THE IMPLICATION OF CREDIT CRUNCH IN THE SOUTH AFRICAN BANKING SECTOR

A credit crunch occurs when there is a lack of funds available in the credit market, making it difficult for borrowers to obtain financing. This happens when lenders have limited funds available to lend or are unwilling to lend additional funds, or have increased the cost of borrowing to a rate that is unaffordable to most borrowers (Investopedia, 2009). When lending institutions have suffered losses from previous loans, they are generally unwilling or unable to lend. This occurs when borrowers default on payments and the properties underlying a defaulted loan decline in value. In this situation, as borrowers default, banks foreclose on the mortgages and attempt to sell these properties to regain the funds they loaned out. Consequently, if home prices fall, the bank is left selling at a loss. Banks are required to retain minimum levels of liquidity (capital), when they suffer losses, their capital positions are reduced, which reduces the amount they are able to lend out. Credit crunches can also occur when regulatory bodies increase capital requirements for financial institutions. Banks and other lenders are required to maintain a set amount of capital liquidity based on their risk weighted level of assets. If this requirement increases, many banks will need to increase capital reserves. To comply, banks will cut lending, reducing the availability of loans for individuals and companies.