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Banks tighten credit standards as loan demand declines

A Federal Reserve survey of bank loan officers showed credit conditions for American businesses and households managed to tighten in the first months of the year. However, the results seemed to reflect the cumulative effect of Fed monetary tightening instead of the cliff-type decline in credit that some feared following the March tanking of Silicon Valley Bank.

As one of the first indicators of the state of the banking industry following the recent spate of bank failures, the Fed’s typical quarterly Senior Loan Officer and their Opinion Survey, or SLOOS, revealed a net 46.0% of banks tightened their terms of credit for a crucial category of business loans for the medium and large businesses compared alongside with 44.8% in the previous survey in Jan. This was a small, gradual change.

Conditions for small businesses were slightly more restrictive, with a net 46.7% of banks reporting that credit terms are stricter now than they were in the previous survey’s 43.8%.

Businesses of all sizes exhibited a lower demand for loans than three months prior, according to bank reports.

The issue of credit availability may not be the whole picture, as banks have also stated they were limiting lending amounts and rising borrowing costs.

Banks reported that slack demand for types of credit card, auto, and other types of household credit was once again prevalent, though not to the same extent as at the end of the previous year. Overall, banks appeared less ready to offer consumer instalment loans or were restricting the size of loans like auto loans.

Not much had changed. J.P. Morgan’s Chief U.S. Economist and expert Michael Feroli, believed the standard-tightening probably wasn’t as severe as anybody might have thought given the financial stress. But the decline in demand, notably the fact that more than half of banks have seen a decline in the number of small businesses looking to borrow money, seems to portray a bleak picture of the future.

The tightening additionally reflected banks’ gradually growing concerns about the need to maintain enough liquidity and retain capital in the face of a gloomier economic outlook. According to the Fed’s assessment on the survey’s findings, mid-sized banks appeared to be particularly overextended.

Since Silicon Valley Bank’s slip off fame in early March and the persistent possibility of pressure among regional banks generally, the quarterly loan and the officer survey has assumed a special significance.

Since March 2022, the Fed has been strongly hiking interest rates in an effort to restrain inflation.

Policymakers do not, however, want the credit tightening to become so severe that it triggers a recession.

At its policy meeting most recently, the Fed had the concluded results of the most recent survey in hand. While officials moved forward with an anticipated quarter-point rate hike, they also left the door open to calling it quits – regarding the effects of a potential credit shock still to be assessed.

Fed Chair Jerome Powell said the stresses that first surfaced in the banking industry in early March appear to be leading to further tighter credit conditions for individuals and businesses.

These more restrictive loan conditions will undoubtedly have an impact on inflation, hiring, and overall economic growth. The scope of these consequences is still unknown.

The survey is used as a leading predictor of how bank credit is likely to change over time, and economists anticipate that credit will continue to tighten in the months to come.

In the study covering essentially the last three months of this year, the net share of banks holding off commercial loan conditions for large and middle-sized businesses increased from 24% to 45%.

Rising proportions of banks tightening criteria, according to economists who analyse the SLOOS replies, progressively lead to decreased economic activity and may even be a sign of a downturn.

Michael Kantrowitz, a chief investment strategist from Piper Sandler & Co., there is a lengthy and unpredictable lag from the effects of stricter lending rules on the economy.

The likelihood of a recession is increased by this confirmation of stricter lending rules.

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