Banks Tighten Lending Standards in Wake of Failures: Fed Survey

Banks Tighten Lending Standards in Wake of Failures: Fed Survey
The Federal Reserve building in Washington, on March 19, 2019. (Leah Millis/Reuters/File Photo)

A Federal Reserve report Monday showed banks raised their lending standards for business and consumer loans after the collapse of three large banks.

More lenders are tightening their standards in the wake of increasing turmoil within the banking sector, according to the Federal Reserve’s quarterly Senior Loan Officer Opinion Survey (SLOOS). The survey also found that a majority of banks expect to further tighten their credit across all loan categories this year.

About 46 percent of all banks said they had raised standards for business loans known as commercial and industrial loans, up from just under 45 percent in the previous quarter. However, banks were tightening credit before the bank failures. A year ago, slightly more banks were easing credit standards than raising them.

Survey respondents attributed the changes in lending standards to economic uncertainty, a reduced appetite for risk, deterioration in collateral values, and broader concerns about banks’ funding costs and liquidity positions, according to the Fed report.

“That will starve firms and households of credit and help push the economy into recession in the second half of this year,” Michael Pearce, lead U.S. economist at Oxford Economics, wrote in a note.

The less lending that banks do, the more likely that various firms are to cut back on investment, which in turn slows the growth of employment and the economy overall.

Other economists say it is hard to know exactly when a pullback in lending will start to slow the economy and by how much. Federal Reserve staff economists have also forecast a “mild recession” for later this year, in part because of an expected reduction in lending.

This is the first Fed survey of bank lending to be released since the recent, regional bank failures of Silicon Valley Bank, Signature Bank, and First Republic Bank.

The Fed surveys up to 80 large U.S. banks and 24 domestic branches of foreign banks, and asks loan officers about topics such as changes in lending terms and standards as well as household demand for loans. The results were gathered from March 27 to April 7.

Since March 2022, the Federal Reserve has been raising interest rates from zero percent to a range of 5.0–5.25 percent in an effort to battle elevated inflation.

Federal Reserve chair Jerome Powell speaks during a news conference in Washington, on Feb. 1, 2023. (Saul Loeb/AFP via Getty Images)
Federal Reserve chair Jerome Powell speaks during a news conference in Washington, on Feb. 1, 2023. (Saul Loeb/AFP via Getty Images)

Last week, Fed chair Jerome Powell said that the turmoil in the banking sector could slow the economy and help the central bank in reducing inflation, which would mean the Fed wouldn’t have to raise interest rates as high as it would otherwise.

“In principle, we won’t have to raise the rates quite as high as we would have had this not happened,” Powell said.

Federal Reserve officials and economists will closely scrutinize the report, because tighter credit standards are expected to be followed by a reduction in lending. That could force businesses to pull back on expansion plans and reduce hiring, and could limit sales of cars and homes.

Separately, on Monday, the Fed released its twice-yearly financial stability report, which examines the financial sector—banks, insurance companies, and investment funds—for any potential signs of future turmoil or disruption.

The report said that commercial real estate loans—particularly loans to downtown office buildings and retail sites—were at greater risk of default as fewer Americans report to work in cities, allowed or preferring instead to work from home. Those loans are disproportionately held by smaller banks.

At the same time, the report said that, on average, most loans for commercial properties were backed by significant down payments, reducing the risk to banks from widespread defaults.

The Associated Press contributed to this report.