Banks began raising lending standards again in 2022.
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The blow-up of SVB and Signature Bank is stoking concerns that standards to obtain a loan will become even tougher.
Lenders started raising the bar for borrowers last year when the Fed started raising interest rates.
“Each bank is going to apply those credit standards differently,” a source told Insider.
Securing a loan or a credit line has gotten tougher since the Federal Reserve started jacking up interest rates, but the recent banking crisis is raising concerns that lending standards will tighten even further, resulting in a potentially harmful credit crunch.
Nearly 45% of banks made it more difficult for businesses to obtain commercial and industrial loans in the fourth quarter of 2022, according to the Federal Reserve’s survey of senior loan officers survey. The $2.8 trillion C&I loan market helps businesses buy equipment and hire staff, among other uses. Requiring higher minimum credit scores and minimum repayments and curbing credit limits were among tweaks banks were making.
That tightening was happening before the blow-up of Silicon Valley Bank and Signature Bank kickstarted a run of at least $500 billion in deposits out of small and mid-sized banks.
With lending a vital part of economic growth, investors are watching to see how risk-averse banks and other lenders will become.
A Dallas Federal Reserve Bank survey released this week gave markets a snapshot of what’s happened at regional financial institutions since the bank failures. Lending to consumers dropped and credit standards and terms “continued to tighten sharply,” with marked rises in loan pricing.
“The credit crunch has started,” Torsten Slok, chief economist at Apollo Global Management, declared in response to the Dallas Fed’s report.
But what does a tighter credit environment actually look like for borrowers?
First, what’s a credit crunch?
A “dramatic worsening of firm and consumer access to bank credit,” is how a 2014 paper on the Federal Reserve’s website describes a credit crunch.
Banks have two key concerns, Brett House, professor of professional practice in economics at Columbia Business School, told Insider.
The first is if borrowers facing higher interest rates can afford to repay and service their loans. The second is centered on a bank’s own ability to maintain liquidity so that if depositors pull their money, they have the cash to meet those demands.
That lays the groundwork for banks to protect liquidity which can feed into higher hurdles for potential borrowers and spill into a credit crunch.
“Many more lenders were tightening at the beginning of 2023 and that’s only going to continue,” Greg McBride, chief financial analyst at Bankrate.com, told Insider.
Tightening standards
The Fed survey found a significant net share of banks raising lending standards for credit card loans, and a moderate share toughening requirements for auto and other consumer loans.
“There’s no hard and fast regulatory rule on these things. Each bank is going to apply those credit standards differently,” said House.
The median consumer credit score is 700, so loan seekers with that score or higher should land approvals and receive competitive rates, said McBride.
House said lenders may also look for long employment histories, solid and upper levels of income and consider if they have lengthy relationships with prospective borrowers.
“It may mean you need to have higher assets in order to reassure the bank that if you lose a job, get sick, or see some other dent in your income that you have the assets to pull on to maintain the loan payments,” he said.
“It’s a big moving target” said McBride. “And a lot of those details they keep close to the vest for competitive reasons.”
Tighter lending standards may have a big impact on floating-rate loans versus fixed loans, CFRA equity analyst Alexander Yokum told Insider. The average mortgage rate paid by most Americans has “barely gone up” as they bought homes before the Fed’s latest rate cycle began.
“Whereas with credit cards, almost all floating [rates], so the average rate that consumers are now paying on credit cards has gone up substantially,” he said.
Credit card balances in the fourth quarter rose by $61 billion to $986 billion, surpassing a pre-pandemic high, according to the New York Federal Reserve data. The NY Fed said the share of current debt shifting into delinquency rose for almost all types of debt.
Defaults should be more pronounced at lower-income households, said Yokum. Those workers logged big wage gains during the pandemic but since then, inflation has outstripped their pay. That means lenders are unlikely to view them as strongly as they would have a few years ago, he said.
“I still think if you’re at the high-end of [income earners], it’s not difficult to get a loan,” Yokum said.
People who have credit scores below 620 have difficulty getting loans “even in the best of times,” said McBride. “There aren’t as many lenders in that market, the terms aren’t as favorable and when credit is tightening that becomes even more the case,” he said.
A Federal Reserve chart shows the percentage of banks tightening standards for business loans.
Federal Reserve