Business, Legal & Accounting Glossary
A credit crunch (or credit crisis) is an economic condition in which loans and credits for investment are suddenly unavailable. This can also represent the unavailability of credit due to the increase in the cost of loans provided by the banks and other financial institutions in an environment in which large losses and asset value write-downs are taking place.
A credit crunch leads to the increase in the interest rates which make it further impossible for the borrowers to secure credit. Banks and creditors cautiously disburse funds to the corporations, fearing bankruptcies and defaults in payments by the borrower. A credit crunch is a product of a recession or negative financial environment. The shrunk credit supply during such a crunch leads to a prolonged recession in the economy.
There are various reasons as to why there is a credit crunch. Most often a major cause of credit crunch is a long period of faulty and injudicious practices on the part of lenders. However, there are other causes that are just as important.
Reduction in prices of goods or assets in a particular market can also result in a credit crunch. In this case prices of assets, that had been previously overinflated, go down and this results in a credit crunch. Excessive leverage in borrowing against assets that had previously been going up in value further exacerbates the situation.
A credit crunch happens when banks are reluctant to loan money to individuals and businesses. In a credit crunch situation, it becomes increasingly difficult for companies to obtain funding. When and if lenders do offer loans during a credit crunch, they do so at relatively higher interest rates, which can be prohibitively expensive. Several situations can lead to a credit crunch. When banks, in unison, are concerned about elevated counterparty risk (i.e. high rates of defaults, bankruptcy, etc.), a credit crunch can ensue. Also, if banks find themselves overexposed in an economic downturn (i.e. subprime mortgages crisis), many banks may have to reduce loan availability in order to not aggravate their collateral shortfall, resulting in a credit crunch. A credit crunch has significant consequences on the economy. A credit crunch can tighten the flow of capital causing businesses to lay off employees or shut down completely due to their inability to borrow capital. A credit crunch is also referred to as a credit squeeze.
A Credit crunch is different from a liquidity crisis. Liquidity crises happen when an economically-sound business enterprise is unable to generate bridge finance that is required in order to operate or expand the business.
Sometimes governments impose restrictions on lending in the form of raising rates or adopting other monetary practices for consumers and businesses. This leads to a credit crunch, also known as a credit squeeze.
To help you cite our definitions in your bibliography, here is the proper citation layout for the three major formatting styles, with all of the relevant information filled in.
Definitions for Credit Crunch are sourced/syndicated and enhanced from:
This glossary post was last updated: 30th March, 2020