessing credit by raising interest rates. In some cases, due to past losses, lenders may not be able to make other loans, even if they wish to. If the participants themselves are heavily indebted (i.e., they have a high debt burden), the damage caused by the bursting of the bubble is more severe and causes a recession or depression. Financial institutions can fail, economic growth can slow, unemployment can rise, and social unrest can rise. For example, the ratio of household debt to after-tax income increased from 60% in 1984 to 130% in 2007, contributing to (and exacerbating) the subprime mortgage crisis of 2007-2008. [6] For some businesses and consumers, the impact of a credit crunch is worse than an increase in the cost of capital. Companies that can`t raise funds at all struggle to grow or grow, and for some, staying in business becomes a challenge. As firms close operations and downsize, productivity declines and unemployment rises, two leading indicators of a deepening recession. In addition to tightening credit standards, lenders can raise interest rates during a credit crunch to generate higher revenues from the reduced number of customers who can borrow.
Rising borrowing costs hamper an individual`s ability to spend money in the economy and consume working capital that could otherwise be used to grow their business and hire workers. When credit contractions are implemented, the first consumers to feel the pinch are those with a limited or poor credit score. Almost immediately, consumers in these categories find it impossible to get a loan even with excessive interest rates. This may mean that a person with a poor credit score may have to forego the purchase of a new vehicle or take out a second mortgage on real estate. There are a number of reasons why banks could suddenly stop or slow down lending. For example, inadequate information about borrowers` financial situation can lead to a credit boom when financial institutions overestimate creditworthiness, while sudden disclosure of information suggesting that borrowers are or have been less creditworthy can lead to a sudden credit crunch. Other causes may include an expected depreciation of the collateral used by banks to guarantee loans; an exogenous change in monetary conditions (e.g. B when the central bank suddenly and unexpectedly increases reserve requirements or imposes new regulatory restrictions on lending); the central government, which imposes direct credit control on the banking system; or even an increased perception of risk relative to the creditworthiness of other banks within the banking system. [3] [4] [5] The fact that credit crunches can potentially discourage people with good credit from getting a loan does not suit me well. Why should they have to pay for the mistakes of others that caused the recession in the first place? It`s not fair.
Credit contractions are generally not long-term situations. Rising interest rates, a common type of credit contraction strategy, is usually a response to an economy that is experiencing rapid inflation. Once measures are taken to slow or possibly reverse the rate of inflation, interest rates could fall back to more acceptable levels. At that point, consumers who have not been able to obtain credit or credit will suddenly be eligible again. Definition: Recession is a massive slowdown or contraction of economic activity. A significant drop in spending usually leads to a recession. Description: Such a slowdown in economic activity can last for a few quarters, completely hindering the growth of an economy. In such a situation, economic indicators such as GDP, corporate profits, employment, etc. decrease. This creates chaos throughout the economy. To counter the threat, economies typically respond by easing monetary policy by pumping more money into the system, that is, by increasing the money supply.
This is done by lowering interest rates. Increasing public spending and lowering taxes are also seen as good answers to this problem. The recession that hit the world in 2008 is the latest example of a recession. Instead, credit contractions should only be limited to individuals or institutions that have not repaid their loans on time in the past. They are the reason why economies suffer, so they are the ones who should bear the consequences. The use of credit contractions makes it difficult for consumers to obtain credit. .