Financial Intermediation, Loanable Funds, and the Real Sector

During the late 1980s and early 1990s several OECD countries appeared to be suffering from a credit crunch. Higher interest rates reduced cash flows and pushed down asset prices, weakening the balance sheets of firms. Loan losses and lower asset prices (particularly in real estate) ate significantly into the equity of the banking sector, causing banks to pull back on their lending and to increase interest rate spreads. The credit crunch hit small, collateral-poor firms the hardest. Larger firms were less affected as they could either renegotiate their loans or go directly to the commercial paper or bond markets.