The Credit Crunch How the economy functions (and why we rely on credit)
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Transcript of The Credit Crunch How the economy functions (and why we rely on credit)
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 banksBusiness 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
ASSETSDepositors cash
+ Loans from other banks+ Shareholder funds
LIABILITIESBusiness 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 can’t 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 arun on the bank.
People withdraw their savings
Other banks try to withdraw loans
... And quickly go bust!
ASSETSFewer deposits
+ Funds from other banks withdrawn
LIABILITIESIncreased by bad debts (borrowers who won’t
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 banksBusinesses 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 columnBanking as Usual During 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