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In: Finance

One of the factors contributing to the 2008-2009 recession was the unwillingness of commercial banks to...

One of the factors contributing to the 2008-2009 recession was the unwillingness of commercial banks to extend loans to customers, some of whom were quite creditworthy. This unwillingness led to what was called a "credit crunch." Discuss reasons why banks would become reluctant to extend credit to customers, and how the financial reporting system represents these loans on the banks' financial statements.

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Expert Solution

The financial crisis of 2008 has made commercial risk averse for few years and therefore, they started to become reluctant for extending loans to even individuals and businesses with good credit worthiness. As the old proverb says "Once bitten, twice shy", due to the subprime crisis of 2008 banks became shy in lending money to people who may have even few % chances of default on repayment, which otherwise in normal course of business would be 'okay' for banks. Therefore, the impact of financial crisis was huge on banks and their lending abilities. This has created credit crunch in the economy, they were not ready to lend money and hence economy takes a hit due to such actions of the banks. Some other reasons for bank's such behaviour were stringent rules applied by the Federal reserve after the emergence of financial crisis, risk aversion among banks and also borrowers to some extent etc. The financial reporting system will represent these loans as 'debt investments' in financial statements of banks.


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