Capital Markets

Ease Up, Frank Tells Bank Regulators

The congressman says bank examiners are keeping the credit markets clogged.
Sarah JohnsonMarch 26, 2009

How can the U.S. financial system improve its lending standards, yet keep cash flowing at high enough levels to help the overall economy recover and reduce its exposure to the depths of future cycles?

That was a question Rep. Barney Frank’s committee posed to bank regulators and bank lobbyists yesterday as they explored the imbalance between those two forces. Frank, the Massachusetts Democrat who chairs the House Financial Services Committee, urged banking regulators to unclog the credit markets by freeing financial institutions to finance “prudent” loans to businesses.

As it is, Frank contended, the regulators’ examiners are giving banks an unduly hard time and preventing well-deserved loans from making their way through the system. Part of the reason may be regional examiners — those directly in contact with borrowers — are wary of second-guessing by their regulator higher-ups. “While there’s always been a problem of bad loans, there’s a very big problem of good loans not being made now,” Frank said. “This is not the time, I think, to worry about excessive criticism. Certainly a number of loans will go bad, but there should be more focus on good loans going through.”

Frank’s hearing centered on what he called “tension” between banks being told to act more prudently and the need for credit to flow. “The economy won’t recover until the credit system does,” he said. The federal government has been pumping capital into the nation’s banks for the past several months, but those funds are not coming out in the form of loans to consumers or businesses at the level that lawmakers and their constituents would like.

For their part, the regulators acknowledged that banks have tightened their lending standards. Still, the Federal Reserve, for instance, has told examiners to keep the procyclical effects of restricted lending in mind and to keep making “economically viable loans,” said Elizabeth Duke, governor at the Federal Reserve Board of Governors.

At the same time, banks are apparently using their bailout capital for purposes other than loans, choosing instead to cushion their loan-loss reserves or their overall capital, satisfying regulatory requirements. Banks aren’t just restricting the loans they make to consumers on mortgages, for instance, but that also are getting tougher on businesses by pulling credit lines, and raising interest rates or threatening to do so. Prompted by examiners, bankers are pushing their corporate clients to reevaluate the collateral that was originally put up to back their loans — such as their real estate, the value of which has since declined.

For example, Randall Truckenbrodt, a member of the National Federation of Independent Business and a small businessman from Florida, started getting pushback from Bank of America on his businesses’ real estate loans, he told lawmakers. He said the bank put him in a workout program because one of his companies, an equipment rental business, was losing money — even though Truckenbrodt’s loans were current. He has since gone back and forth with the bank over fees to reevaluate the loans and change the terms of their contract. The fees on top of his already hurting company has puzzled him. “It feels as though Bank of America is doing everything in its power to drive my company towards bankruptcy,” he said, according to his written testimony.

As a whole, the 50 largest U.S.-based bank-holding companies reported a fourth-quarter net loss of $42.7 billion last year after taking good-will impairment charges, trading-asset writedowns and for meeting higher loan-loss provisions, according to Duke. Still these banks’ regulatory capital ratios improved in 2008, with help from the federal government’s Troubled Assets Relief Program, also known as the $700 bailout plan approved under the Bush administration late last year.

In aggregate, Duke added, the bank-holding companies have given themselves a capital cushion above what is required of them. “To the extent that institutions have experienced losses, hold less capital, and are operating in a more risk-sensitive environment, supervisors expect banks to employ appropriate risk-management practices to ensure their viability,” Duke said. “At the same time, it is important that supervisors remain balanced and not place unreasonable or artificial constraints on lenders that could hamper credit availability.”

Even though past experience has shown that borrowing by nonfinancial businesses has slowed in previous downturns, slowdown in debt has been “much more pronounced” this time, said Duke. Growth in debt for nonfinancial corporations slowed from a 12.5 percent annual rate in the fourth quarter of 2007 to a 1.5 percent annual rate in the fourth quarter of last year, she added.

Scott Polakoff, acting director for the Office of Thrift Supervision, suggested that Congress come up with “countercyclical” legislation that would allow banks to have lower regulatory capital thresholds during downturns — and higher thresholds during the good times — to let them feel comfortable in lending again.