This paper analyzes financial intermediation, loanable funds, and the real sector using a model where firms and intermediaries are capital constrained. The study shows that capital tightening (credit crunch, collateral squeeze, or savings squeeze) disproportionately affects poorly capitalized firms. The model predicts that interest rates and monitoring intensity depend on relative changes in capital components. It aligns with observed patterns during recent financial crises in Scandinavia, where credit supply issues shifted to credit demand problems. The model suggests that in an unregulated environment, a credit crunch leads to lower solvency ratios for intermediaries, implying that more permissive capital adequacy requirements may be appropriate. The paper introduces a model where firms' net worth determines their debt capacity. Firms with high net worth can finance investments directly, while those with low net worth rely on intermediaries. Monitoring reduces the need for collateral, but intermediaries must invest their own capital to be credible monitors. The model shows that monitoring is a substitute for collateral, and the equilibrium in the monitoring market depends on the relative amounts of firm and intermediary capital. The study highlights that the effects of capital changes on investment, interest rates, and the role of direct vs. indirect finance depend on the financial status of both firms and intermediaries. The model is consistent with Scandinavian experience, where firms with substantial net worth use cheaper, less information-intensive finance, while highly leveraged firms require more information-intensive finance. When monitoring capital is abundant relative to firm capital, banks shift to more monitoring-based lending. Conversely, when monitoring capital decreases, capital-poor firms are the first to be squeezed. The paper concludes that capital adequacy ratios are procyclical, suggesting that looser banking norms may be appropriate in recessions. The model builds on previous literature on capital-constrained lending and provides insights into the role of different capital constraints. It also discusses the implications of endogenous monitoring, where monitoring intensity varies with aggregate and individual capital levels. The model shows that monitoring intensity is positively related to the amount of capital intermediaries must put up, and that the relative amounts of firm and intermediary capital affect aggregate investment. The study underscores the importance of capital constraints in shaping financial and real sector interactions.This paper analyzes financial intermediation, loanable funds, and the real sector using a model where firms and intermediaries are capital constrained. The study shows that capital tightening (credit crunch, collateral squeeze, or savings squeeze) disproportionately affects poorly capitalized firms. The model predicts that interest rates and monitoring intensity depend on relative changes in capital components. It aligns with observed patterns during recent financial crises in Scandinavia, where credit supply issues shifted to credit demand problems. The model suggests that in an unregulated environment, a credit crunch leads to lower solvency ratios for intermediaries, implying that more permissive capital adequacy requirements may be appropriate. The paper introduces a model where firms' net worth determines their debt capacity. Firms with high net worth can finance investments directly, while those with low net worth rely on intermediaries. Monitoring reduces the need for collateral, but intermediaries must invest their own capital to be credible monitors. The model shows that monitoring is a substitute for collateral, and the equilibrium in the monitoring market depends on the relative amounts of firm and intermediary capital. The study highlights that the effects of capital changes on investment, interest rates, and the role of direct vs. indirect finance depend on the financial status of both firms and intermediaries. The model is consistent with Scandinavian experience, where firms with substantial net worth use cheaper, less information-intensive finance, while highly leveraged firms require more information-intensive finance. When monitoring capital is abundant relative to firm capital, banks shift to more monitoring-based lending. Conversely, when monitoring capital decreases, capital-poor firms are the first to be squeezed. The paper concludes that capital adequacy ratios are procyclical, suggesting that looser banking norms may be appropriate in recessions. The model builds on previous literature on capital-constrained lending and provides insights into the role of different capital constraints. It also discusses the implications of endogenous monitoring, where monitoring intensity varies with aggregate and individual capital levels. The model shows that monitoring intensity is positively related to the amount of capital intermediaries must put up, and that the relative amounts of firm and intermediary capital affect aggregate investment. The study underscores the importance of capital constraints in shaping financial and real sector interactions.