What happens during a ‘credit crunch’ and how you can prepare for one
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The recent banking crisis has fueled concern of a “credit crunch” and the resulting negative impact on households, businesses and the U.S. economy.
But what is a credit crunch and how might you prepare?
Loans would be tougher to get
During a credit crunch, banks significantly tighten their lending standards.
Loans become tougher to get. Banks that offer them might do so with more onerous terms like high interest rates or other restrictions — making such financing more costly.
Overall, it becomes harder, for example, for households to buy cars and homes or fix their roofs, and for businesses to hire, expand and open new stores or factories. A cooling in bank lending flows down to the economy’s bottom line, making a recession more likely.
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“Credit is the mother’s milk of economic activity,” said Mark Zandi, chief economist at Moody’s Analytics.
“I’d be surprised if we don’t see a pretty significant tightening of credit in the near term, among small and midsize banks,” he added.
Of course, there must be a happy medium in a well-functioning economy, Zandi said.
Lending standards that are too loose can be damaging, too. During the financial crisis, for example, subprime mortgages issued en masse by banks triggered a housing crisis that ultimately cascaded into a deep recession.
Banks may prioritize a healthier balance sheet
A credit crunch seems likely given banking woes that have unfurled over the past two weeks.
Silicon Valley Bank and Signature Bank failed when depositors rushed to withdraw their money and the banks were unable to meet the cash demand.
Banks don’t keep all customers’ cash on hand. They make money off those deposits by investing some of the funds or lending it (and receiving interest payments).
Among SVB’s problems was an investment in long-term U.S. Treasury bonds. SVB locked up billions of dollars in these bonds, which lost money as the Federal Reserve started raising interest rates aggressively last year to combat high inflation.
What this all means: To avoid a similar fate, many banks will likely prioritize shoring up their balance sheets to weather a potential bank run, experts said.
Banks might crimp lending in order to have more cash on hand to meet customer redemptions, for example. Also, if bank customers withdraw funds, a bank might then have a smaller stockpile from which to make loans.
“You’re going to see a credit crunch happening in the U.S., and that’s starting to get priced into the market in a dramatic way,” Mike Novogratz, CEO of Galaxy Digital, an investment management firm, said in an interview with CNBC’s “Squawk Box” last week.
A severe credit crunch isn’t a foregone conclusion, though.
The extent of the banking contagion remains unclear, Zandi said. The nation’s…
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