Economic recovery begins with responsible access to credit. Banks know that businesses and consumers need credit, and that they aren’t always getting the credit they need. That leaves many asking, “Why?”
Despite the financial turmoil in 2008 — when lending in most states and in the United States, as a whole, declined — banks in Colorado increased lending by an amazing 11.7 percent. Colorado loans subsided approximately 0.8 percent in the first quarter of 2009, and 5 percent in the second quarter 2009. (One of Colorado’s two bank failures was responsible for 40 percent of that entire reduction.)
In a nutshell, the lack of lending reflects low loan demand combined with four key variables that have created our current climate:
• Decreasing creditworthiness among borrowers,
• The greatly diminished role of nonbank lenders,
• Financial constraints on lenders,
• Increasingly stringent regulatory standards.
Bank lending plays a critical role in our economic recovery. Many are familiar with what borrowers, lenders and the government are doing to address current financial issues. Bank regulation is a piece of the puzzle that’s rarely discussed.
The regulation and examination process directly affects a bank’s ability to offer loans. Regulatory oversight is vital to the financial stability of our country, but the Colorado Bankers Association believes bank regulators are currently impairing some responsible bank lending, and thus the recovery, by taking overly aggressive action in the three areas discussed below.
Demand for loans (except for home mortgages) is down across the board due to customer caution and economic uncertainty. The financial status of many borrowers deteriorated in the last year to a point that they no longer qualify for loans. Their assets are worth less, and their income (capacity to repay loans) has declined.
Demise of Nonbanks
In the past, borrowers have been able to turn to nonbank lenders (unregulated or less-regulated private lenders) that had more liberal lending standards. However, many nonbank lenders have disappeared or tightened standards, and their lending practices look more like traditional prudent bank lending.
Banks are heavily regulated and examined by government agencies, so they are held to higher standards than other lenders. Banks always have “bank” in their name and always are insured by the Federal Deposit Insurance Corporation.
Nonbanks, on the other hand, are financial service providers not subject to such heavy regulation. These include mortgage companies, securities firms, insurance companies, finance companies, Fannie Mae/Freddie Mac, secondary markets, mutual funds and others.
The demise of many nonbank lenders has had a larger than anticipated impact. Decades ago, banks provided 70 percent of U.S. loans. Although bank lending has grown over the decades, the nonbank sector has grown even faster. In recent years, nonbanks provided 70 percent of U.S. credit, and banks provided only 30 percent. The turmoil in the last third of 2008 eliminated many nonbank entities and severely damaged others. Borrowers have fewer options and customers (particularly commercial and commercial real estate customers) now are more reliant on bank lending. Many borrowers who had financed with nonbank lenders are refinancing with banks.
As more borrowers run into financial difficulty, loan losses inevitably grow for banks. Losses generally won’t affect a bank’s viability, but they do deplete bank capital, which dictates a bank’s ability to lend. Regulators decide the amount of capital a bank must hold, and that amount is increasing significantly. That means less money is available to borrowers.
Changing Standards in Bank Regulation
Despite constraints on borrowers and lenders, there are responsible loans that banks could make if they were permitted to do so. Banking is a highly regulated business. Examiners scrutinize lending practices and individual loans.
Regulators play a valuable role. They must regulate and examine banks to assure their safety, minimizing the chance of bank failure.
We think they also should have a second objective: to foster bank lending to customers so long as that lending is done safely. Regulatory agencies now focus on bank safety with no regard for credit availability in the community.
If banking is a lending machine, then Congress and the public have their foot on the accelerator. They’re saying, “Go faster! Lend more money!”
But bank regulators have their feet on the brakes. They’re saying, “Oh, no you don’t! We don’t want banks taking any risks!”
We think this single focus on the part of regulators damages customers and the public.
Three areas of increasing regulatory standards bolster our argument:
• Rising capital levels. Since the last banking crisis in 1990, banks have doubled their capital ratios to 13 percent. However, regulators are asking banks to boost capital holdings even higher. This takes significant funds away from what can be loaned. Nationally, banks have $1.4 trillion in capital, and another $211 billion in reserves for potential loan losses. That’s a $1.6 trillion cushion to protect against losses.
• Overcautious reductions in loan-type concentration standards. Bankers will be the first to tell you proper management of loan concentration levels is responsible and necessary, because if a bank’s loans are overly concentrated within one industry, and something happens to the viability of that industry, the bank is exposed to major losses. However, regulators are increasingly critical of concentrations such as commercial real estate, forcing some banks to decline to make or renew loans to businesses they otherwise would approve. Responsible caution is good, but excessive caution can constrict the ability of some businesses to secure funding.
• Use of subjective and unpredictable standards to downgrade loans. A loan gets downgraded when a regulator thinks there is a good chance it will not be repaid. Banks can do this preemptively — before the loan becomes delinquent. Now, some regulators are broadly downgrading business loans according to type, despite good payment histories that indicate no clear danger of default. Downgrading with an overly cautious, broad-brush approach forces banks to put more capital aside, and to steer banks away from loans for fear of regulatory criticism and action.
Regulators have received public and political pressure to increase standards, which has largely been derived from misperceptions of the roles banks and nonbanks played. Banks, like other businesses, are affected by hard economic times, and their tribulations show up in the bottom line.
Regulators have confused failures in the unregulated sectors of finance with the less serious problems in the regulated banking industry, leading them to overreact.
A look at the numbers shows few troubled banks. On June 30, 2009, the FDIC listed 416 troubled banks nationwide (5 percent of the 8,195 banks in the U.S.), which held $300 billion in assets (2.2 percent of the industry’s $13.3 trillion assets). Comparatively, there were 1,496 on the list in 1990. Historically, 87 percent of those banks work their way back to health with extra attention — just as hospital patients are more likely to recover if they get good care.
Banks have better lending standards than nonbanks and, thus, fewer foreclosures. That means their loans are safer. Banks and affiliates account for 58 percent of residential mortgage lending, but only 18 percent of foreclosures in Colorado. Banks try to make sure the borrower can, in fact, repay a loan. Nonbanks, conversely, make 42 percent of mortgage loans, but have 82 percent of foreclosures.
As of Aug. 31, there had been 84 bank failures in the United States, two of which were in Colorado. In 1990, 534 banks failed nationwide over a 10-week period, and 1,617 banks failed in the late 1980s and early 1990s. Yet, no depositor has ever lost a penny of FDIC-insured deposits.
The Colorado Bankers Association stresses prudent bank regulation. It is valuable and essential. When a bank’s focus is on complying with complex regulatory matters, it can’t keep its first priority on serving customers and the community. That has consequences not only for banks, but also — and very importantly — for bank customers and the entire economy, which depend on bank lending now more than ever.
Let banks do their job.
Don Childears is president and CEO of the Colorado Bankers Association.