Don't Push Banks to Make Bad Loans: Contrary to myth, commercial bank lending is up

Don't Push Banks to Make Bad Loans. By Vert Ely
Contrary to myth, commercial bank lending is up. So are standards.
WSJ, Feb 02, 2009

There is a widespread belief that banks are now refusing to lend as much as they should, and that Congress should pressure them to extend more credit to consumers and businesses.

In reality, banks as a whole increased their lending during 2008 -- the notion they haven't is based on a misunderstanding of U.S. credit markets. Pressuring banks to lend more could backfire.

Lost in too many discussions of the financial sector is that banks and other depository institutions account for only 22% of the credit supplied to the U.S. economy (down from 40% in 1982). "Shadow banking" -- notably asset securitization and money-market mutual funds -- now supplies 33% (up from 14%). Insurance companies, other financial intermediaries, nonfinancial firms and the rest of the world provide the balance.

As far as commercial banks go, Federal Reserve data released last week show that their lending increased 2.36% during the last quarter of 2008. For all of 2008, commercial-bank lending rose by $386 billion, or 5.63%, even as the economy slid into recession. Over that 12-month period, business lending jumped $152 billion, or 10.6%, real-estate loans were up $213 billion, or 5.9%, and consumer lending rose $73.5 billion, or 9%. Other categories of bank lending such as loans to farmers, broker-dealers and governments, declined $53.2 billion, or 5.4%.

Fed data also show that during the first three quarters of 2008, the total amount of credit supplied to the economy increased $1.91 trillion, or 3.8%, with $540 billion of that amount coming from foreign lenders.

Nevertheless, Treasury recently demanded that the 20 largest recipients of government capital investments start providing detailed monthly reports about their lending and investment activities. This new requirement could lead to government lending mandates. That would not be a good idea.

In the first place, the drop in stock-market and house prices has made millions of families feel poorer and led them to save more than in recent years. It has also encouraged them (especially Baby Boomers approaching retirement) to pay off debt. They don't need more debt.

More broadly, many of the most creditworthy neither need to nor want to borrow right now. Richard Davis, CEO of U.S. Bancorp, recently said that he is seeing the demand for loans diminish at his and other banks "from people and businesses spending less and traveling less and watching their nickels and dimes."

Lenders moreover have tightened lending standards, correcting an excessive laxness that contributed to our financial mess. Zero or very low down-payment mortgages are out, as are "covenant light" corporate loans. Likewise, lenders have trimmed credit-card limits and cut the amount of money available under home equity lines of credit as home values have declined.

And contrary to the "lend more" message broadcast from inside the Washington Beltway, bank examiners are criticizing weak loans and forcing banks to tighten lending standards. Bankers are caught in a vise between politicians and examiners.

A lot of the credit tightness is a reflection of the near-collapse of loan securitization. Recent Fed plans to buy asset-backed securities may help revive asset securitization, but bankers have no control over the fate of that initiative.

The economy is in recession and working off the consequences of a housing bubble fed by excessive mortgage credit. Given that loan demand typically falls during a recession, it's amazing that bank lending increased as much as it did last year. It was essentially flat during the 2001 recession.

Bankers should always lend prudently, as they are now doing. If they are jawboned or worse by Washington into reckless lending, the U.S. will set itself up for another debt crisis, even before the present mess has been cleaned up.

Mr. Ely, the principal in Ely & Co. Inc., is a financial institutions and monetary policy consultant.