Fed Warns Banks About Lax Lending

The Federal Reserve warned U.S. banks against relaxing their lending discipline, citing a rising number of weak loans in recent quarters. In a supervisory letter, the Fed told bankers it feared they were becoming overly optimistic about borrowers’ ability to pay back loans and about the likelihood of continuing economic growth. The Fed said that U.S. banks tightened some lending standards after last year’s market turmoil but problems remained. “A recurring theme emerging from supervisory reviews is that credit is being extended to some borrowers based largely on the expectation that the current strong financial performance of these borrowers will continue indefinitely, and with potentially undue reliance on aggressive or optimistic views of their future prospects,” the letter said. Vulnerable loans were made more perilous by weak underwriting practices, including failure by some banks to apply “stress tests” to a borrower’s ability to withstand shocks to operating revenue, the Fed said. It said loan portfolios “are currently sound at the vast majority of banks” but said guards must be kept up against laxity to ensure that the U.S. banking system remained strong and able to lend in both good times and in bad.