Document Type

Master's Culminating Experience

Publication Date

2012

Abstract

This study of the Great Recession of 2007-2009 and the credit crunch phenomenon suggests that there is an ongoing rationing effect on bank loans following the financial crisis of 2008. The rationing effect may lead to lower interest rates as banks switch to safer lending in order to hedge risk. However, the credit crunch may be inequitable as it primarily affects bank dependent borrowers, as well as restricting lending to new customers. An in-depth review of the current literature, empirical studies, leading economic indicators, and bank surveys are examined to reach this conclusion. We find that there are real economic effects due to the monetary transmission mechanism of credit. The risk-based capital standard (RBC) associated with the Basel Accords is a contributing factor of the credit crunch phenomenon. The capital standard restricts bank lending, most notably during periods of economic downturn, but also provides incentives for banks to reconfigure their portfolios towards securitized assets. These incentives created by the Basel Accords for banks to shift their portfolios towards securities may have had an integral role in the growth of the subprime mortgage market leading to the financial crisis of 2008. It is recommended that the risk-based capital standard should be re-examined in order to free up credit markets and incentivize banks to shift away from investing in government securities rather than private loans.

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