Some years ago there was a word in the financial area, which was also in the media in all mouth, namely the so-called credit crunch. Today, there is hardly any talk of this, but there are still situations in which a credit crunch can occur. Therefore, in our article you will learn what the credit crunch is about and what can be the triggers of such a situation.
What is a credit crunch all about??
The term credit crunch he is colloquial and refers to a restriction that exists with regard to the volume of credit to be granted on the part of the banks. The triggers and reasons for a credit squeeze can be very different, but they usually originate from the individual lender itself. For example, a bank may decide internally to grant fewer loans or to apply stricter standards when assessing creditworthiness. In principle, the term "credit crunch" is usually used when banking institutions reduce or completely stop granting loans, especially to companies. This happens then against the background that it would be actually possible to give more credits due to the market conditions. The credit crunch is therefore not a situation in which the banks are forced to restrict the volume of loans issued.
What are the triggers of a credit crunch?
There are several triggers of the credit crunch, which in practice can lead to banks limiting or even significantly reducing their volume of loans to be granted. More often, it is mainly the following triggers that can lead to a credit crunch at individual credit institutions or sometimes within the entire industry:
- Liquidity has deteriorated
- Problems with refinancing
- Change of business policy
In the cases mentioned, one reason for the credit crunch is more often that the credit institutions lack equity capital. One reason for this in turn can be a debt situation of the banks, but also general changes in the market, as shown especially in the financial crisis, can trigger a credit crunch.
When does one not speak of a credit crunch?
As mentioned at the beginning of this article, a credit crunch is not always automatically mentioned just because a bank is granting fewer loans. Untypical of a credit crunch, for example, is that lenders reject a loan application solely because the customer's creditworthiness is insufficient. This may result from the fact that the bank may apply stricter standards, but this does not lead to a general credit crunch and is not referred to as such. In addition, it may happen that the bank – perhaps due to a change in business policy – wants to lend less to companies within certain industries.
Possibly this is done because these industries are considered risky, so they are simply more cautious about providing capital. Again, this has nothing to do with a typical credit crunch. Another issue that is also not a credit crunch is a decline in demand from those seeking credit. In that case, there would also be significantly fewer loans or lower volumes in total, but of course this has nothing to do with a typical credit crunch.
Poor core capital ratio as a possible trigger for the credit crunch
When people talk about a credit crunch, the term core capital ratio often comes up in this context. This refers to the ratio of the bank's own funds to the total available capital funds. The core capital ratio depends above all on the bank's loan portfolio, which, as you know, is an asset item on the balance sheet. If the assessment of these assets should now also deteriorate, for example due to a worsened rating, this would result in the core capital ratio being lower. This, in turn, is due to the so-called solvency principles a cause for the fact that the banks can grant fewer loans. In order for this situation to improve again and for the core capital ratio to increase, banks have the task of either increasing their own core capital ratio or instead reducing the existing risky assets.