Loan Demand Falls as Banks Tighten Credit

Banks have tightened lending conditions for corporate and consumer loans and expect to increase them further this year, according to a Federal Reserve report issued on Monday, raising the risk of a recession in the coming months.

Since March 2022, the Federal Reserve has rapidly raised interest rates to limit inflation. One of the primary ways this strategy works is by increasing the cost of borrowing money for firms and families, which discourages big investments and purchases. The results of the most recent three SLOOS polls, which date back to the beginning of the rate rises, have shown an increasing net percentage of banks tightening their requirements.

There is a greater danger of recession in the coming months, as indicated by a new Federal Reserve study released on Monday, showing that banks have tightened lending requirements for business and consumer loans and anticipate raising them further this year.

In the first months of the year, credit conditions for U.S. businesses and households tightened further, according to a survey of bank loan officers conducted by the Federal Reserve. Nonetheless, the results appeared to reflect the cumulative impact of Fed monetary tightening rather than the cliff-like decline in credit that some anticipated following the March failure of Silicon Valley Bank.

The Senior Loan Officers Survey, a report that inquired about banks' lending standards, examined whether they have implemented measures such as raising credit score requirements, increasing interest rates, or mandating additional collateral, among other actions. These measures, if taken together, could potentially impede the ability of businesses and consumers to secure loans.

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In the current quarter, approximately 46% of banks reported an increase in the criteria for commercial and industrial loans compared to slightly less than 45% in the preceding quarter. The observed increment was comparatively less significant than in the preceding quarters. However, financial institutions were already imposing stricter credit regulations prior to the occurrence of bank insolvencies. One year ago, a slight majority of banks were relaxing their credit standards compared to those tightening them. Currently, approximately 50% are implementing stricter measures.

Because of a more uncertain economy and the Fed's aggressive interest rate rises, a comparable proportion of banks already made it more difficult for people and companies to borrow money in the three months preceding this period.

In the most recent study, financial institutions expressed continued anxiety about the state of the economy and a diminished appetite for risk. However, more small and midsize financial institutions indicated concerns about clients' withdrawal of deposits, liquidity difficulties, and financing costs.

According to the poll's findings, banks have also tightened their lending rules for consumer, vehicle, and credit card loans. As a result of strong inflation, families with low and moderate incomes are having a harder time keeping up with their credit card payments, which has led to record-high credit card balances and increased delinquency rates.

The financial institutions also said that they anticipated increasing the stringency of their lending standards over the remainder of the year for any loan.

The opinions of some economists, it isn't easy to pinpoint when a lending reduction begins to impede the economy and how much this reduction would occur. In addition, experts working for the Federal Reserve have predicted that the economy would enter a "mild recession," as what happened in  2018, in part because of the anticipated decline in lending.

Last week, the Chair of the Federal Reserve, Jerome Powell, said that the recent instability in the banking industry may slow the economy and assist the central bank in controlling inflation. If this were to occur, the Fed would not be required to hike interest rates to the same extent as it would have otherwise.

Powell said that "in principle, we won't have to raise the rates quite as high as we would have had this happened" while referring to the potential need to hike interest rates.

Also on Monday, the president of the Federal Reserve Bank of Chicago, Austan Goolsbee, said that he is hearing from business contacts that banks are beginning to rein down their lending practices. He speculated that this would signal that the Federal Reserve might slow the pace of its rate rises. In a statement released the previous week, the Federal Reserve hinted that it might decide to halt further rises in the target range for the federal funds rate at its next meeting in June.

This study follows other indications that the failure of Silicon Valley Bank, Signature Bank, and First Republic Bank in the preceding two months has prompted other financial institutions to reduce the amount of money they give out in order to conserve capital.

Officials and economists from the Federal Reserve will be paying careful attention to the report since it is anticipated that a decline would follow stricter credit requirements in lending. Because of this, firms may be forced to scale down their growth plans, cut back on employment, and see reduced sales of automobiles and houses.

The responders to the study were from 65 different American banks and 19 different international banks with branches in the United States. The data collection took place between March 27 and April 7, long after the failures of Silicon Valley Financial and Signature Bank in early March, which was the catalyst for the most recent wave of financial upheaval. The fall of First Republic Bank a week ago was the second-largest bank failure in the history of the United States.

According to the study published by the Federal Reserve, mid-sized financial institutions, or those with assets ranging from $50 billion to $250 billion (such as the three financial institutions that went bankrupt in March), were more likely to declare stricter rules.

The banks have also said that they are taking measures to limit access to credit for the majority of consumer loans. These measures include lending for automobiles, credit cards, and home equity lines of credit.

On Monday, the Federal Reserve published the results of its semiannual assessment of the financial system's stability. This analysis looks at the financial industry as a whole, including banks, insurance firms, and investment funds, for any possible signals of future instability or disruption.

According to the findings of the analysis, commercial real estate loans, and in particular loans to downtown office buildings and retail sites, are at an increased risk of default because fewer people in the United States are choosing to work in cities, and more are opting to work from home. Smaller banks hold these loans on a disproportionately large scale.

The research said that the majority of loans for commercial properties were secured by considerable down payments, which reduced the danger of widespread defaults to the lending institutions.

On the consumer side of things, banks reported that slack demand persisted once again for credit card, vehicle, and other types of household lending, albeit not to the extent experienced at the tail end of the previous year. The overall trend across banks indicated a decreased readiness to give consumer installment loans, and they also restricted the maximum loan amounts for automobiles.

At its meeting last week, the Federal Reserve had the findings of the most recent poll in its possession. While policymakers went through with a predicted quarter-point rate rise, they also opened the door to call it quits - with the implications of a potential credit shock yet to be evaluated.

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                       U.S. banks report tighter lending standards and weaker demand: Fed loan officer survey