May 5, 2008 / 6:32 PM / in 10 years

Fed says banks still tightening loan standards

WASHINGTON (Reuters) - Banks in the United States kept tightening lending standards and terms for both business and consumer loans over the past three months out of concern about a weakening economic outlook, according to a Federal Reserve survey issued on Monday.

The April survey of senior loan officers at 56 domestic banks and 21 U.S. branches and agencies of foreign banks also underlined that demand for loans from businesses and consumers was weaker -- though not as markedly as in January.

“Substantial majorities of domestic and foreign respondents pointed to a less favorable or more uncertain economic outlook and to a worsening of industry-specific problems as reasons for tightening their lending standards on C&I (commercial and industrial) loans over the past three months,” the Fed said.

Harm Bandholz, an economist with UniCredit Markets, said the Fed findings implied that a broad-based credit crisis “has spilled over to the real economy and will continue to weigh on investment and consumer spending for some time.”

That will be accentuated by declining job opportunities, Bandholz suggested. Jobs have been lost in each of the first four months of 2008, according to government statistics.

Fed policy-makers may have had the outlines of the loan officers’ report when they decided last week to reduce official interest rates another quarter percentage point. At the time, the Fed hinted it might halt its rate-cutting campaign while it assesses whether the 3.25 percentage points by which it has lowered benchmark U.S. rates since September will spur growth.

The loan survey shows the tight lending continues to be a problem for the U.S. economy, which has grown at only a 0.6 percent rate during each of the last two quarters due to the drag from a deep housing crisis.

“About 35 percent of domestic banks and 45 percent of foreign institutions -- somewhat larger fractions than in the January survey -- noted that concerns about their banks’ current or expected capital position had contributed to more stringent lending policies over the last three months,” the Fed said.

PUMP PRIMING

The Fed -- the U.S. central bank -- and its counterparts in major industrial economies around the world have taken measures to pump liquidity into the banking system while policy-makers have urged financial institutions to keep lending.

The survey shows banks are still lending but they are charging more, which to some extent thwarts the Fed’s purpose in cutting rates and pumping money into the banking system.

“About 70 percent of banks -- up from 45 percent in the January survey -- indicated that they had increased spreads of loan rates over their cost of funds,” the Fed said.

Reduced lending potentially worsens any deceleration in the broader economy because it restricts credit that businesses need for investment in such things as new equipment, and that consumers need for purchases such as new homes.

The survey cited, as a reason for reduced loan demand, less need on the part of banks’ customers to finance investment in plant and equipment or to carry inventories.

“All foreign respondents noted a decrease in customers’ needs for merger and acquisition spending,” the Fed said.

Some 80 percent of U.S. banks and 55 percent of foreign banks -- about the same proportions as in January -- said they were imposing tougher standards for making commercial real estate loans than they had been in the prior three months.

COSTS AND TERMS UP

A majority of banks were also toughening standards for not only prime mortgage loans but also for nontraditional and subprime residential mortgages. Some 65 percent said that there was less demand for subprime loans, the type made most frequently to borrowers with spotty credit records.

One reason that banks cited for becoming wary about lending was concern about their current or expected capital position, a sign that they are worried about their loan portfolios.

With the U.S. housing sector still in steep decline, lenders are bracing for a rising wave of foreclosures that is expected to top two million homes this year and for an inevitable increase in loans that go bad.

Notably, the survey found that 70 percent of U.S. banks had stiffened their lending standards for approving applications for home equity lines of credit since January.

Fifty percent of banks said that for customers who already had lines of credit, they had tightened terms because the value of the collateral securing them -- the homes on which credit lines were issued -- had declined significantly below appraised values.

Editing by James Dalgleish

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