Banks tighten lending standards like in 2008
U.S. banks are tightening standards on business loans and credit cards to rate comparable to 2008, latest says Opinion poll of senior loan officers on bank lending practices, which is published every few months by the Federal Reserve.
Banks are also tightening standards on all other categories of loans, including auto loans and mortgages. The investigation was conducted in late March and early April and largely reflects how banks have responded to the coronavirus outbreak.
Barron followed regularly weekly data from the Fed on bank balance sheets because it provides timely information on how borrowers and lenders have behaved amid an unprecedented blow to economic activity. Businesses used bank lines of credit in March like never before, credit card balances have plunged at the fastest rate on record since mid-March, and paycheck protection program funds have been distributed almost exclusively through small lenders.
These weekly figures only show what happened, however, rather than why. Balance sheet data shows that the big banks stopped making new commercial and industrial loans in April, but it does not indicate whether it was because companies no longer needed the money or because the banks have tightened the credit supply. The Fed’s irregular investigation fills this gap and makes it clear that it was the banks that cut lending, rather than the other way around. As demand for commercial and industrial loans has increased for both small and large businesses, lenders have tightened standards at the same pace as in 2008.
In all categories of business loans, the Fed loan-weighted data show that supply has tightened considerably even though demand was stagnant. Normally, supply and demand move at the same pace because banks and borrowers react to the same underlying economic conditions. In this case, however, the sales collapse was so severe that companies continued to want to borrow even though they no longer had any desire to make new investments or acquire competitors.
Banks have also tightened the standards for their lending to households. But even though standards are tightening at the fastest rate outside of the global financial crisis, the shift in the supply of consumer credit is far less dramatic than what has happened to businesses. This is mainly due to the fact that banks have refrained from tightening standards on the main types of mortgages.
In other categories, things look different. The change in supply is particularly acute in credit cards. Unlike mortgages or auto loans, credit card debt is unsecured, making it much riskier for lenders. Compared to the end of 2019, banks have sharply reduced their credit limits and increased their minimum credit scores. Overall, standards are tightening at the same rate as in mid-2008.
Lending standards on other forms of consumer credit are tightening as well, but so far much less than in the last financial crisis. It probably helps that demand for auto credit, for example, also plunges as potential buyers stay home to avoid the virus.
The last thing to note is that banks have also started to tighten the supply of mortgage credit for anything that is not explicitly guaranteed and subsidized by the US Treasury and the Fed. That doesn’t mean much to most people interested in buying a home, as the overwhelming majority of purchase mortgages go through government channels. It is also unlikely that many people would otherwise try to buy homes at this time if credit standards were relaxed.
But the change is potentially significant for home equity lines of credit. Helicopters are meant to be a useful source of pocket money for homeowners who may need extra cash in the short term. Banks have started to tighten standards on these lines of credit significantly for the first time since the financial crisis.
It’s understandable that lenders don’t want to expose themselves to borrowers who might lose their jobs or face wage cuts, but it’s also a sign that the assumed insurance value of owning a home is overvalued if it cannot be used as collateral to secure money when needed.
Write to Matthew C. Klein at email@example.com