Meet the Author

James B. Thomson |

Author

James B. Thomson

James Thomson is a former vice president and financial economist in the Research Department of the Federal Reserve Bank of Cleveland. He retired in February 2013.

Meet the Author

Kent Cherny |

Research Assistant

Kent Cherny

Kent Cherny was formerly a research assistant in the Research Department of the Federal Reserve Bank of Cleveland.

03.12.10

Economic Trends

Commercial Bank Lending

James B. Thomson and Kent Cherny

As the economy emerges from its economic winter, concerns remain about the fragility and robustness of the recovery, in part because of anecdotal evidence that credit flows have yet to return to normal. The most recent data from one of the most important credit channels, commercial bank lending, adds credence to these concerns.

In terms of commercial banks’ total assets, the U.S. banking system grew at an average rate of 9 percent from 2000 through 2008, with yearly growth ranging from just over 5 percent in 2001 to nearly 13 percent in both 2006 and 2007. Banking system growth slowed in 2008 to just over 7 percent, before turning negative in 2009, as the industry shrank by over 4 percent.

The trend in commercial bank assets tells only part of the story. Over the past decade, lending has accounted for only 52 percent of bank assets on average (lending consists of net loans and leases). This means that changes in bank assets may not provide an accurate picture of what is happening with bank credit. This is especially true in 2008 and 2009, as Federal Reserve actions to contain the financial crisis and restore credit flows more than doubled the level of bank reserves—bank reserves rose from an average of 5 percent of assets from 1998 through 2007 to over 8 percent of assets in 2008 and 2009.

The growth of net loans and leases mirrors that of bank assets through 2007. (Net loans and leases are total loans and leases less reserves set aside for loan losses.) Loan growth is much weaker than asset growth after 2007, as bank loan growth in 2008 fell to under 3 percent in 2008 and shrank at a rate of 6 percent in 2009.

From the standpoint of an economic recovery, two forms of bank lending are especially important, commercial and industrial (C&I) lending and commercial real estate (CRE) lending. These represent a major source of credit for businesses of all sizes, but particularly small and medium-sized firms. Commercial and industrial loans contracted at a rate of 20 percent in 2009. Commercial real estate loans have fared slightly better that net loans and leases and much better than commercial and industrial loans, as this category of lending shrank only 4 percent in 2009. By all measures discussed so far—from total assets to commercial real estate loans—bank credit declined in 2009.

These measures reflect assets that are on banks’ balance sheets. Increasingly, on-balance-sheet measures of credit tell an incomplete story about the bank lending channel. Some types of credit don’t appear on balance sheets, and some loans have been taken off.

Bank lines of credit are commonly used by business customers for backup credit. Businesses that regularly fund themselves in the commercial paper market, for example, often have bank credit lines as backup sources of funding as a hedge against a disruption in their ability to borrow in the commercial paper market. In addition, a number of businesses use credit lines as liquidity facilities–drawing them down temporarily to cover unexpected expenses or to take advantage of an unforeseen investment opportunity. Letters of credit allow customers to get credit from other sources, such as a business getting trade credit from a supplier.

Both undrawn lines of credit and letters of credit represent an off-balance-sheet form of credit availability, but neither results in an on-balance-sheet asset when it is created. A credit lines becomes an on-balance-sheet asset only after it is drawn on, and a letter of credit only if a bank takes over the loan backed by the letter.

Banks also sell or securitize a number of loans they make, causing on-balance-sheet loans to understate the amount of credit being intermediated.

Both securitized asset exposure and letters of credit declined in 2009 at a rate exceeding 4 percent. More troubling is the sharp contraction in banks’ undrawn lines of credit—this source of credit fell 11 percent in 2008 and 16 percent in 2009. With on-balance-sheet loans declining in 2009, it is clear that the declines in off-balance-sheet credit facilities are due, in part, to a retrenchment in bank credit facilities and credit substitutes.

While all of these components of the bank credit channel showed increasing weakness after the financial crisis of 2007, comprehensive measures of bank credit have also contracted. The figures below show two such measures. Commercial credit facilitated by the banking system measures on-balance-sheet business loans and off-balance-sheet credit facilities. Total bank credit activities is a measure of on-balance-sheet net loans and leases plus total off-balance-sheet credit facilities. Both commercial credit facilitated and total credit facilitated by banks peaked in 2007 and have declined subsequently. Commercial credit facilities fell by 2 percent and 10 percent in 2008 and 2009, while total credit facilities shrank by 2 percent and 9 percent over the same time period.