It’s rare the phrase ‘credit crunch’ is out of the media these days but what is it and how does it relate to the credit cards you have or would like to have?

What is this ‘credit crunch’?

In the early part of this decade big banks including high street names you will recognise such as HSBC, Lloyds TSB and Barclays began investing in financial packages known as Collateralised Debt Obligations (CDOs for short). Think of CDOs is as a music compilation, you buy the record because it has some songs that you like and are willing to pay for but to fill out the album the record label has included songs which aren’t so good that you certainly wouldn’t buy on their own.
CDOs are the financial equivalent – they are unrelated debts which have been packaged together, some of the debt is good i.e. the debtor will almost certainly pay it back, but some of the debt is bad i.e. the debtor is unlikely to pay it back.

This is where the now infamous America sub-prime housing market comes in. Unscrupulous lenders were giving mortgages to risky Americans who were unlikely to be able to make the payments, and then selling that debt on as part of a CDO to other financial institutions. These financial institutions weren’t aware of the high level of risk they were taking on because the rating agencies classed the CDO according to the best debt in the package rather than the worst.

This couldn’t last forever and when those people in the US stopped paying back their mortgages the big banks looked at their books and discovered the unpleasant truth; that a lot of what they thought of as safe assets where actually worth much less than they thought.

This has plunged some banks in to real trouble; notably Northern Rock in the UK and Bear Sterns, Merrill Lynch and Citigroup in the US though few if any major banks have been wholly unaffected.

OK fine, but how does that relate to me?

When lending to you via a loan, mortgage or credit card, banks don’t usually borrow money directly from the Bank of England or other central banks. It is in fact mostly borrowed from other banks at a rate know as the London Inter-Bank Offered Rate (LIBOR). Because all the banks are now suspicious that other banks may be holding back a large loss which would mean that they were unable to repay their loans, they are increasing the costs of lending to off-set these perceived risks.

That means that the money that you are borrowing from the financial institutions, for example which is owned by Citigroup now has to be borrowed from another bank, say Barclays, at a more expensive rate than previously.
What this means in practice is that APRs will increase, promotional rates such as and may reduce and the criteria used to accept you or not will become more stringent.

So it’s a bad time to get a credit card?

There have been few obvious immediate consequences of the credit crunch on the UK credit card market. did cancel the accounts of more than 160,000 customers though that would probably have happened anyway. Indeed the 0% balance transfers and purchases promotions offered by the major card issuers such as , , , and others in the fiercely competitive UK market are largely unaffected if not improved.

Depending on how this ‘credit crunch’ plays out this might continue to be the case but it if you are thinking of getting a credit card it might be wise to get one now before the big banks decide it’s no longer worth promoting such good offers when their margins are being squeezed by the cost of funds.