CREDIT CYCLE

A cycle involving the access to credit by borrowers. Credit cycles first go through periods in which funds are easy to borrow; these periods are characterized by lower interest rates, lowered lending requirements and an increase in the amount of available credit. These periods are followed by a contraction in the availability of funds. During the contraction period, interest rates climb and lending rules become more strict, meaning that less people can borrow. The contraction period continues until risks are reduced for the lending institutions, at which point the cycle starts again.

Credit availability is determined by risk. The lower the risk to lenders, the more they are willing to lend. During high access to credit in the credit cycle, risk is reduced because investments - such as real estate and businesses - are usually increasing in value. Individuals are also more willing to take out loans because interest rates are lower.

After the peak, the assets and investments usually begin to decrease in value, or they do not return as much income, making it harder to pay back loans. Banks then tighten lending requirements and raise interest rates. This is due to the higher risk of borrower default. Ultimately, this cuts down the available credit pool which brings the credit cycle to the low access point.