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The Credit Crunch – What does it mean?
Situation Overview
In recent weeks the news headlines have been dominated by the problem of the "credit crunch". But what is it, and what does it mean for individuals and families?
Global economic growth has been driven by access to cheap money; the ability to borrow at low rates. Recently the cost of borrowing, for both individuals and big institutions like banks, has been going up. Problems in the global economy, starting in the USA, have meant that the price of borrowing has become very high and so there is less money is available.
The trigger for this has been the slowing economy in the United States, which has given rise to a large number of mortgage payment defaults, particularly among the sub-prime market (higher risk mortgage owners with low, often inconsistent income streams). As interest rates go up, many mortgage payments increase and those with low incomes often struggle to meet the growth in their monthly expenses. Banks are afraid to lend because they run the risk of defaults, thus they choose to increase the costs of borrowing to cover this risk. This has brought about a widespread credit crunch.
The rise in the cost of borrowing money has made it harder for banks to access finance. This has created a liquidity (lack of money in the short term) problem for some banks, such as the problems at Northern Rock. It has not been able to borrow like it normally does to cover its mortgage lending and so had to apply for emergency help from the Bank of England to ensure it had the cash it needs available. This is, in theory, a short-term problem though the repercussions may be quite long term.
Implications for the Individual
The long, snaking queues outside Northern Rock branches throughout this week have left many wondering whether their money would safer in another bank or perhaps even safer under the bed!
However, whether you are a Northern Rock customer or not, there is no cause for concern. As the problem at Northern Rock was one of illiquidity (an inability to convert its assets into cash), not solvency (the ability to pay debts when they are due) according to the Financial Services Authority, the Bank of England's decision to inject £10bn into the banking system, with a potential £30bn to follow, has served to diminish the liquidity problem.
Previously, deposits in Northern Rock were only covered by the Financial Services Compensation scheme, which offered a maximum payout of £31,700. However, the Bank of England has made the decision to go beyond the Financial Services Compensation scheme and has promised to guarantee all deposits held by customers in Northern Rock. Thus there is no need to move your money to another bank or store it under your bed.
If you have taken your money out of Northern Rock, they are now offering to pay you back the interest that you have lost by taking the money out and are also willing to put your money back into your account without any transfer fees or penalty charges provided that you put your money back in by October 5th.
Whether at Northern Rock or another bank, using the banking system provides a great deal of security and is a much better option than keeping your money in a bag under the stairs. Have a look at the Banking section for more info about banking and the services that banks offer.
Future Outlook
While a month ago many would have expected interest rates to reach 6% by the end of the year, the changing economic circumstances have made this unlikely. Many are now forecasting that there could even be a rate cut by the year end to help to stem the problems that have arisen from the credit crunch. However, what is clear is that we are now in more uncertain times economically that we have been for some time.
Whatever the future holds, it is advisable to have a minimum of 3 months worth of your salary saved up to see you through difficult circumstances. Drawing up a budget can help you to stay in control of your finances and to live within your means. It can help you see where your money is going and to plan for future spending. A quick visit to the Budgeting section and to the Budget Calculator will allow you to set up a budget quickly.
Prepared for moneybasics by Jason Taylor, (Credit Action, Advocacy Officer).
In recent weeks the news headlines have been dominated by the problem of the "credit crunch". But what is it, and what does it mean for individuals and families?
Global economic growth has been driven by access to cheap money; the ability to borrow at low rates. Recently the cost of borrowing, for both individuals and big institutions like banks, has been going up. Problems in the global economy, starting in the USA, have meant that the price of borrowing has become very high and so there is less money is available.
The trigger for this has been the slowing economy in the United States, which has given rise to a large number of mortgage payment defaults, particularly among the sub-prime market (higher risk mortgage owners with low, often inconsistent income streams). As interest rates go up, many mortgage payments increase and those with low incomes often struggle to meet the growth in their monthly expenses. Banks are afraid to lend because they run the risk of defaults, thus they choose to increase the costs of borrowing to cover this risk. This has brought about a widespread credit crunch.
The rise in the cost of borrowing money has made it harder for banks to access finance. This has created a liquidity (lack of money in the short term) problem for some banks, such as the problems at Northern Rock. It has not been able to borrow like it normally does to cover its mortgage lending and so had to apply for emergency help from the Bank of England to ensure it had the cash it needs available. This is, in theory, a short-term problem though the repercussions may be quite long term.
Implications for the Individual
The long, snaking queues outside Northern Rock branches throughout this week have left many wondering whether their money would safer in another bank or perhaps even safer under the bed!
However, whether you are a Northern Rock customer or not, there is no cause for concern. As the problem at Northern Rock was one of illiquidity (an inability to convert its assets into cash), not solvency (the ability to pay debts when they are due) according to the Financial Services Authority, the Bank of England's decision to inject £10bn into the banking system, with a potential £30bn to follow, has served to diminish the liquidity problem.
Previously, deposits in Northern Rock were only covered by the Financial Services Compensation scheme, which offered a maximum payout of £31,700. However, the Bank of England has made the decision to go beyond the Financial Services Compensation scheme and has promised to guarantee all deposits held by customers in Northern Rock. Thus there is no need to move your money to another bank or store it under your bed.
If you have taken your money out of Northern Rock, they are now offering to pay you back the interest that you have lost by taking the money out and are also willing to put your money back into your account without any transfer fees or penalty charges provided that you put your money back in by October 5th.
Whether at Northern Rock or another bank, using the banking system provides a great deal of security and is a much better option than keeping your money in a bag under the stairs. Have a look at the Banking section for more info about banking and the services that banks offer.
Future Outlook
While a month ago many would have expected interest rates to reach 6% by the end of the year, the changing economic circumstances have made this unlikely. Many are now forecasting that there could even be a rate cut by the year end to help to stem the problems that have arisen from the credit crunch. However, what is clear is that we are now in more uncertain times economically that we have been for some time.
Whatever the future holds, it is advisable to have a minimum of 3 months worth of your salary saved up to see you through difficult circumstances. Drawing up a budget can help you to stay in control of your finances and to live within your means. It can help you see where your money is going and to plan for future spending. A quick visit to the Budgeting section and to the Budget Calculator will allow you to set up a budget quickly.
Prepared for moneybasics by Jason Taylor, (Credit Action, Advocacy Officer).
