Credit crunch, often regarded to as credit crises, is an economic situation where there is a reduction in the general availability of loans or credit. During this period, investment capital is hard to obtain as banks and investors become strict in lending out funds to individuals and business bodies. It’s an extension of the recession period. Credit crunch makes it very difficult for individuals and businesses to borrow because lenders and investors are scared of defaults, bad debts, bankruptcies, this leads to a rise in interest rate which discourages borrowers. Since there is a reducing credit supply, recession then comes in.
In the year 2007-2008, there was a global financial crisis which affected almost all nations, this was commonly referred to as the credit crunch(Hunt,2009). The question is not about what caused it as the causes and solutions of the financial crisis were not farfetched but the question here is that can the financial crisis happen again? Rather, can there still be a credit crunch in Nigeria? The answers to these questions can be answered when we know the causes of the problem.
A quick guess that often comes to one’s mind when asked about the likely cause of credit crunch is that there is a rise in the required reserve ratio (RRR) since it affects the supply of credit. However, the reserve ratio in Nigeria stood at 22.50% since 2015. This shows that the RRR isn’t the leading factor or cause of the credit crunch. A study showed that some of the causes of credit crunch are:
1.The rise in nonperforming loan: this is a major cause of credit crunch. A non- performing loan is referred to as a loan which the interest and principal is due and unpaid for 90 days or more. Non-performing loans shrink the profitability of banks and therefore decreases the loanable fund of banks.
The data below shows the rate of non-performing loan in Nigeria from 2007 to 2017.
The rates of nonperforming loans in Nigeria have been fluctuating over the years. However, in year 2009, the rate increased from 6.30% to 37.3%. This can be attributed to the global financial crisis which ended the year before. The high proportion of non-performing loans (NPLs) to total loans and advances of the banking system is the main cause of financial crisis both in developing and developed nations. The rate declined afterwards but in 2016, the rate increased again from 4.90% to 12.58%, this can be attributed to the fact that during the period, there was recession in the economy and this led to credit crunch which extended to 2017.
2. Excessive credit creations by banks: financial institutions, banks in particular are always ready and are so lenient in offering credit facilities because of the interest that will be accrued to them, so they give out credit to individuals and businesses with questionable ability to repay. This results in losses for the bank or investors thereby reducing the profits and reducing the amount of credit available.
3. Business Cycles: A business cycles shows the period of growth or decline in the economy. During periods of economic growth and boom, financial institutions tend to have an increased level of credit facilities, but when there is a decline in the economy’s growth, banks tend to reduce the credit made available to the public and also increasing the interest rates, this leads to a credit crunch.
IMPACTS OF CREDIT CRUNCH ON THE NIGERIA ECONOMY.
- Credit crunch which signifies a fall in bank lending will lead to a reduction in total investment as domestic investors won’t have the available funds to go on with their businesses. Consumers are not left out as their spending will fall.
- The credit crunch issue affected most sectors of the economy especially small and medium enterprises. Since funds weren’t available for individuals and businesses to continue their operations, most firms closed down, prices in stocks crashed and in general, this led to a fall in the real gross domestic product and also a fall in output.
- Credit crunch occurs as an extension of recession, during recessions government borrowing will increase. An alternative for the Government is to cut spending (Austerity) and increase tax rate. However, austerity in periods of election will further lead to a fall in aggregate demand.
- Since credit crunch led to a fall in the money supplied into the economy, price increased and therefore led to inflation. During the financial crisis in 2008, inflation rate doubled, Inflation rate increased from 5.4% in 2007 to 11.6% in 2008. Also in 2016, when there was recession, the inflation rate increased from 9.0% to 15.7%.
Conclusively, it is difficult to state if the Nigeria economy will experience a credit crunch again with the fluctuation in macro-economic variables. To prevent another financial crisis/credit crunch therefore, financial regulators of the economy especially the Central Bank of Nigeria should implement regulations using the regulations used then in the 2007/18 financial crisis as a checkmate. This will help to foresee if the financial crisis is about to happen and help in preventing it.
By Oladele Abigail
Oladele Abigail, an economics student of Bowen University who applies her passion for writing to her career path.
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