Banks Impeding Growth By Limiting Loans

Despite the Fed creating vast amounts of liquidity, the banks are impeding the flow of the money to consumers and businesses by holding onto their money to rebuild their balance sheets. Starved of cash, businesses will unable to hire new workers and expand production. See the following post from The Capital Spectator for more on this.

There are many things to worry about for the economy in 2010, but perhaps the leading cause of anxiety is bank lending, or the diminishing state thereof.

Commercial and industrial loans made by U.S. commercial banks fell in November to the $1.36 trillion, the lowest since September 2007, reports the Federal Reserve. This isn't surprising after the large negative economic shock over the past two years, but it's troubling nonetheless.



The Federal Reserve can print all the money it wants, but if the liquidity isn't finding its way into the coffers of businesses, the recovery will suffer. Financial institutions, of course, are only too happy to accept the central bank's monetary gifts of late. Nothing makes a banker smile more than a world where he can borrow short and lend long. But while there's a whole lot of borrowing short going on, there's a dearth of lending. What are they doing with the money? For reasons that need no explanation at this point, banks have been focused on rebuilding their balance sheets.

The four largest banks in the U.S., for instance, reduced loans by 15%, or $100 billion since April, according to analysis of government data released earlier this week, reports The Huffington Post.

Bank lending is a lagging indicator and so we should expect to see lending levels decline at this point in the business cycle, or so history suggests. Richard Yamarone's The Trader's Guide to Key Economic Indicators notes that C&I loans tend to "bottom out more than a year after the end of a recession."

If we're optimistic and assume that the recession ended sometime in the summer, that implies that bank lending will continue to fall through the first half of 2010. That's a long time to wait for an economy that's struggling to mount a recovery in the wake of the deepest economic retreat since the Great Depression. Bank loans are critical for juicing business growth, which in turn helps the labor market expand. The latter is essential for an economy that's lost more than 7 million jobs over the last two years and continues to shed workers (of last month).

The good news is that there appear to be signs that the descent of C&I loans is slowing. As our second chart below illustrates, last month's 1.2% drop in lending was roughly half as deep as the 2%-plus pace that prevailed in each of the previous three months.



It's too early to say if C&I loans have hit bottom, but for the moment there's at least reason to hope. That's doesn't mean that lending will quickly soar. The ranks of qualified corporate borrowers have thinned. Meanwhile, banks continue to look for any excuse to hold on to their cash. Lending has remained frozen to the point that the President earlier this week asked bankers to consider "every responsible way" to boost loans.

Talk is cheap, of course, and so are loans. But for the moment, talk is all we have, and some hope that the trend has finally turned.

This post has been republished from James Picerno's blog, The Capital Spectator.