In the aftermath of failures, bank economists expect poorer credit quality and less lending

Bank economists surveyed by the American Bankers Association expect that consumers’ purchasing power may come under pressure as lending standards tighten.

Victor J. Blue/Bloomberg

Credit conditions are bound to weaken in the second quarter and beyond as the economy slows and the recent banking crisis hits the industry.

This is according to the latest American Bankers Association credit conditions index, released in April which covers forecasts for the next six months. If the projections materialize, it would be a stark turnaround from 2022, the year in which banks grew lending at a steady rate while maintaining historically low credit losses.

“The recent strong credit quality will be challenged by heightened uncertainty and broader economic headwinds this year,” ABA chief economist Sai Srinivasan said in an email. “Lenders are responding with caution and underwriting caution.”

The ABA Credit Index produced a reading of 5.8, a sharp drop from the already poor result of 12.5 published in the January report. A sub-50 reading would be expected by economists Deteriorating credit market conditions. The findings are based on a survey of chief economists at 15 of the country’s largest banks.

The latest reading is the weakest since the peak of the pandemic in 2020.

The dispute revolves around the convergence of multiple forces threatening the economy and, by extension, the ability of banks to lend without increasing exposure to losses.

The Federal Reserve has raised interest rates several times over the past year in an effort to tame inflation, which has soared to the highest level in decades in the wake of supply chain disruptions caused by the pandemic. When interest rates rise rapidly, borrowing costs increase and loan defaults tend to follow.

Inflation in 2022 peaked at 9.1%. It ended the year at 6.5% and has since fallen to 6%. However, it is three times the level that Fed officials say is healthy for the economy. The combination of historically high rates and worsening inflation has sent the economy into recession.

Then, in March, the failures of California’s Silicon Valley Bank and New York’s Signature Bank amplified concerns about industry weakness.

The sudden demise of the two banks — along with the self-liquidation of Silvergate Bank in California — injected massive doses of uncertainty into the financial system. Silicon Valley Bank is based on $209 billion in assets Deposits from risky tech startups Drop it, while signing assets are $110 billion and assets are $11 billion Silvergate fell After forays into the cryptocurrency market.

Robert Bolton, chief investor in Iron Bay Capital, said in an interview that the problems in the failing banks seem isolated. However, they have nonetheless heightened recession fears and are likely to spur bankers to become increasingly selective in their lending decisions.

“It’s a safe bet that banks will become more conservative,” he said.

The ABA Credit Index found that economists expect the quality of consumer and business credit to deteriorate this quarter and the next. They also expect banks to hold back on lending to avoid potential pockets of vulnerability, including consumer loans and Commercial real estate.

The Association Consumer Credit Index, a subcategory, decreased by 7.9 points, to 5.8 points, from the previous quarter. Banking economists surveyed by the ABA expect consumer loans to be available and Low credit quality. During recessions, job losses tend to accumulate and consumers’ collective ability to make loan payments often weakens.

Meanwhile, the ABA’s Business Credit Index fell 5.6 points from January to a reading of 5.8. Economists expect that overall corporate credit conditions will continue to soften over the next two quarters.

Piper Sandler analysts Scott Seaver and Brendan Nosall said in a report this week that the Fed’s latest data — which covers conditions through the end of March — showed that lending did indeed slow late in the first quarter.

During the last two weeks of March, total industry loans fell 0.9%, “marking the worst two-week period we can remember,” Piper Sandler analysts said. They noted that 70% of the decline in loans over that period came from community and regional banks. They added that every category of loans other than credit cards declined in the last week of March, “which also marks the broadest deterioration we can remember… the loan contraction is now a more pronounced pressure point.”

This comes on top of deposit losses. Clients, worried about the bank outflows that have precipitated the recent failures, have pulled some of their money out of banks in favor of safe havens like US Treasuries.

Federal Reserve data showed that total industry deposits fell by another $65 billion in the last week of March. That brought the total deposit loss to $411 billion from levels before the bank crash that occurred in the second week of March, according to a Piper Sandler tally. But the latest data shows that the pace of deposit outflows slowed by two-thirds in the last week of March.

Deposits “have leveled off in the last week, which we consider positive,” Sievers and Nosal said.