There is an opinion survey from the Federal Reserve Board that indicates banks have been loosening their lending terms lately. The senior loans officers survey conducted in April 2018 addressed several categories including household lending, commercial lending, as well as real estate lending.
The study shows that most, if not all, U.S banks are loosening lending policies across all three major categories. There are indications that the practice is cutting across the banking industry as foreign banks follow suit and do the same thing across all three categories.
Why are Banks Loosening Lending Standards?
The simple answer to this question is that banks are loosening lending standards in a bid to attract more borrowers. The global financial crisis experienced in the wake of the housing market crash in 2008 led to the adaption of stricter lending policies by banks the world over. However, since then, more non-bank financial institutions have come into the picture, and the aggressive competition they pose to traditional banks has led to a review of lending strategies and policies.
Other factors that led to this decision include:
- A willingness to assume more risk: with looser lending policies, banks are essentially saying that they are willing to take on more risk as the number of eligible borrowers will grow to include even those who were previously considered high-risk or disqualified as viable clients.
- Relatively stable commercial real estate prices: the commercial real estate market has since bounced back, and as such, banks are slowly regaining their confidence in dealing with this sector as the prices have remained relatively stable.
- High vacancy rates: high vacancy rates in the real estate sector spurred many non-bank lenders into action as real estate borrowers seek to find tenants as well as the money to repay their loans. This leads to a cyclic effect where banks and other lending institutions find it profitable to lend to both commercial real estate clients as well as regular mortgage borrowers.
The greatest factor, however, is the fact that non-bank lenders have found a footing in the industry after banks tightened their lending practices due to the 2008 crash. This means that banks now have to compete with a section of the lending market that does not necessarily adhere to the old “tried and tested” stringent rules that most banks use to ensure coverage for their positions when they loan out money.
Most of these new lenders do not even take credit scores or credit histories into account when dealing with borrowers. Even though they are a bit more expensive when compared to banks, the fact that they are a lot more accessible makes them the first choice for many borrowers who have poor to bad credit.
Advantages of Loose Lending Policies
While it is true that loose lending policies were a big part of the recent real estate crash, the fact of the matter is that, if managed properly, loose lending policies can actually spur the growth of an economy. Here are some advantages that come about with banks loosening their lending policies:
- It allows for more investments and higher consumer spending: when banks lower their interest rates and begin loosening their lending policies, they open up the door to budding entrepreneurs who previously had no access to the kind of funding they need to start their own business ventures that would potentially create more jobs. Additionally, friendlier lending practices could encourage business owners to take on business loans to expand their enterprises thus creating more for the local economy in general.
- It can encourage low inflation rates: one of the biggest advantages of having friendly monetary and lending policies is that it can encourage a stable economy where lenders and borrowers work in some kind of symbiotic harmony. This, in turn, promotes stable commodity prices which can be very helpful in ensuring that inflation rates stay low. Since inflation rates affect just how much money is worth and how people spend it in general, a low inflation rate is an excellent incentive for people to make financial decisions such as taking up a mortgage or a business loan without worrying that prices will drastically change thus putting them in a financial crisis.
- It can help reduce the wealth and wage gap: when more people have access to the capital they need to start their own business and improve their own lives, they get the kind of foundation necessary to create their own
- Leads to fewer financial delinquencies: most people default on their loans or financial responsibilities because they simply cannot afford these facilities. However, looser lending practices can help tame this menace as people gain access to more facilities at more affordable rates.
While these advantages are essentially good for the economy and the well-being of the borrower and the lender, to some extent, it is still not without its risks.
Disadvantages that Come with Loose Lending Policies
- It could create more delinquencies: there are two sides to this coin. On the one hand, loose lending policies could foster fewer financial delinquencies as borrowers have access to more facilities are affordable rates. On the other hand, it could mean that undisciplined borrowers have access to more loans than they can manage thus leading to more borrowing without a solid repayment plan that could, in turn, lead to more delinquencies.
- It could foster predatory lending: as lending policies become looser, more and more non-bank institutions come into the fray and with them come almost no requirements for loan qualification. When someone says that they will not even consider your credit score or history before giving you a loan, you can bet your house that the loan they give you will be as expensive as they come. High interest rates and shady fine print requirements come into play, and this is how people get unknowingly trapped under a mountain of debt.
Yes, banks are loosening their lending policies to attract more customers and spur economic growth, but is it really for the best? In an economy where there are more responsible than irresponsible borrowers, yes, it is for the best. But are we that economy?