The Credit Crunch How the economy functions (and why we rely on credit)

Learning Objectives At the end of this lesson, you should know: How banks fit into the economy Why banks stop lending Definition of a credit crunch How a credit crunch effects ordinary people

Key terms you need to know DEPOSITOR: Someone who hands their cash over to a bank for safe keeping. LOAN: A sum of money that is lent, and repaid with interest. MORTGAGE: a loan from a bank to fund the purchase of a house or flat. CREDIT: Money (or the promise of money) loaned to people or businesses that need it.

How banks work MEGABANK Ordinary people deposit their savings Depositor Personal borrowers (eg taking a mortgage to buy a house) Banks borrow money and lend it to people and businesses who will repay these loans with interest Other banks Business borrowers (eg taking a loan to build a new factory) Other banks lend money

Banks cannot lend more money than they have (or can borrow) MEGABANK ASSETS Depositors cash + Loans from other banks + Shareholder funds LIABILITIES Business loans + Mortgages + Personal loans CANNOT BE LESS THAN >>

Why banks stop lending MEGABANK And unemployed people may find it hard to repay their mortgages If businesses and people start to loose money, and cant repay their loans, then the bank will have less cash. The bank will have less money to loan out. But businesses can shrink and sack workers Normally, loans are repaid bit by bit every month

If loans go bad the bank may loose depositors and lenders... MEGABANK If a bank looks like it cannot pay back money, then the people and banks that have DEPOSITED money may withdraw. This is called a run on the bank. People withdraw their savings Other banks try to withdraw loans

... And quickly go bust! ASSETS Fewer deposits + Funds from other banks withdrawn LIABILITIES Increased by bad debts (borrowers who wont repay) MEGABANK

What is a credit crunch Many of the banks around the world lend to each other every day, and have long-term investments in other banks SO, if one bank reduces lending (and keeps the cash to itself), then all the others will reduce lending The CREDIT CRUNCH is a result of every banks reducing lending at the same time, and means that no one is able to borrow money easily

The Credit Crunch in action MEGABANK Depositor People are unable to get a mortgage and so cannot buy a house Other banks Businesses are unable to invest in new factories or services People stop depositing money Banks stop lending to each other Megabank will try to preserve what cash it has by stopping lending

How will the credit crunch effect you and me Some of the ways the credit crunch may effect ordinary people: – Moving house: mortgages are harder to arrange, and so buying a new house takes longer – Starting a new business: more difficult to get the investment needed – Personal loans: more expensive to get a new car – Jobs: businesses try to save money by firing workers or stopping hiring new employees

Where do banks get their money? All of the above From businesses repaying their loans From stockmarket investors From other banks From individuals with savings accounts

Why do banks lend money? All of the above Because the law says they must Because they need to give it away So that the bankers have a job to do So that they can earn interest on the loans

What happens in a credit crunch? All of the above People find it difficult to borrow from any bank There is an increase in car crashes Banks start lending money for free There are lots of earthquakes around the world

Put the statements in the right column Banking as UsualDuring a Credit Crunch People with a steady job and a deposit can get a mortgage Even people with good jobs and a large deposit may not get a mortgage Banks can get extra money by borrowing from other banks Any bank will find it difficult and expensive to borrow extra money Established, profitable businesses can get cheap loans Profitable businesses can only get bank loans at high interest rates