Credit crunch is a normal phenomenon. Every economy faces it. It is a situation where “there is reduction is the availability of loans in the market in spite of the increase in interest rates”. (Turner, 2008) This results in a mismatch. It is a situation where “the interest rates don’t match with the credit availability as a result the relationship gets hampered”. (Turner, 2008) It is a situation which happens during recession. It is important to find out the reasons. Some of the reasons for it are
• Decrease in bank capital: After a recession situation banks are not able to match the demand. The demand for loans rises. During the recession period banks incur loss. As a result they are not able to lend in the same way. So, when the demand peaks, banks are not able to generate it. This causes deficiency. It gives arise to a situation where “not only does the bank’s capital fall but the minimum capital standards also rises”. (Clair & Tucker, 1993) This reduces the money. As a result a credit crunch like situation arises.
• Mismanagement of risk: Not proper management of “risk results in credit crunch due to the inter-connection relation between business activities and management”. (Priddy, 2008) This results in risk. As a result, there is not “proper reporting of risk and financial transaction”. (Priddy, 2008) It results in non clarity. As a result the situation leads to crisis.
• Lack of training: Not able to “understand the business model leads to poor management” (Priddy, 2008) as a result there is a problem. This leads to taking wrong decision. Organisations continuously face it. This results in over estimating the market. So, organisations run out of money. This spreads and the entire economy is engulfed in it.
• Human Weakness: “Cultural and motivational factors also lead to credit crunch”. (Priddy, 2008) People have ego. This makes them certain decision which they know are wrong but they don’t want to change. Rigidity in their decision affects the outcome. This causes taking a wrong decision. Thus, not having the desire to change affects the decision and causes crunch.
• Lending to below poverty line customer: Lending money to people who don’t have proper financial condition results in failure. “People with unstable income are not able to return the loan and these causes less money with the bank to lend thus forming a circle and affecting the economy”. (Turner, 2008) This is what happened recently. The housing bubble was this. Banks had given loan to people not having proper records. This resulted in defaults. Even the housing prices fell. As a result banks suffered losses. This was because they had sold securities on the basis of property. The fall in the price and default of loans resulted in banks failure. This made less money in the system. As a result credit was unavailable. This resulted in less people getting loans and created a credit crunch in the entire world.
• Financial Innovation: Coming with “new financial products...