U.S. Banks Found to Be Easing Loan Standards : Lending: Top regulator admonishes industry executives for allowing their institutions to take on riskier customers.
Driven by tough competition for new customers, many big U.S. banks are seriously relaxing their standards for making consumer loans, the top regulator of national banks warned Wednesday.
Management “should not lose sight of the effect of new lending on the risk in their portfolios,” Comptroller of the Currency Eugene A. Ludwig said in a letter sent to the chief executives of the 3,000 national banks.
Ludwig’s admonition could serve as a warning to banks not to squander their current strong financial health. The number of bank failures has fallen dramatically, and analysts see little risk of a repeat of the 1980s when the business was rocked by massive losses on real estate, energy and agriculture loans.
However, loans to new high-risk customers--including consumers with previous credit problems--can become a troublesome source of potential losses during a recession. These customers often are among the initial casualties of a major recession, “the first ones who lose their jobs and are not able to repay loans,” said Cynthia Glassman, managing director at Furash & Co., a Washington-based bank consulting firm.
And consumer debt already is at extraordinarily high levels, with many households apparently increasing their borrowing to maintain their standard of living.
Within the lending industry, potential borrowers traditionally have been categorized as “A,” “B,” “C” or “D” prospects, based on their credit history. Banks generally limited their lending to the A group, or those with the best credit rating and repayment records.
Now, however, “a lot of banks have begun efforts to lend to B and C customers,” said Fritz Elmendorf, spokesman for the Consumer Bankers Assn., an organization with 700 member institutions accounting for two-thirds of the industry’s assets. “This market is riskier and it is different.”
Elmendorf noted that B and C customers traditionally have obtained loans from finance companies, which charge higher interest rates than banks. A typical finance company loan carries an interest rate that is three percentage points higher than a comparable bank loan.
Banks’ expansion into higher-risk markets probably prompted the comptroller’s expression of concern, Elmendorf said.
The comptroller’s letter to the national banks was accompanied by the results of a survey of the 40 largest federally chartered banks conducted by his office’s examiners between May, 1994, and May of this year.
The survey found “relaxed standards for making loans on some products, primarily in retail lending,” the comptroller’s office said in a statement. “Where standards were relaxed, they were done so to meet competitive pressures and because of changes in the bank’s market strategy.”
The biggest changes noted by the comptroller involved retail credit products, a category covering loans to individuals, which can include credit cards, home equity loans and automobile loans.
“I continue to believe that vigilance, by bankers and regulators, is the best way to avoid future problems,” Ludwig said in the letter to the bank CEOs. The letter, dated Nov. 7, and the accompanying analysis of bank lending activity were made public Wednesday by Ludwig’s office.
Ludwig, as chief regulator for federally chartered banks, is “obligated to express prudential perspectives,” said Rep. Jim Leach (R-Iowa), chairman of the House Banking Committee. “But the concerns that he has expressed must be understood in the context of the positive news that American banks are in an unprecedentedly strong position to provide capital to American business, and the bank insurance fund has never been better capitalized.”
The comptroller’s warning “may be a little behind the curve,” said Bert Ely, an Alexandria, Va., bank analyst and consultant.
“In the last couple of months, there have been numerous indicators of consumer debt starting to worry people,” Ely said. “What is troubling is that the economy is doing about as well as it has in 20 years, and this is the time when financial stress on individuals should be easing.”
Consumers normally pay down some of their credit obligations and add to savings in a period of prosperity. Instead, consumer debt continues to rise. “If this happens in a good economy, you can say, ‘My God, what happens if things turn down,’ ” Ely said.
With wages rising at the slowest rate since the government began keeping detailed records in 1981, consumers appear to be using credit to buy the additional goods and services they want. This creates a growing debt load for individuals and families. As the best customers reach their limits on credit cards and home equity loans, many banks apparently are turning to the riskier borrowers they normally shun.
It has reached the point that banks are going after finance company customers, some of whom have a history of late payments or personal bankruptcy and who may maintain lifestyles that exceed their available income, according to Elmendorf of the Consumer Bankers Assn.
Expanding their lending universe can be a “good and profitable business” if they handle it prudently, said consultant Glassman. Banks can make money by managing their loan portfolios closely, charging higher interest rates, and maintaining adequate reserves for losses, she said. “It requires much more hands-on monitoring, close personal attention,” she noted.
Competition has tended to force banks into new markets. The small personal loans of 20 years ago have been replaced by credit cards, according to Glassman. In the automobile loan business, banks have tough rivals in credit unions and the finance subsidiaries of the auto manufacturers. And the specialized mortgage lenders have taken much of the home loan business once enjoyed by banks and thrifts.
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