Credit Rationing

Credit rationing refers to the situation where lenders limit the supply of additional credit to borrowers who demand funds, even if the latter are willing to pay higher interest rates. It is an example of market imperfection, or market failure, as the price mechanism fails to bring about equilibrium in the market. It should not be confused with cases where credit is simply "too expensive" for some borrowers, that is, situations where the interest rate is deemed too high. On the contrary, the borrower would like to acquire the funds at the current rates, and the imperfection refers to the absence of equilibrium in spite of willing borrowers. In other words, at the prevailing market interest rate, demand exceeds supply, but lenders are not willing to either loan more funds, or raise the interest rate charged, as they are already maximising profits.

Credit rationing is not the same phenomenon as the better-known case of food rationing, common in times of war. In that case, shortages lead governments to control the food portions allocated to individuals, who would be willing to pay higher prices for more portions. However, credit rationing is not necessarily the result of credit shortages but rather of asymmetric information. More importantly, food rationing is a result of direct government action, while credit rationing is a market outcome.

Two main types of credit rationing can usually be distinguished. "Redlining" refers to the situation where some specific group of borrowers, who share an identifiable trait, cannot obtain credit with a given supply of loanable funds, but could if the supply were increased. More importantly, they would not be able to get loans even if they were willing to pay higher interest rates. "Pure credit rationing" refers to the situation where, within an observationally indistinguishable group, some obtain credit, while others do not, and will not receive credit even if they are willing to pay a higher interest rate. A third and less interesting type is disequilibrium credit rationing, which is a temporary feature of the market, due to some friction preventing clearing.

Read more about Credit Rationing:  Theoretical Background, Equilibrium Credit Rationing - Stiglitz and Weiss, Other Contributions

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Famous quotes containing the word credit:

    Laws remain in credit not because they are just, but because they are laws. That is the mystic foundation of their authority; they have no other.
    Michel de Montaigne (1533–1592)