Credit rationing

Credit rationing is the limiting by lenders of the supply of additional credit to borrowers who demand funds, even if the latter are willing to pay higher interest rates. It is an example of market imperfection, or market failure, as the price mechanism fails to bring about equilibrium in the market. It should not be confused with cases where credit is simply "too expensive" for some borrowers, that is, situations where the interest rate is deemed too high. With credit rationing, the borrower would like to acquire the funds at the current rates, and the imperfection is the absence of equilibrium in spite of willing borrowers. In other words, at the prevailing market interest rate, demand exceeds supply, but lenders are not willing to either loan more funds, or raise the interest rate charged, as they are already maximising profits.

Credit rationing is not the same phenomenon as the better-known case of food rationing, common in times of war. In that case, shortages lead governments to control the food portions allocated to individuals, who would be willing to pay higher prices for more portions. However, credit rationing is not necessarily the result of credit shortages but rather of asymmetric information. More importantly, food rationing is a result of direct government action, while credit rationing is a market outcome. Three main types of credit rationing can usually be distinguished:

One of the main roles markets play is allocational; they allocate goods to the buyers with the highest valuation. Market equilibrium occurs when the demand of a good at the equilibrium price is equal to the supply of the good. If prices are deemed "too high" by the consumers, supply will exceed demand, and sellers will have to reduce their prices until the market clears (i.e. equilibrium is reached). On the other hand, if prices are "too low", then demand will be higher than supply, and prices will have to be raised to obtain market clearing.

The graph to the right shows this simplified case for the credit market. The interest rate is denoted by r, and S and I denote savings and investment respectively. This is a highly stylised example, where one abstracts from changes in output, and where the economy is in financial autarky (and, consequently, savings and investment express the supply and demand of loanable funds, respectively).

...
Wikipedia