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Fed reports tighter bank lending standards

The Fed reports that more banks are tightening lending standards on home mortgages, other types of consumer loans and business loans in response to a spreading credit crisis.
/ Source: The Associated Press

The Federal Reserve reported Monday that more banks are tightening lending standards on home mortgages, other types of consumer loans and business loans in response to a spreading credit crisis.

The Fed said the percentage of banks reporting tighter lending standards was near historic highs for nearly all loan categories.

The survey, conducted in April, found that nearly two-thirds of banks surveyed had tightened lending standards on traditional home mortgages with 15 percent saying those standards had been tightened considerably.

But the survey found that the tougher lending standards extend far beyond home mortgages to other types of consumer debt such as credit cards and home equity lines of credit.

The current credit crisis began last year with rising defaults in the market for subprime loans, loans extended to borrowers with weak credit histories. Many of those subprime loans were packaged into mortgage-backed securities and sold to investors around the world.

Those investors, however, have pulled back from the subprime market and from other types of credit as losses have soared with the rising mortgage defaults.

As losses have mounted, more and more banks have grown reluctant to make loans and have been tightening up on standards. The Fed has been pumping billions of dollars into the banking system in an effort to encourage banks to keep lending to guard against the threat that the tighter credit could push the country into a deep recession.

However, working against this effort are the huge losses banks have occurred both on direct loans to consumers and businesses and in their own investments in such debt instruments as mortgage-backed securities. In reaction to the losses, banks have raised their own standards, especially because of the growing worries that the weak economy will make even more loans go bad.

“This survey reflects the high level of angst among banks involving the erosion of credit quality, rising delinquencies, foreclosures and defaults,” said Mark Zandi, chief economist at Moody’s

Analysts said the tightening up on credit card borrowing was coming at a particularly bad time given that slumping home prices have made it difficult for borrowers to tap their home equity lines of credit as a source of cash and many consumers have turned instead to using their credit cards.

The latest Fed survey found that banks tightened their lending standards on not just prime or traditional mortgages but also on nontraditional mortgages such as “Alt-A” loans given to people who supplied only limited income verification. The survey found that about 32 percent of the banks responding to the survey had tightened “considerably” their standards for nontraditional mortgages and another 43 percent had tightened standards in this category “somewhat.”

The survey found that only nine banks are currently making loans in the subprime category and of that group, 78 percent had tightened lending standards either considerably or somewhat.

About 55 percent of banks reported imposing tougher standards on business loans, up from about 30 percent in the previous survey in January, the Fed reported.

“The net fractions of domestic banks reporting tighter lending standards were close to, or above, historical highs for nearly all loan categories in the survey,” the Fed said.

The central bank last week announced new steps to aid with tight credit conditions by increasing the size of cash auctions to banks and allowing financial institutions to put up credit card debt, student loans and car loans as collateral for Fed loans.

The central bank also last week cut a key interest rate, the federal funds rate, by a quarter-point, in an effort to lower borrowing costs for consumer and business loans. However, the central bank signaled that this rate cut may be the last for a while as the Fed pauses to determine the impact of the seven rate cuts it has made since September.

Sen. John Kerry, D-Mass., said the new Fed report underscored the need for passage of his bill which would temporarily reduce fees on government-backed loans to small businesses.

“Over half of our banks have tightened their lending standards, making it harder for small businesses to expand their payrolls and invest in new equipment,” Kerry said in a statement. “The Bush administration and Republicans in Congress have bailed out Wall Street and done nothing to help small businesses on Main Street.”