Big Banks Loosen Lending Standards: Does it Matter?

The front page of the Wall Street Journal today proclaimed that “Big Banks Loosen Lending Standards”. Further reading revels that while credit standards are becoming more liberal, demand is still weak; especially among businesses with annual sales less than $50 million.

So the question is, will the easing of lending supply also spur demand or will the deleveraging trend (see below) continue within this key driver of economic growth, the small business?

Historically, the correlation between loosening of credit standards, as measured by the Federal Reserve’s Senior Loan Officer Survey on Bank Lending Practices, and stronger small business demand for lending is 72%. This rises to 79% with a one quarter lag and 82% with a two quarter lag. Also, a decrease in loan spreads, above the banks cost of funds, has a 72% correlation with increased demand. The correlation also increasing to 75% with a one quarter lag.

As can be seen in the chart below as credit conditions improved from their peak in Q4 2008 demand has also increased. Also note, that last quarter while conditions improved the net per cent of respondents reporting stronger demands remains negative while a net loosing of standards took place for the first time since 2006.

So conditions on the supply side have improved now let’s take a look at the demand side. All data from the NIFB Small Business Economic Trends Report.

You can clearly see in this chart that small businesses are less optimistic than nearly any point in the past five years. Only 6% feel it is a good time to expand with only 19% planning to make a capital purchase in the next one to two quarters.

Also, plans to expand inventory, hiring and sales expectations remain at low levels. A net of 5% expect lower sales, 3% lower inventory and only a net 1% expect to increase hiring.

It remains to be seen if the loosening of lending standards will spur demand from small business. However, if they are not borrowing to fund capital expenditures, new hiring or inventory what would be the reason to borrow? If the small business outlook is any indication it appears the deleveraging trend will continue and commercial loan demand will continue to be tepid at best.

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