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Understanding the Impact of a Credit Crisis on Loan Applications – Only Money

The current banking crisis, in which banks such as Silicon Valley Bank and Signature Bank have been involved, has brought to the table a serious problem that few have talked about and that would affect millions of American consumers: the credit crunch.

A credit crunch is one that occurs when banks significantly tighten their lending standards. In a nutshell, loans are getting harder to come by. Banks that offer them may do so with more onerous terms, such as high interest rates or other restrictions, making such financing more expensive.

This situation makes it more difficult to buy cars, houses, make repairs and other types of large purchases. For companies, there is no hiring or expansion with new stores or factories. A tightening in bank lending causes the economy to cool, making a recession more likely.

Both Silicon Valley Bank and Signature Bank failed when depositors withdrew their money in a run on the banks, unable to meet the demand for cash. If consumers did not know, lThe banks do not have on hand all the cash that is deposited. They earn money on those deposits, investing part of the funds or making loans and receiving interest on them.

For example, among SVB’s problems was an investment in long-term US Treasury bonds. SVB locked up billions of dollars in these bondswhich lost money when the Federal Reserve began raising interest rates aggressively last year to combat high inflation.

Some banks could weather potential bank runs, restricting lending to have more cash available and comply with customer refunds.

“We’re going to see a credit crunch in the US, and that’s starting to take a toll on the market in a dramatic way,” Mike Novogratz, chief executive of Galaxy Digital, an investment management firm, said in a interview with CNBC last week.

Before the recent chaos, banks had already been reducing the flow of credit to businesses and households.

In the fourth quarter of 2022, banks reported that tightened their standards for credit cards, home equity lines of credit, auto loans and other consumer loans, according to the latest Federal Reserve Senior Loan Officers Opinion Survey. They reported raising the minimum credit scores required to guarantee such loans, for example.

A significant share also tightened standards for commercial and industrial lending to businesses, according to the survey.

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