Friday, February 12, 2010

G-4 bank lending standards stabilize but demand still falls

• Rare decline in bank lending was both a cause and symptom of the global downturn

• The latest bank lending surveys for the G-4 suggest the credit supply curve has stopped shifting inward

• Although loan demand is still falling, the stabilization
in standards reduces a key drag on the recovery

The Great Recession produced an unprecedented decline in bank lending in the major developed economies. This decline resulted from inward shifts in both the supply and demand curves for bank credit. The latest survey data point to a steadying in the supply curve for bank credit, reducing a major drag on the expansion. However, these same surveys indicate that the demand for bank loans continues to fall. Although both the level and the change in credit standards might have a significant effect on the growth of spending, an examination of data in the US, where there is more history available, suggests that it is the change in standards that matters most. As such, the recent stabilization in standards bodes well for the economic recovery.

Standards stabilize across the board

Banks began to tighten credit standards on large firm C&I lending in late 2007 and reached a peak in late 2008 and early 2009, when the share of banks tightening standards outnumbered the share easing by 40%-pts.1 On net, banks continued to tighten through 2009, but as of the current quarter, slightly more banks in the G-4 were easing or leaving standards unchanged than were tightening.

The tightening in C&I lending standards during the recession was most severe in the US and the Euro area, where between 80% and 90% of all banks raised standards in late 2008. Banks in the UK tightened standards in 2008 as well, but to a lesser extent. By contrast, Japanese businesses experienced little tightening through the economic downturn.

The move to stability in credit standards in the G-4 has been broad-based, with bank standards in all four countries roughly unchanged as of the latest reading. The continued decline in demand for business loans reflects offsetting moves in the G-4. The US has seen a sharp moderation in the share of banks seeing reduced borrowing demands.

Improvements in business demand for credit have been more limited in the Euro area and UK but appear to have never fallen off as much, either. Loan demand in Japan, which held up well during the downturn, recently has deteriorated considerably, perhaps reflecting increased concerns about deflation and the stronger yen.

Banks carried out a similar policy of raising terms and standards on loans to small firms. Indeed, the G-4 aggregates for large and small firms virtually overlay one another, including in the United States, where there is a deeper history. This close correspondence tends to undermine any thought that banks recently have been tougher on small firms. In the household space, the tightening in standards for residential mortgages has abated considerably in the past year.

As with business lending, the US has seen the largest moderation. However, the tightening of credit standards on household secured lending in the UK moderated sharply in 2H09 and banks were eaG-4 bank lending standards stabilize but demand still fallssing, on net, at the turn of the year.

Mortgage demand improved throughout 2009 in the US, Euro area, and UK and was expanding, on net, at a solid pace in 4Q09. However, the latest readings suggest that the perceived curtailment in the first-time homebuyer tax credit in the US damped demand. The UK also saw a dropoff. The ultimate test of the usefulness of these surveys is whether they correlate with actual behavior. As noted above, the readings on credit standards only give insight into the supply side of the lending equation, and they are diffusion indexes, rather than a survey of the amount of new lending.

Moreover, taken literally, the mere stabilization in credit standards leaves the level of standards still quite tight and thus presumably an impediment to growth. However, for the United States, the mapping of changes in credit standards (the levels of the diffusion indexes) on actual spending is impressive, both for the business and the household sector. As a result, the latest survey readings are encouraging.

Credit standards for large firm C&I lending align well with the growth of business investment (includes both fixed and inventories) in the US (which includes nonresidential construction). Indeed, lending standards appear to lead BFI, particularly at turning points in the business cycle. The latest 1Q10 reading suggests nominal BFI, which only edged up in 4Q09, could expand at a 10% annualized pace this quarter according to a simple univariate regression. Similarly, the recent improvement in banks’ willingness to extend consumer installment credit points to a further decent gain in nominal consumer spending this quarter.
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