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.