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Subject 2. Credit Cycles PDF Download

The credit cycle describes recurring phases of easy and tight borrowing and lending in the economy.

Credit availability is determined by risk and profitability to the lenders. The lower the risk and greater profitability to lenders, the more they are willing to extend loans. During high access to credit in the credit cycle, risk is reduced because investments in real estate and businesses are increasing in value; therefore, the repayment ability of corporate borrowers is sound. Individuals are also more willing to take out loans to spend or invest because funds are cheaper and their incomes are stable or on the rise.

During the contraction period of the credit cycle, interest rates climb and lending rules become more strict, meaning that less credit is available for business loans, home loans, and other personal loans. The contraction period continues until risks are reduced for the lending institutions, at which point the cycle troughs out and then begins again with renewed credit.

The average credit cycle tends to be longer, deeper and sharper than the business cycle, because it takes time for a weakening of corporate fundamentals or property values to show up. In other words, there can be an over-extension of credit in terms of amount and period, as spectacularly demonstrated last decade.

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