Financial Update

Domestic banks tightened standards on all major types of loans to businesses and households during the second quarter, although the net percentages of banks that tightened declined compared with a similar survey in April, according to the Federal Reserve's July 2009 Senior Loan Officer Opinion Survey on Bank Lending Practices.

Most lenders said they restricted standards on business loans mainly because of reduced risk tolerance and "a more uncertain economic outlook."

Weakening continued across the loan spectrum
Meanwhile, loan demand continued to weaken across all major categories except for prime residential mortgages. The percentage of domestic banks reporting additional weakening in demand, however, was slightly lower than those in the April survey for commercial and industrial (C&I) loans and home equity lines of credit, about the same for commercial real estate and nontraditional residential mortgages, and a bit higher for consumer loans.

The results in the July quarterly survey are based on responses from 55 domestic banks and 23 U.S. branches and agencies of foreign banks.

In response to a special question in the July survey, domestic banks cited decreased loan demand and deteriorating credit quality as the primary reasons for declines in C&I lending this year. Responding to another special question, most banks reported that they expect lending standards in all categories to remain tighter—compared with their average level for the past 10 years—until the second half of 2010 at minimum.

Uncertain outlook tightens standards
Thirty-seven of 38 banks that answered the specific question said a less favorable or more uncertain economic outlook was the reason for tighter credit standards on C&I loans over the previous three months, while 29 of 37 banks said lower risk tolerance led them to maintain strict standards on C&I loans. None of the responding banks eased standards on prime mortgages, while 39 said demand for mortgages was roughly the same, moderately stronger or substantially stronger.

After holding nearly flat in the April survey, the net percentage of domestic banks that tightened standards on prime residential real estate loans fell to roughly 20 percent. This measure peaked at a level of about 75 percent a year ago. For the second consecutive survey, domestic banks reported increased demand for prime residential mortgages.

August 31, 2009