Bank Loans: Still Contracting

Article excerpt

08.10.2010

Information from various sources suggests that the number of loans that banks are making to businesses continues to fall. The contraction appears to be driven by both supply and demand; banks are extending less credit, and businesses are asking for less. The restriction of credit may be one important factor that is constraining the current recovery, since businesses, especially small ones, rely on bank loans and access to credit to finance their operations, capital expenditures, and growth.

Bank lending has decreased by 11 percent relative to its 2008 peak. This represents the second largest percentage decline after the one that occurred in 1990-1993. Lines of credit have been greatly reduced as well, according to anecdotal evidence.

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The rapid pace of the decline is especially conspicuous when lending growth is compared across past recession-recovery cycles. Loans have tended to increase on average during the recovery phase. Only in 1990-1993 did loans decline at a comparable pace at this stage of the business cycle.

Tight lending standards have contributed to the decline in loans. Evidence that current lending standards are unusually tight comes from the Senior Loan Officer Survey, which asks officers of large banks how their credit standards for commercial and industrial loans or credit lines have changed over the past quarter. Officers reporting tightened standards have been outweighing those reporting eased standards for over three years. Since standards have been tightening for so long, their current level must be very tight. To see this clearly, we compute an index of how tight lending standards are, using a moving average of the net percentage of those reporting tighter standards. (More precisely, the index is a weighted average of current and past net percentage balances, with larger weights on more recent observations and smaller weights on older observations). This index is currently close to its historical peak, confirming that current lending standards are very tight.

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Weak demand for loans has contributed to the decline in loans as well. …