Banks Lending More Riskily, Regulator Says

The nation’s chief financial regulator warned Sunday that banks are making increasingly risky loans, a practice that could come back to haunt them, especially if the economy turns sour.

Comptroller of the Currency Eugene A. Ludwig told the annual convention of the American Bankers Assn. in Boston that federal bank examiners will tighten their surveillance and regulation of the 2,000 federally chartered banks to try to head off any major bank failures. A copy of his speech was made available here.

Credit standards are slipping in “almost every category of loans except for agricultural loans” as banks rush to make questionable loans rather than lose business to other banks or even, as the lines blur between different kinds of financial institutions, to other financial institutions, Ludwig said.

He reminded the bankers, now enjoying record profits, of the 1980s, when some banks collapsed and others “suffered ruinous losses” as hard times hit individual economic sectors.

Ludwig said banks saw a series of their hot products--loans to the oil and gas industry, credits for developing countries, financing for commercial real estate projects and complex corporate buyouts with borrowed funds--turn sour after promising huge profits.

“We have learned before that imprudent loans made in the heady atmosphere of good times come back to haunt you when the good times fade,” Ludwig said. “No one wants to learn that lesson one more time.”

The 1980s was also the time when more than 700 savings and loans collapsed, costing the taxpayer-supported system of deposit insurance $150 billion. Like the S&L; industry then, the banks today carry federal insurance on deposits up to $100,000. So their depositors figure to escape losses no matter what happens, although taxpayers could once again be left footing the bill.

*

Ludwig’s speech was unusually frank because he fears the banks have been ignoring his previous warnings. In 1995, he created a National Credit Committee of veteran bank examiners to look at lending standards and risks in the banking system. He warned the industry in April 1995, December 1996 and August of this year about slipping standards.

“Unfortunately, there is every indication these standards have slipped further,” he said.

Because consumers are increasingly paying their credit card debts late or not at all, banks have tightened the standards for issuing cards, Ludwig noted. But this has been offset “by an easing in terms for home equity and residential real estate loans.”

Meanwhile, he said, many consumers are paying for such big-ticket items as cars with unsecured credit cards rather than ordinary secured loans.

Bankers admit that competition “is driving them to make loans that might or might not make sense on their merits,” Ludwig said. “They tell us that if they don’t make these loans, a competitor will. In the process, a good potential customer might be lost forever.”

The comptroller rejected this explanation as ill thought out. “True or not, such arguments will be small consolation when the economy becomes more volatile and the loans turn sour.”

Among the measures that Ludwig is ordering are these:

* Federal bank “examiners will review credit underwriting standards with senior management at every national bank.”

* His office will prepare “definitive guidance” for banks on the best methods to manage risk in their loans.

* “Examiners will evaluate every national bank’s ability to deal with increases in problem loans and follow up with bank management to make sure any weaknesses are corrected.”

* The heads of the banks will be forced to become directly involved. “Examiners will personally meet with the chief executive officer of every national bank to discuss any loans that demand the CEO’s attention,” Ludwig said.

The comptroller is the regulator for federally chartered banks, which hold more than half the assets of the banking system.

Like an angry parent with a child who has eaten too much candy, Ludwig is saying that stern measures now--taking away the candy of easy loans--can avert tears and sickness later. “The maintenance of sound credit standards and supervisory vigilance today will have little or no noticeable impact on economic growth now and will avoid more serious consequences in the future,” he said.

His warning and his announcement of tougher supervision lessen the dwindling chance that Congress will pass legislation this year to tear down the legal barriers between banking and commerce. Banks are keen to expand into lines of business that have been barred to them since the Great Depression.

*

Federal Reserve Board Chairman Alan Greenspan told the bankers convention Sunday that technology and the beginnings of financial deregulation have “changed forever our ability to place commercial banking, investment banking, insurance underwriting and insurance sales into neat separate boxes.”

Market pressures are rising “to permit the common ownership of financial and nonfinancial firms,” Greenspan noted. He said he intends to resist such pressures.

If “we dramatically change the rules now about banking and commerce . . . we may well end up doing more harm than good,” he said. “And, as with all rule changes by government, we are likely to find it impossible to correct our errors promptly, if at all.”