Bank lending stalled despite reform

Posted June 29, 2010 at 6:12 a.m.

From CNN | While Washington moves ahead on reforming the nation’s financial system, bank lending appears to be going nowhere fast.

Many banks have been reluctant to make new loans in recent months, in part, because of uncertainty about just how harshly lawmakers would crack down on the industry. But last week’s ironing out of a Wall Street reform bill may do little to revive the flow of credit.

“If anything, this legislation could reduce credit outstanding — not increase it,” said Gerard Cassidy, managing director of bank equity research at RBC Capital Markets.

The creation of a consumer protection agency, for example, could crimp lending activity on certain mortgages and credit cards. The new agency, which will be housed within the Federal Reserve, will have the power to rein in unfair practices on consumer loans.

As part of the proposed new law, banks would also be banned from making so-called ‘liar loans’. Instead, lenders would be required to verify both a borrower’s income and their ability to make payments.

The reform bill also leaves many other questions unanswered. Bankers, particularly those at the nation’s top financial institutions, are still awaiting details on just how much capital their firms are required to hold.

International regulators are negotiating the appropriate level for financial institutions. There are expectations among some federal regulators that the new Basel capital standards are at least five more months away.

Small banks, on the other hand, continue to face tough oversight from regulators about both the loans on their books, and in some instances, the types of loans they are making.

But these aren’t the only reasons why banks may still be reluctant to lend more. Troubling economic numbers like last week’s sharp decline in new home sales may keep bankers nervous as they try to manage their current loan losses.

Mounting deficit troubles in California, Illinois and other states haven’t helped regional and community bankers who are still coping with the troubled commercial real estate market.

“Most lending, when it comes down to it, is local,” said Robert DeYoung, a professor of finance at the University of Kansas’ School of Business. “In a situation like this, local conditions reflect the big picture.”

Ultimately though, experts said loan activity has remained weak largely because consumers and businesses aren’t as interested in borrowing.

Last month’s survey of senior loan officers by the Federal Reserve revealed, for example, that the demand for credit among consumers weakened further during the first quarter for all types of loans.

Businesses also appear to be holding pat on borrowing. A survey of senior finance and treasury executives published Monday by the Association for Financial Professionals revealed that companies are hoarding more cash than they did just six months ago to ensure they can ride out the recession.

“There is such uncertainty about the economic outlook that individuals and corporations are going to try and paid down debt or sit on whatever cash they have,” said Richard Staite, a London-based banking analyst with Atlantic Equities, which tracks several large U.S. banks. “The demand for loans will remain very weak.”

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