Much has been made about the fact that economy-wide bank lending is down considerably despite the fact that the stock market and other economic indicators have begun to improve. Even after the unprecedented cash made available by the Federal Reserve and direct bailouts from the Federal government, some estimates state that bank lending is still down some $600 billion from this time a year ago. This has created widespread frustrations which became apparent in an interview with real estate mogul Donald Trump this morning on CNBC. In that interview, Trump argued that the economy cannot heal until we have a fully functioning credit market and even suggested that perhaps the government should force banks to lend more.
Now, it is worth pointing out that we are not of the opinion that legitimate borrowers should be denied loans. That is, loans to credit-worthy borrowers who have a valid need for the capital and can reasonably be expected to pay it back absolutely should have access to credit. Banks are lending institutions and loans have in the past and will continue in the future to be an important source of revenue. However, taking the job of risk assessment out of the hands of bankers is not a recipe to heal the still-damaged balance sheets of financial institutions. Banks are hanging onto more of their capital than before for one of two reasons: (1) they fear problems on the horizon and need a capital cushion or (2) they lack attractive candidates for loans.
Clearly, banks are not making as many loans right now because many are still reeling from the credit crisis and need to rebuild their capital reserves in case of future turbulence. The recent debt scare in Dubai demonstrates that globally there are still challenges ahead. Renowned bank analyst Dick Bove of Rochdale Securities said that, while U.S. institution’s exposure to Dubai is minimal, the situation does show that the worst of the global credit crisis may not be behind us. Again in an interview on CNBC, Bove opined that if Dubai can default on its loans, what is to stop other troubled nations from doing the same thing? Furthermore, he discussed the increasingly likely prospect that U.S. bank regulators will increase capital requirements in the coming months. Out of the 30 largest banks by assets, only four — Citibank (C), State Street (STT), Northern Trust (NTRS) and First Horizon National (FHN) would be able to meet the proposed 12% capital ratio without needing to raise fresh capital.
It is unfortunate that some are frustrated that obtaining credit is more complicated than in the past, but we do not really see a way around this period of deleveraging. If the government forced banks to lend, then quotas would take precedence over proper due diligence. At the same time, there are real concerns that the government will being requiring that banks hold a greater percentage of capital in reserve hoping to avoid the necessity for bailouts in the future. As painful as it may be, the current risk aversion in the credit markets is a natural market response. This too shall pass, and banks will lend again when they see good opportunities in the market and are adequately capitalized to handle any economic environment.