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Fed Survey Shows Tightening Lending Standards After Rate Hikes and Turmoil

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A recent survey by the Federal Reserve has revealed that more lenders are tightening their lending standards in the wake of increased turmoil within the banking sector. The survey, which is conducted quarterly, is known as the Senior Loan Officer Opinion Survey or SLOOS. It showed that lenders attribute the changes in their lending standards to economic uncertainty, a reduced appetite for risk, deterioration in collateral values, and broader concerns about banks’ funding costs and liquidity positions. Additionally, lenders reported they expect tightening standards on all loan categories for the rest of the year, citing the above concerns and customer withdrawals.

Impact of Tightening Credit on the Economy

The tightening of credit could have material impacts on how fast the economy grows. According to Warren Kornfeld, senior vice president of Moody’s Investors Service, small businesses, which are very large employers, are major providers of credit to small and mid-sized businesses. Depending on how long and significant the tightening is, it can impact the real economy in the near term as investment, hiring, and growth slow on the back of tighter lending.

The report doesn’t usually garner much attention from the public, but that’s not the case now after three large regional banks failed within four weeks. The Fed is aiming for a precarious “soft landing” to lower inflation without causing a ballooning in unemployment. 

Senior Loan Officer Opinion Survey (SLOOS)

The SLOOS released in January showed that standards tightened for most business loans, particularly commercial real estate products. Standards tightened and demand weakened for residential loans and consumer-specific categories such as credit cards, autos, and personal loans. At the time, banks expected that the trend of tightening credit, waning demand, and deteriorating loan quality would continue.

Risks and Implications of Tightening Credit

According to a separate report released on the same day by the Federal Reserve Bank of New York, the impacts of tightening credit have varied for consumers. The sharp decline in perceived credit access and availability in March wasn’t replicated in this month’s survey results. In April, declines were seen in both the share of households reporting it’s easier to get credit and the share of households reporting it’s harder. 

Still, household income growth expectations fell slightly, but a steeper drop in spending growth expectations was seen. The latest federal snapshots on consumer spending showed a cooling that economists say could indicate either people “retrenching” or returning to more typical spending patterns.

Federal Reserve Bank of Chicago President Austan Goolsbee said that “the credit crunch, or at least a credit squeeze, is beginning” and that it should be something Fed officials should strongly consider when deciding interest rates. Fed officials, including Chair Powell, noted that credit tightening could be similar to a rate hike.

Assessing Risks to the US Financial System

Separately on Monday, the Fed released its semi-annual Financial Stability Report, which assesses the resilience of the US financial system. Ongoing banking stresses vaulted into a “salient risk” since the previous stability report was released in November. According to the report, other risks include persistent inflation, monetary tightening, US-China tensions, commercial and residential real estate, and Russia’s war in Ukraine. 

To Wrap Up

The tightening of credit presents risks to the economy, but a soft landing is still possible. According to Treasury Secretary Janet Yellen, credit tightening could have material impacts on the economy, but she still believes that a soft landing is possible. Nonetheless, from the survey, it is clear that banks are experiencing stress, and the potential for a credit crunch remains a salient risk. Policymakers and investors should anticipate this risk to impact the economy in the near term as investment, hiring, and growth slow on the back of tighter lending.

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