Washington is constantly urging banks to increase lending. In spite of this, credit remains tight. Small business loan originations continue to lag and credit card issuers have significantly reduced lines of credit and canceled thousands of accounts. The American taxpayers bailed out the banks hoping that they would make loans and stimulate the economy. But given the current state of the economic mess, lending is probably the last thing the banks should be doing. Since the current recession was caused by an overextension of credit, making additional loans available doesn’t make sense.
Every loan carries the risk that it will not be repaid. Before making a loan, a lender must first accurately price the risk. If this isn’t possible, the lender reduces risk by lowering the total number of loans that it originates or the dollar amount of the loans. It has yet to be determined how costly new initiatives, such as cap and trade legislation and the healthcare proposal, will be on business. The unknown cost of these and other current regulations are interfering with the accurate pricing of risk. Therefore, lenders are reducing their risk exposure by reducing the number of loans they make.
Another hurdle for lenders is the risk-adverse nature of bank regulators. Although presidents and Congress have urged banks to make more loans, bank examiners have required just the opposite. Bank executives across the country have demonstrated that bank examiners have become extremely cautious in determining the value of a bank’s assets, thereby requiring an increase in bank reserves. This results in a reduction of lending.
In an effort to control the money supply, the Federal Reserve began paying interest on bank reserves it held on deposit. Reserve balances immediately went up, and they have been rising ever since. Banks can borrow at low rates and place those funds on deposit with the Fed receiving a risk-free, guaranteed rate of return. This effort by the Fed to control the money supply and encourage lending has actually backfired.
In today’s tough economic environment, this risk of default is greater than it has been in years. High unemployment and the reduced value of collateral, such as housing, has required banks to tighten their lending standards to comply with more stringent bank regulations. As lending criteria becomes tighter, fewer companies and individuals qualify for loans.
Current economic conditions and levels of government oversight don’t support additional bank lending.
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