Accounting Scandals Take a Toll on Bank Lending Practices

The Federal Reserve Board recently reported that few banks have encountered significant problems with the accuracy or completeness of financial statements submitted to them, but many are tightening up lending practices after widely-publicized accounting scandals and accusations about the roles of banks in cover-ups of unexpected business failures.

The Fed's report is based on a survey conducted from May through July. Key findings:

• The trend over the past year in the number of firms submitting erroneous or misleading financial statements as part of the loan approval process was described as: a "notable increase" by 5.4% of the banks surveyed and "some increase" by 12.5%. The vast majority (80.4%) reported no change in the frequency of erroneous or misleading statements.

• Loans to companies with accounting problems represented more than 5% of total business loans at three large U.S. banks. The majority (58%) said these loans represent less than 1%.

• Their own experiences notwithstanding, most banks have taken action in response to the accounting scandals. Examples: Some began to request additional financial detail during the approval process. Others increased the frequency or intensity of monitoring. Still others are enforcing loan covenants more strictly.

• A significant minority (23.5%) further tightened loan standards and terms for both businesses and households, down slightly from the 25% who had reported tightening credit standards in the previous three-month period.

• Only one bank reported that it had eased standards for business loans. This was the first financial institution to report easing standards since 1999. The Fed did not name the bank.

Participants in the survey included 56 large U.S. banks and 20 foreign banks with U.S. operations.

-Rosemary Schlank