Monday, February 22, 2010

Bank credit update

This chart shows Total Bank Credit as measured by the Federal Reserve, a measure which focuses on lending to small businesses. Banks have been lending less (about $650 billion less, or 6.8% less than the high water mark) since the start of the financial panic in October 2008, and I'm sure everyone has heard that it is very difficult if not impossible for small businesses to get credit these days. The reasons for this are several: banks have tightened lending standards, not being eager to lend more in an uncertain economic environment; demand for loans has declined on balance, as lots of people and businesses have made a conscious effort to deleverage and otherwise clean up their balance sheets; and loan covenants have forced many borrowers to deleverage given the decline in the value of assets collateralizing their loans.

This chart suggests that there is another story that is playing out as well. Banks had gone on a lending spree in the years leading up to 2008, creating a lending or credit bubble of sorts, and the decline in lending since then is having the effect of bringing bank credit back into line with the size of the economy.

(Note that the 7% trend line on the chart reflects the annual average rate of bank lending growth from 1984 through the present. The average annual growth rate of nominal GDP over this same period was 5.7%, so even 7% annual growth represents an expansion of bank credit that is more than enough to accommodate growth in the economy.)

I would argue from these facts that, despite the recent decline in bank lending, there is no shortage of money in the economy (a theme I talked about frequently in the latter part of 2008). There has been some rationing of credit to some sectors which has been painful, but overall the economy has plenty of liquidity and plenty of credit. I suspect that given time and given more improvement in the economy, we will see banks once again expanding credit to those sectors most in need of credit. It's already the case that lending to large, well-established corporations has grown at a very impressive 13% annual pace since the end of 2008, according to the growth in the face value of the Merrill Lynch Corporate Master Index. Paradoxically, it's much easier for big companies to borrow hundreds of millions than it is for small companies to borrow millions. I doubt that banks will continue to forego the opportunity to profit from lending to small companies for much longer.


Bill said...

Scott: In your view, what role does the "crowding out" of private borrowers by the massive increases in federal borrowing play in this decrease in credit available to consumers?

Here is an article on the topic:

alstry said...


There is OVER $50 Trillion of public and private debt and only a small fraction of that amount in M2. Debt is now over 350% of GDP.

With savings paying essentially nothing, and debt consuming trillions in interest.....with the new found desire to do you think we can ever get this monster in check before running out of savings?

Scott Grannis said...

Bill: This is a very hard question to answer. On the one hand, it is clear that government is borrowing sums that are almost without precedent (with the exception of the WW II period). Surely this must be "crowding out" private borrowers, since the supply of funds to borrow is effectively limited. On the other other hand, yields on all loans (both Treasury and otherwise) are relatively low from an historical perspective, which suggests that the demand for credit is not materially greater than the supply thereof.

What most concerns me today is not the size of the government's deficit so much as the increased amount of the economy's resources that the government is seeking to control. This is the real crowding out effect, when the government effectively displaces the private sector when it comes to deciding how to use the limited resources we have available to us. Government can never utilize resources as effectively as the private sector can, and it is the waste which government creates that is the true drag on growth, the ultimate "crowding out" that occurs.

狂猪 said...

I think the best source of information is from NFIB. They regularly put out a regular survey of 1/2 million small business.

The biggest problem for small business is lack of customer and as such credit demand is low. Only 5% reported financing as their #1 problem.

Here is the latest report

Here is a snippet on credit condition:

Eleven (11) percent of all owners reported that their borrowing needs were not satisfied, up three points from December. The remaining 89 percent of all owners either obtained the credit they wanted or were not interested in
borrowing. Only five percent of the owners reported “finance” as their #1 business problem (up one point). Pre-1983, as many as 37 percent cited financing and interest rates as their top problem.

Public Library said...

There are a few good articles out there about this being a balance sheet recession. And it could take a decade to repair.

Some Economist may find it difficult to grapple with businesses/consumers switching from a profit maximizing mindset to a survival/repair mindset.

You won't find any explanations in textbooks. Many businesses take profits from core operations to repair poor performing segments or flat-out pay down debt rather than investing in or expanding operations.

Regardless of the opportunities that exist out there. We definitely have a two-part problem.

Banks with tighter lending standards and businesses frankly not in the mood or positions to take on more debt.

This occurred in Japan and some subscribe government intervention until the private sector switches modes.

The problem is, the repairing process could last a very very long time. said...

It'll be interesting to see how far below the 7 percent trendline the lending falls in the next several months.

Scott Grannis said...

Interestingly, the Fed recently changed the definition of bank credit, with the result that the new total has jumped above the 7% line. I haven't done enough digging to know exactly what is going on, however.