What is credit rationing

Abhijeet Gaurav

Credit rationing – a situation in which lenders are unwilling to advance additional funds to borrowers at the prevailing market interest rate – is now widely recognized as a problem arising because of information and control limitations in financial markets. Broadly speaking, ‘credit rationing’ refers to any situation in which lenders are unwilling to advance additional funds to a borrower even at a higher interest rate. In the words of Jaffee and Modigliani , ‘credit rationing is a situation in which the demand for commercial loans exceeds the supply of these loans at the commercial loan rate quoted by the banks’. Key to this definition is that changes in the interest rate cannot be used to clear excess demand for loans in the market. In essence, this definition treats credit rationing as a supply-side phenomenon, with the lender’s supply function becoming perfectly price inelastic at some point. We reserve the term credit rationing for circumstances in which either (a) among loan applicants who appear to be identical some receive a loan and others do not, and the rejected applicants would not receive a loan even if they offered to pay a higher interest rate; or (b) there are identifiable groups of individuals in the population who,with a given supply of credit, are unable to obtain loans at any interest rate, even though with a larger supply of credit, they would. This means that the lender (one who lends the money) is already making profit so he doesn't wishes to lend more credit that is money to borrower even at higher interest rates because they want to maintain the equilibrium in the market between loan money & the credit. Basically means that the demand is high but supply is low even when borrower is giving high interest rates. It mainly happens in developed country because they already would have exceeded the limit so they don't want to further risk their business or their financial asset.