Banks Tighten Lending Standards

Read what Federal Reserve Vice Chairman Roger W. Ferguson, Jr. is telling Congress about the problems small to mid-sized businesses are having with...
Ed ZwirnMay 17, 2001

It should come as no surprise to many senior financial executives that credit has been getting harder to obtain recently.

But a speech being given today by Federal Reserve Vice Chairman Roger W. Ferguson, Jr. before the House Small Business Committee offers some specifics:

In a May survey conducted by the Fed, “just over one-half of domestic banks reported tightening their C&I loans to large and middle- market firms over the past three months, and 36 percent tightened standards to small firms over the same period.”

The reason this has happened is of course continued uncertainty over both the economy in general and credit-worthiness in particular, according to Ferguson.

“During the market turmoil in late 1998, banks began taking a harder look at the loans that they make to large and middle-market businesses” the Fed official said. “While financial markets settled down subsequent to 1998, banks appear to have maintained a more vigilant posture.””Last year, in an environment of rising delinquency rates on loans and indications of declining credit quality, the percentage of banks who reported some firming in their lending standards for large and medium borrowers rose steadily in each of our surveys,” he continued.

And the huge (though decreasing) volume of venture capital pouring into U.S. firms in recent years has filled only part of this gap, according to Ferguson.

Some $214 billion of VC money has been invested in emerging enterprises over the past five years, and more than $100 billion of that has gone to a record 5,300 firms last year alone, he said. About 270 companies originally backed by VC were bought out last year, while another 250 were able to raise money through IPOs.

But, with these sources of funding in decline, and given their inadequacy in meeting the needs of older, more established firms, the facts and anectodal evidence converge to support the widespread perception of a credit crunch, at least for the small firms which he said make up “around 50 percent of all sales and private domestic product.”

“For every new, high-growth firm seeking venture capital,” he notes. “There are hundreds of small businesses in the manufacturing, construction, trade, and service sectors that have quite different financing needs. Some of these firms have established operating histories and marketable assets that make them good candidates for credit from conventional financial institutions. A few are small corporations that have access to bond market financing, though their bonds are likely to be rated below investment grade.”

But “the vast majority are small enterprises to pledge as colateral and with only limited operating experience from which investors can assess operating performance and future earnings streams,” he added.

But, despite the difficulties he outlines, Ferguson still manages to conclude on an upbeat note:

“Although risky borrowers face close scrutiny, banks apparently have continued to accommodate the needs of their creditworthy business customers, while bank lending rates, on average, have moved lower,” he stated.

Click here for a complete text of the Ferguson speech.

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