Federal Reserve Warns of Relaxed Lending Standards
The Federal Reserve Board warned Tuesday that some of the nation’s banks have relaxed their lending standards too far during the current economic boom. It asked federal bank examiners to tighten their supervision to make sure the banks remain sound.
In a letter to bank examiners, Richard Spillenkothen, the Fed’s top bank supervisor, cautioned that while the deterioration has not become a serious problem, loans that now look OK could turn sour if the economy weakens or if business profits begin to fall off.
The warning applied only to loans made to businesses, not personal loans.
“Since there is no indication that [current] competitive pressures [for banks to ease their lending terms] are subsiding. . . . This is a critical time for banks to maintain their lending discipline,” Spillenkothen said.
The warning to regulators follows a formal Fed study of bank lending practices nationwide that found a “measurable easing"--in both the terms of the loans and the standards that banks used to make them--between late 1995 and late 1997.
Although the review found that the overall quality of loans did not deteriorate significantly over the two-year period--mainly because of the booming economy--it warned that all that could change if the economy slows down.
Spillenkothen’s letter puts into written form concerns that Fed Chairman Alan Greenspan and other bank regulators, including former Comptroller of the Currency Eugene Ludwig, have been warning about repeatedly for months, both in speeches and in congressional testimony.
Spillenkothen stressed that the 11-page letter was designed only to provide guidance and did not constitute a formal regulation. He warned, however, that banks should brace themselves for a more critical look at their loan portfolios in the future.
The report cited these shortcomings in bank lending practices:
* Too many banks are not going far enough to project the likely performance of would-be borrowers before approving loans, particularly the “downside risks” that might result in a potential default.
* Partly because they hope to attract more business, some banks are not charging high enough interest rates to cover the risks they are taking in providing their loans.
* Some banks are lending too high a proportion of their resources to real estate investment trusts, whose borrowings typically are large, syndicated and not secured by sufficient collateral.
The letter from Spillenkothen urged commercial banks to develop formal, written credit policies, to make sure that lending decisions are made by trained--and presumably detached--credit officers and to require thorough loan-approval documents.