Giving Credit Where It Is Due…Literally

[i]WORD ON THE STREET:[/i][/u] In recent months, when I have spoken to bankers who say they are reluctant to extend new credit or to renew or restructure existing loans, many have cited an uncertain regulatory environment as a primary concern. [/b]The current regulatory uncertainty stems from a number of causes, such as the ongoing work on regulatory reform in the Congress and international regulatory standards in Basel. In addition, a number of recent and proposed changes in accounting standards will intersect with the regulatory changes in ways that cannot yet be predicted. While bankers keep an anxious eye on these developments that will shape lending in the future, they are also concerned about the stance of bank examiners in bank examinations right now. I do not believe it is appropriate, or even possible, for regulators to urge banks to make loans that are outside their risk tolerance or that would be unsafe or unsound. But we can and should be sure that supervisory policies do not impede the flow of credit to all eligible borrowers. That's why the Federal Reserve and other regulatory agencies have worked so hard during the past few years to ensure that while banks appropriately recognize loan problems they also continue to make loans that are safe and sound. I'm sure you're aware of what we have done, but I wanted to briefly discuss the lending guidance the Federal Reserve issued in collaboration with the other regulators. In November 2008, regulators issued guidance stressing the importance of continuing to make prudent loans to creditworthy customers. In October 2009, the agencies issued guidance covering commercial real estate (CRE) loans and workouts, and in February of this year, we issued guidance regarding loans to small businesses. All three pieces of guidance are intended to be accessible and easy to use by both banks and examiners and to provide clarity and consistency about the supervisory treatment of new loans, problem loans and different loan workout approaches. In particular, the CRE guidance includes a number of examples drawn from common loan situations and specifies classification treatment for alternate scenarios that depend on actions taken by the bank and the borrower. To test my understanding of the specifics and to be sure our intentions were clearly communicated, as we were finalizing the guidance, I sat down with our supervision staff and went through each of the examples just as if we were in a loan-closing conference. Importantly, at the Federal Reserve, we have complemented these issuances with training programs for examiners and outreach to the banking industry to underscore the importance of sound lending practices. In January, Federal Reserve staff instituted a system-wide examiner training initiative that is reaching Federal Reserve and state examiners all across the U.S., including approximately 100 examiners from Ohio. In addition, in May, more than 1,400 bankers and state bank commissioners from across the country participated in an ‘Ask the Fed’ conference call to discuss CRE-related issues, such as credit workouts and troubled debt restructurings. The session was an effective way of helping to clarify the guidance, and it helped us hear more about the concerns that people in the industry have. The Federal Reserve is also working to develop better ways to measure the effectiveness of the lending guidance we have issued. After all, if these sorts of issuances don't work, we need to know that so we can figure out a better way to get our messages across. Before issuing the CRE guidance last year, Federal Reserve staff surveyed examiners to gain a better understanding of the banks' workout practices. That information is serving as a baseline for assessing the impact of the supervisory guidance. We also are asking examiners to capture, where possible, information on troubled debt restructurings and other types of loan workouts and dispositions as part of the ongoing examination process. In addition, we are exploring the feasibility of more-formal statistical approaches for measuring and evaluating the effectiveness of the CRE workout and restructuring policy statement. Despite all we are doing, I still hear the concern that the pendulum has swung and that examiners are being too strict on banks – a development some say is curtailing loans. I hear this often when I talk to members of the Congress, who say bankers in their district tell them that examiners from all the banking agencies are making it too tough for them to make loans. So, I will say the same thing here that I say to people on Capitol Hill: If you believe Federal Reserve examination policies are improperly impeding the flow of credit, we want to know about it. I can't stress this enough: We want to know if you believe that our supervisory actions are unnecessarily impeding the flow of credit. I also want to emphasize that we are focused on lending to creditworthy borrowers. In no way do we want to return to the world where people could buy a house with no money down and no documentation. But where prudent loans can be made, we want to do everything we can to make sure those deals are struck – it's best for the banks, it's best for the borrower and it's best for our economy as a whole. Ultimately, the most important step policy-makers can take to improve credit availability to businesses and households is to achieve a sustainable economic recovery. Over the past two years, the Federal Reserve has acted forcefully on multiple fronts by instituting accommodative monetary policy, expanding existing liquidity programs for depository institutions and establishing new liquidity facilities to support market functioning. In light of the improved economic outlook, fewer lenders are tightening loan standards. Business spending for equipment and software continues to improve, which should ultimately lead to more demand for bank credit. As economic activity picks up and, importantly, the economic outlook brightens, I would expect both the supply of credit and the demand for credit to improve. However, a note of caution is in order. The staff at the Federal Reserve has been studying how credit growth typically resumes after an economic downturn. While it is still early in this recovery period, the resumption of credit growth following the recession has lagged that of all other cycles of the past 40 years, with the exception of the 1990-91 recession. That cycle, as you will recall, was also accompanied by a banking crisis and was followed by significant regulatory change. Just to give you an idea of how long it could take for credit volumes to recover: adjusting for inflation and measuring the time it took to return to the level of credit at the trough of the cycle in the first quarter of 1991, it took three years for consumer credit to return, 4.5 years for home mortgages, 5.25 years for nonfinancial business credit and a full 8.75 years for commercial real estate. Bearing this in mind, we will continue to study and assess the impact of the various factors at work in determining the total level of credit outstanding. Credit plays a critical role in our economy. That is why policy-makers invested so much money and energy into ensuring the survival of our financial system. There really is no single step that can be taken to quickly unclog all lending markets. Just as the causes for the decline in lending are multifaceted and complex and took time to evolve, the solutions will likely be equally difficult and will take time to fully work. The financial condition of the banking system, the evolving regulatory climate, the financial condition of businesses and consumers, and the path of the economy will all influence supply and demand for credit. We at the Federal Reserve, meanwhile, will continue to do everything we can to encourage a return to a healthy credit environment. [i]Elizabeth A. Duke is a governor with the Federal Reserve System. This article is adapted from a speech delivered at the Ohio Bankers Day conference in Columbus, Ohio, on June


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