Flow of Funds Point to Slower Loan Growth

Article excerpt

At one time, flow-of-funds analysis was widely used for interest-rate forecasting. This approach fell into disuse with the increased volatility of financial markets in the 1970s, but there is useful information to be gleaned from the flow of funds.

Funds flows provide information about prospective commercial loan demand. As with many forecasts, the relationship works better with direction than with magnitude. Nevertheless, it can provide a good background for planning.

Corporate uses of funds are dominated by two large flows. These are inventory accumulation and shifts in spending on plant equipment. Equipment spending, in particular, is an important swing variable. In their early stages, most projects are funded on the margin by an increase in short-term credit. Longer-term debt or equity financing generally comes later in response to balance sheet needs rather than as an initial source of funds.

Corporate sources of funds are dominated by profits. While taxes and depreciation can result in short-term fluctuations, profits comprise the major source of cash flow.

The residual between sources and uses is the financing gap and can be extracted from the Federal Reserve flow of funds data. This gap represents corporate needs for short-term financing and is an important determinate of loan demand. The relationship between the financing gap and bank lending is not exact. Alternate methods of financing have an important impact.

For example, the decline of rates in the early 1990s was accompanied by renewed use of longer-term debt instruments. …