Credit where credit is due

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Federal Reserve governor Elizabeth Duke is due to give a really nice piece of testimony tomorrow unpacking what’s going on with small-businesses lending. Judging by the advance text up on the Fed’s web site, it will be a joyously nuanced picture. Banks are hesitant to lend, yes, and are sometimes hamstrung by their own imprudent lending of the past. But businesses are also often not in the mood to borrow, considering the uncertain economic recovery. This does not make for a snazzy populist sound bite, but, alas, it is an honest portrayal.

Duke makes one other major point: bank examiners, like those employed by the Fed, shoulder some of the responsibility.

That’s right, someone is owning up to something. To wit:

The Federal Reserve has been placing particular emphasis on ensuring that its supervision and examination policies do not inadvertently impede sound small business lending.  If financial institutions retreat from sound lending opportunities because of concerns about criticism from their examiners, their long-term interests and those of small businesses and the economy in general could be negatively affected, as businesses are unable to maintain or expand payrolls or to make otherwise profitable and productive investments.

The reason she says that is because banks have in some cases been feeling pressured by their regulators to keep risk-taking (i.e., loan-making) at a bare minimum. She goes on:

The Federal Reserve has directed examiners to be mindful of the effects of excessive credit tightening on the broader economy.  As a general matter, we do not expect examiners to adversely classify loans based solely on a decline in collateral value where, for example, the borrower has stable revenue streams and thus the ability to repay the loan.  We have implemented training for examiners and outreach to the banking industry to underscore this expectation.  We are aware that bankers, as well as examiners, may become overly conservative in an attempt to ameliorate past weaknesses in lending practices, and are working to emphasize that it is in all parties’ best interests to continue making loans to creditworthy borrowers. 

Bank examiners have been told to be more realistic: there’s one reason to be optimistic about the possibility of small-business lending ticking up. Duke also gives another:

There is… some tentative, anecdotal evidence that many bankers may be devoting considerably more energy toward extending new loans in 2010, as contrasted with their overwhelming preoccupation in 2009 with collecting on or writing down loans already on their books.  With respect to small business lending in particular, some banks have instituted so-called “second look” programs that–as the name implies–involve a reconsideration of loan applications that would not be pursued based on a credit scoring model alone.  

Although loans to small businesses are still performing worse than those to larger companies, and lenders know that. So don’t expect anything to change too quickly.