Credit crunch and banking sector Essay Example | Topics and Well Written Essays - 3000 words

Credit crunch and banking sector - Essay Example Credit crunch was a strange term for people in the UK. But the phrase has become common as the extreme shortage of credit or money has caused the cost of credit to rise sharply and has led the financial world to realize the seriousness of the situation. The root cause of the credit crunch had started earlier when the US interest rates increased from 1 percent to 5.35 percent during 2004 to 2006 that created a slowdown to the housing market. This was followed by the default in mortgage payments by individuals who could barely afford the payments even when they had to pay low interest rates. The rate of default on sub prime mortgages (high risk loans) offered to customers with no or poor credit histories increased to record levels and these defaults in mortgage payment had an impact throughout the financial systems because many of the mortgages were combined and sold to investors and banks around the world (Timeline: Credit crunch to downturn 2009). Recklessness in the economy for a considerable period of time is a major factor that causes credit crunch. A period of very cheap credit, low interest rates, irresponsible lending and rise in housing prices mostly leads to a tipping point when bad debts begin to emerge and credit becomes an expensive affair and price of housing tumbles paving way for a credit crunch. Credit crunch is a negative factor for business, especially for the banking sector because it is exposed to high levels of risk with bad debts.