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Banks Are Tightening Lending Standards

The Federal Reserve isn’t the only one tightening credit. Commercial banks are too.

And that spells trouble for the US economy.

The proportion of US banks tightening terms on loans for medium and large businesses and for commercial real estate rose last quarter to levels usually seen during recessions, according to a Fed survey of lending officers released earlier this month.

Lending standards for credit cards and other consumer loans also became more restrictive, as the Fed raised interest rates and the economic outlook darkened.

“The tightening in standards by senior loan officers goes part-and-parcel with significantly higher rates and a shrinking balance sheet by the Fed,” said Joseph Lavorgna, chief US economist for SMBC Nikko Securities America Inc. “They’re basically self-reinforcing.”

The increased stringency by the commercial banks will likely affect the economy with a lag, as business and household borrowers find it more difficult to obtain credit and eventually scale back their spending.

So while growth in the closing months of 2022 looks pretty solid, “there’s a really high probability of a recession over the coming quarters,” of around 75%, said Matthew Luzzetti, chief US economist for Deutsche Bank Securities. He sees a downturn beginning in the third quarter of 2023 that ends up raising the unemployment rate to 5.6%, from October’s level of 3.7%.

Luzzetti said the tightening of lending standards by the banks — and the impact that will have on the economy — means the Fed might not have to raise rates as much as feared to restrain demand and rein in elevated inflation. He expects the central bank to eventually increase rates to about 5%, from its current target range of 3.75% to 4%.

Banks told the Fed they had tightened lending standards on commercial and industrial loans for a variety of reasons, including a more uncertain or a less favorable economic outlook and a reduced tolerance for risk. A significant number also cited decreased liquidity in the secondary market for such loans and less aggressive competition from other banks or nonbank lenders.

The industry set aside $13.05 billion in the third quarter for expected credit losses, up from $10.95 billion in the second quarter, according to S&P Global Market Intelligence data. It was the sixth straight quarter that provisions for loan losses were increased, S&P said.

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