Bank Lending Standards Tighter, Fed Says

by: Tom Lindmark

Banks aren’t loosening their purse strings at all. In fact, it looks like they’ve decided to put their pocket books away for the foreseeable future.

The Fed’s quarterly report on bank lending standards was released today and it confirms what just about everyone knows, the banks are getting stingier. Here are some details from MarketWatch:

Banks were still clamping down on lending to businesses and consumers over the past three months, and they said they planned to keep their credit standards tight for at least a year, the Federal Reserve reported Monday.

In its quarterly survey of banks’ senior loan officers, the Fed said lending standards got even tighter for almost every type of loan, from prime residential mortgages to commercial and industrial loans. The survey covered May, June and July.

Banks have been tightening their standards for various types of loans for more than two years. For residential mortgages, banks have tightened their standards for 11 straight quarters by increasing requirements for down payments, interest-rate spreads, or credit scores.

In the most recent survey, no banks reported easing their terms for residential real estate loans, commercial real estate loans, or consumer credit cards. Less than 4% of banks said they had eased terms on commercial and industrial loans and for home-equity loans.

Given that the FDIC is going to need some more capital to shore up its insurance fund that has been depleted by bank failures, I suppose it’s worth asking whether we truly want banks to be pumping money out the front door. It seems that tightening is in order at this particular time and perhaps the banks’ response tells us something about the economy that reams of government statistics fail to reveal.

Banks, particularly smaller banks, tend to have a fairly good sense of the condition of the local economy in which they operate. You can learn a lot from lunch or golf with the local plumbing and heating contractor or a beer after work with one of your retail clients. Just maybe, these banks are hearing and seeing things that tell them lending into the current environment isn’t the wisest business plan at this moment.

Another part of the study also caught my attention:

The Fed asked the banks when they thought their policies would get back in line with their long-term trend. For commercial and industrial loans to businesses, just 13% said conditions would return to normal by the middle of 2010, with another 36% saying it would be in late 2010.

For commercial real estate, just 2% said normal credit policies would return within a year, and 40% said policies would remain tighter than usual for the foreseeable future.

For prime mortgages, 9% said they expected policies to return to normal within a year, and 42% said policies would remain tighter than usual for the foreseeable future.

For nonprime borrowers, a majority of banks said policies would remain tighter than normal for the foreseeable future, and fewer than 10% said standards would normalize within the year.

I didn’t see a definition of normal in the article, so I am left wondering what the Fed defines as normal lending standards. One would hope that it isn’t the standards that persisted during the bubble years, but what is it. Based on the numbers cited in the article, I am inclined to think that the banks may believe that normal is something much closer to the standards under which they currently operate as opposed to the policies and procedures that applied earlier in the decade.

If we are going to honestly deal with excessive leverage and over-consumption along with the financial peril of overly agressive bank lending, then underwriting standards have to become more strict and stay that way. Let’s hope that normal is something with which we are not familiar.

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