Banks and other creditors become reluctant to lend money during a credit crunch. Both private companies and individuals notice the change. Banks are more apprehensive regarding lending because there is a greater risk of defaults in a credit crunch. This is due to other political problem or adverse economic conditions. During credit crunch, lenders become more selective about who they lend to and their focus shifts from quantity to quality. In a credit crunch, lower income groups suffer significantly. The accounts of defaults reduce the interest rates. In 1929, after the Wall Street crash there was a period of deflation for over 3 years where money was not available to people and most of the population became jobless. The major causes of credit crunch is that the lenders become lenient in giving loans and slower recovery of loans also causes credit crunch.
In US, in beginning, the lenders and banks were doing well and lend money with no worries. There were many people who took loans and when they had to pay the loans gave the money to the bank in the given period of time. But later on, the lower income group, people with low credit score and unreliable people were given loans and they in return, constructed houses for themselves. There was an assumption that the market in real estate will always increase and when they purchased the land with the loan amount, they thought that they had enough to pay back to the bank. But as the market of the real estate increased, more and more people took loans which were never given loans and all of them invested their money in the real estate due to which the market slowly started going in negative equity due to scarcity in the land. The people who lend the money never thought that they will get their money back due to the deflation in the rates of the real estate market. This led to the reduction in the interest rates as the lenders wanted their money back in time, but in return more people took money as loans which made money difficult to flow around the world. Credit crunch is defined as the reduction in the availability of loans, reduction in the interest rates and lessening of credit. Lenders and investors from small to medium investment groups do careless lending with inadequate information about borrowers which can lead to contraction to credit. A liquidity crisis occurs when a business finds difficult to grow and a credit crisis occurs when the credit is made unavailable to people due to bankruptcies and recession.
When people suffer from credit crunch, it becomes difficult for banks to lend money to the people and the money is not made to grow as the borrowers find it difficult to pay back the money regardless of the interest rates. The banks lower the interest rates when they need the money back instead the rates must be made high in case of recovery so that no one suffers from credit crunch. But the lower rates of interest compel other people to buy loans and make the economy worse after which the economy grows at a very slow rate trying to get the money back.
Conclusion: The credit crunch is a financial issue which every country suffers. People must take loans and pay back the amount with interest in the given period of time so that the money flow remains constant and every citizen of the country is made to grow economically.
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