RECENT CREDIT CRUNCH

“The Main Factors that Contributed to the Recent Credit Crunch, and Assess to what Extent the internationalisation of the Financial Markets was Responsible”

“The Main Factors that Contributed to the Recent Credit Crunch, and Assess to what Extent the internationalisation of the Financial Markets was Responsible”

Introduction

Many bankers, legislators, borrowers, and regulators have expressed their views about the cause of the credit crunch. Like the blind men examining an elephant, each has an opinion that has been formed from his perspective. Each has characterized the problem and potential solutions differently. None are completely correct or completely wrong.

Bankers cite the lack of high quality loan demand. Legislators blame overzealous regulators. Borrowers say banks are too conservative. Regulators encourage bankers to lend and tell their examination staffs to facilitate the extension of credit but maintain the safety and soundness of the banking system. Many economists studying the credit crunch explain it as a cyclical decline in credit demand. They often suggest that the cyclical swing is reinforced by structural changes in the demand for credit. These economists have minimized the numerous important factors that have reduced the ability of banks to supply credit or, at a minimum, have increased the cost of providing it. In this article, we view credit crunches as localized events that occur at different times in different parts of the country. (Coutinho 2002)

The Texas banking industry provides an important case study. The causes of the Texas credit crunch are highly similar to the causes of credit crunches that have developed elsewhere in the country. We focus on the past seven years because the contraction of bank credit began in Texas in 1986. While demand may play an important part in the decline in loans outstanding during some of this period, we focus on the factors affecting the supply of loans from banks over the past seven years. While there are other sources of credit to business, banks continue to be vitally important, specially to small and mid-size businesses.

Many of the factors that are limiting credit supply from banks also affect other suppliers of credit. In some cases, however, the factors limiting credit from banks are unique to banks and place banks at a competitive disadvantage. As discussed in the next section, the definition of a credit crunch is fundamentally related to the supply of credit, as opposed to the demand for it. The following section presents the complexity of the credit crunch as it developed in Texas, where supply was reduced at both financially healthy and unhealthy banks. In the remainder of the article, we present six general factors that caused the supply of credit to contract. (English 2003)

What is a credit crunch, and are we in one?

The economics profession is unclear as to what constitutes a “credit crunch.” The crucial differences in definition depend on the cause of the contraction and whether credit is rationed by means other than price Credit normally contracts during a recession, but an unusually large contraction could be ...