CREDIT CRUNCH

Credit Crunch - An International Finance Perspective



Credit Crunch - An International Finance Perspective

Synopsis

This report will explain what the term “credit crunch” and what the background and causes that led to the problem. Will also advise and explain what policies that UK Government need to implement in order for the British economy to emerge from the recession caused by the “credit crunch”.

Introduction

The term “credit crunch” is used to describe a sudden cut in availability of loans or credit that include mortgage, credit cards, and inter-bank lending or when the cost of obtaining loans from the bank has suddenly increase.

The credit crunch makes it impossible for companies to loan because of the shortage in the availability of loans or credits from the banks and other lenders who are worried of rising bankruptcies and mortgage defaults (John 2008, 110). The banks or other lenders want to minimise their risk resulting by increasing the cost of obtaining the loans (i.e. charging higher interest rates) or reject all loans except for safest loans. During credit crunch, many businesses may have trouble with their cash flow causing them to lay off their employees or even close down due to insufficient funds resulting from inability to get loan or credit (Baba, Naohiko, and Frank Packer, 2008, 106).

How and why does it happen?

Background and Causes:

The credit crunch has been blamed for the more general economic downturn and everyone around the globe has been affected by it. The most obvious effect would be the slow-down in the housing market.

It seem that the cause of credit crunch is being blamed on thousands of borrowers who took out loans that they could not afford and fail to pay for in the long term, eventually abandoning the payments altogether. This leaves lenders having debts on trillions of dollars sitting in their books (Erdinc, 2004 79).

It believed that the credit crunch that we are been experiencing is cause by the ill lending decision making by the financial institution itself, where mortgages loan were being offered to people who really did not considered qualify for a mortgage (i.e. high risk of default).

To understand what had happen, first we need to know how the mortgages are funded and how they are funded. The financial institution got too much money available due to people depositing money into their saving account. The banks have keep certain percentage of the saving money as 'capital reserve' and the rest are use to make investment and to loan it out to people and organisations in order to make profit by charging interest on all the money they lend (Addison, 2001, 100).

The financial institutions generate in more creative ways and strategies of finding more and more potential borrowers, and had made number of loan increased with less regard to ability to repay. People who were considered a “good” risk already got a financing / mortgage loan were offered to get another loan. The banks even lowered their standards for those people who have low incomes to apply ...