Unprecedented moral suasion from regulators on small businesses lending
Today, I received a press release from the complete list of federal government regulators of the financial industry which all but ordering banks to lend to small businesses. Clearly, regulators are concerned as comments by Marc Chandler intimated in my last post.
The regulators supporting the press release were the following: The Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration
Office of the Comptroller of the Currency, Office of Thrift Supervision, and the Conference of State Bank Supervisors.
Here’s some of what they said verbatim [emphasis added]:
Some small businesses are experiencing difficulty in obtaining or renewing credit to support their operations. Between June 30, 2008, and June 30, 2009, loans outstanding to small businesses and farms, as defined in the Consolidated Report of Condition (Call Report), declined 1.8 percent, by almost $14 billion. Although this category of lending increased slightly at institutions with total assets of less than $1 billion, it declined over 4 percent at institutions with total assets greater than $100 billion during this timeframe. This decline is attributable to a number of factors, including weakness in the broader economy, decreasing loan demand, and higher levels of credit risk and delinquency. These factors have prompted institutions to review their lending practices, tighten their underwriting standards, and review their capacity to meet current and future credit demands. In addition, some financial institutions may have reduced lending due to a need to strengthen their own capital positions and balance sheets.
Supervisory Expectations
While the regulators believe that many of these responses by financial institutions are prudent in light of current economic conditions and the position of specific financial institutions, experience suggests that financial institutions may at times react to a significant economic downturn by becoming overly cautious with respect to small business lending. Regulators are mindful of the harmful economic effects of an excessive tightening of credit availability in a downturn and are working through outreach and communication with the industry and supervisory staff to ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound small business borrowers. Financial institutions that engage in prudent small business lending after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for loans made on that basis.
Translation: small business lending is declining for a lot of reasons – one of which is excessive caution by lenders. We don’t like that. So, please lend more to small businesses and farms; we will go easy on you if you do.
Is it just me or does this sound like regulators are extremely concerned about credit? First, you have every single major financial regulator except the SEC joining forces to issue this joint press release. Then you have language which suggests quite directly that banks which increase small business lending “will not be subject to criticism for loans.”
What does that mean exactly? Let’s say my bank does a comprehensive review and compiles data which determines that we can lend to specific borrowers who then default. What then? Regulators will not be subject us to criticism for those loans? Does that mean I will get a bailout or a free pass for having inadequate capital ratios? I would like more specifics here.
The rest of the press release is boilerplate stuff. But I sense a slight whiff of panic and I will be watching to see how regulatory officials couch their explanations of this policy. Long story short, this is official confirmation that the credit crisis is not over and that regulators are worried.
Source
Interagency Statement on Meeting the Credit Needs of Creditworthy Small Business Borrowers (pdf) – FDIC website
Banks have no incentive to look for small businesses when they can borrow at 0 and go get 3 or 4 in the Treasury market. Why not squeeze that margin so they are motivated to lend to real customers? I do not see that zero has created any investment. It seems to help those who have loans tied to the prime rate, identified now, I guess, as 3 percent above the federal funds rate, and more importantly, it helps the banks via backdoor bailouts.
Why would that squeeze not get them back in the real economy looking for good credit risks? It seemed to work in the early 1990s.
The problem with bank margins is that banks have a lot of dodgy assets on their books. They need the margins to build up a buffer for the writedowns those assets will engender. If you look at the S&L crisis, having the banks lend via investing in HY ended up being a disaster that only worsened the problem.
And if you remember, in the early 90s the high margin trick was exactly what was in vogue before Greenspan started to hike rates in 1994. He did so because he felt that enough time had transpired since recession had ended in early 1991 to do so. We have had a BIGGER recession and less time. So following that logic, rates aren’t going anywhere. We’ll see less unconventional measures, but higher rates – I’m not a believer.
Personally, I do think rates should be higher for different reasons. Zero rates distort investment decisions making higher risk longer-term payoff options that are uneconomic palatable. The result of course is more malinvestment. Low rates are not the solution. We are going to have recognize the bad debts.
My recollection is that bank lending to the real economy did not start until after the rate hikes in the early 1990s. The HY investing is more similar to the speculative games now in vogue than to finding creditworthy borrowers.
The fact that the banks have dodgy assets is something that ought to be directly addressed. Not being direct and allowing this zombie process is not functional. Let the writedowns begin! The sooner they are cleared, the better.
Yes, the banks may not survive. But you are right on, “We are going to have to recognize the bad debts.” And by that, I don’t mean backstop them at the Fed or Treasury. Resolution authority is the way to go. Will it take another crisis to get people off their butts to get this done?
You are also right in “more malinvestment.” It is creating bubble conditions.
This is equivalent to not getting to the Banking Act of 1933, the Glass-Steagall protections, and the reconstruction of the banking system so it functions. All that is still ahead.