Banks act as intermediaries between borrowers and depositors, creating new money through lending rather than holding pre-existing funds. This results in a pyramid of credit supported by equity. Demand for credit grew so large that banks outsourced risk through securitization and credit derivatives, creating an opaque shadow banking system. This extended pyramid funded a housing bubble which began to deflate in 2007, leaving no one knowing where the underlying risks lay, causing banks to stop lending to each other. The problem became one of solvency rather than liquidity as losses ate into bank equity while investors refused to recapitalize the shadow banking system.

1. The Credit Crisis explained in 30 slides...….

2. ........a Bank is a Credit Intermediary – or “Middleman” £ £ Bank Borrower Depositor

3. But rather than lending pre-existing money, it creates new money as interest–bearing credit….

4. … .which is then deposited back into the system

5. Now, if you think about it, a Bank’s true economic function.....

6. … is to guarantee that the borrowers’ credit is good…

7. Interest is charged for the use of the guarantee Interest Bank Borrowers

8. ..from which Interest is paid to Depositors.. Interest Interest Bank Borrowers Depositors

9. ..Default and Operating costs deducted... Interest Interest Costs Bank Borrowers Depositors

10. ..and a profit to Investors normally results Interest Interest Costs Investors Bank Borrowers Depositors

11. Result: Banks create a Pyramid of Credit, on a base of Equity Bank Credit Bank Equity

12. Demand for Credit has been so high…

13. … .that Banks began to “outsource” their guarantee to rid themselves of risk.

14. … and thus allow their Equity to support more credit creation

15. Banks outsourced risk totally – through “securitising” debt and sale to investors….

16. … temporarily – with “Credit Derivatives” (a time-limited guarantee)….

17. … and partially – using credit insurance from insurers such as AIG

18. The Result was a bigger Credit Pyramid than Banks alone could sustain… Investor Equity Credit Bank Equity

19. … and an opaque “shadow banking system” of Investors holding “sliced and diced” risk… Investor Equity Credit Bank Equity

20. The extended pyramid of Credit funded the Mother of All Bubbles in US property prices...

21. ....and in August 2007 the bubble started to deflate....

22. ..but by now no-one knew where the Risk lay… Investor Equity Credit Bank Equity

23. Banks started to think, “if this is what our balance sheet looks like…..”

24. “… what does everyone else’s look like…..?”

25. … and stopped lending to each other.......

26. The problem is not shortage of money - liquidity – Central Banks can handle that….

27. … ..it is shortage of Equity - a Solvency problem – which Central Banks cannot handle…..

28. Bank Equity is being eaten away by defaults….

29. … and Investors will not recapitalise the shadow banking system…

30. The Result? Equity Credit