Loan Me a Dime

Put on your wonky hats for this one. The second quarter Senior Loan Officer Opinion Survey (SLOOS) was released by the Federal Reserve last week. It addressed changes in the standards and terms on—and demand for—bank loans to businesses and households over the prior three months (generally corresponding to the first quarter of 2024). The top-line takeaway is that more than a year after the "mini" banking crisis—during which three of the four largest U.S. banks failed—there's been an easing in the percentage of banks tightening lending standards.

Survey respondents generally reported tighter standards and weaker demand for commercial and industrial (C&I) loans, as well as commercial real estate (CRE) loans to companies of all sizes. For loans to households, banks reported that lending standards tightened across some categories of residential real estate (RRE) loans, while remaining unchanged for others on balance. Not surprising was a weakening in demand for all RRE loan categories as well as for home equity lines of credit (HELOCs). Tighter standards and weaker demand were also evident for credit card, auto and other consumer loans.

What's notable about the recent period of tight lending standards was the absence of a recession. In addition, since late 2022, the tightening has been largely driven by Treasury yields and bank credit, rather than risk assets like credit spreads or equity market volatility (VIX). This adds color to why the Fed continues to view monetary policy as remaining fairly restrictive, even though market-based financial conditions measures, like the index shown below, suggest looser conditions.

Easing in financial conditions

Source: Charles Schwab, Bloomberg, as of 5/10/2024.

The GS (Goldman Sachs) U.S. Financial Conditions Index is defined as a weighted average of riskless interest rates, the exchange rate, equity valuations, and credit spreads, with weights that correspond to the direct impact of each variable on GDP.

It's an important distinction to make, especially since there has been some confusion among investors, analysts, and strategists lately as to why members of the Federal Open Market Committee (FOMC)—and notably, Chair Jerome Powell himself—have continued to claim that conditions are tight when measures of financial conditions have seemingly eased (or loosened).

Key to keep in mind is that Fed officials are not solely looking at asset prices to determine the level of restrictiveness in the real economy. Instead, they have focused (and still focus) on the fact that bank lending has slowed considerably, the housing market has weakened over the past couple years, and labor demand has come down swiftly, among other things. As such, there are times during which market-based financial conditions indexes (like the one shown above) can tell a different story from what real economy metrics say. The Fed is not targeting asset prices, though, which means that an improving stock market (and/or falling bond yields) in and of itself does not put rate cuts on hold (and vice-versa).

C&I trends

Of the banks that reported having tightened standards or terms on C&I loans, a significant share cited a less favorable or more uncertain economic outlook, a reduced tolerance for risk, and a worsening of industry-specific problems as important reasons for doing so.