Banks Tightening Lending Terms to Businesses

According to a Federal Reserve survey conducted in January, bank loan officers have continued to tighten their lending terms, particularly to riskier firms. Worried that business borrowers may have a hard time repaying loans with the economy growing so slowly was cited as the main reason for the stricter standards.

Over half of the 54 U.S. banks surveyed said that their institutions have put stricter standards on commercial and industrial loans and credit lines to large and medium-size firms. Sixty percent had done so in the period preceding the January survey. Nearly as many banks, 43 percent, reported they had tightened conditions on similar loans to small businesses, the Fed said. No bank said it had eased terms for either class of business borrower.

When banks tighten terms on business loans, they may do more than raise interest rates. For example, if some form of collateral, such as equipment or inventories, backs the loan the bank may ask for more to be pledged. The size of a line of credit may be reduced. And if a company is required to keep part of the loan proceeds on deposit in the bank in what is called a compensating balance, that balance may be increased.

Tighter terms do not necessarily mean that small-business borrowers are paying higher interest rates than they were three months ago. Many small-business loans are tied directly to banks' prime lending rate, with loan rates frequently stated in terms of the prime rate plus a spread of one or more percentage points.

"As in the previous survey, about two-thirds of the domestic respondents said that they had raised premiums on riskier loans to large and middle-market firms at least somewhat, including a significant fraction that had widened these spreads considerably," the survey summary said. "For small firms, 48 percent of banks reported charging somewhat higher premiums on riskier loans and 10 percent increased their premiums considerably."

The loan officers, who routinely track their borrowers' ability to keep their loans current, said they were finding that some companies that previously were seen as very creditworthy were showing financial strain.

Fed Chairman Alan Greenspan has urged bankers not to become so over cautious that they deny loans to creditworthy firms.

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