Has Loan Growth Fully Recovered from the Financial Crisis?

On Friday afternoon, the below tweet was posted from @SenateBanking

image of graph on twitter

As you can see, the graph shows a steady increase in the dollar amount of total loans made by commercial banks, generally since the 1950s, and also since 2010.

The graph has several significant shortcomings if it is being used to suggest that current bank lending is encountering no meaningful regulatory or other obstacles.  First, as you’d expect, the level of loans rises over the decades because everything in the economy has generally risen and access to credit has gone up during the post-war period.  For these reasons, it is standard in the academic literature to divide bank loans by nominal GDP and remove the long-run trend in the series to focus solely on cyclical fluctuations in the ratio of bank loans to GDP.  In particular, in the post-war period the ratio of bank loans-to-GDP exhibits an upward trend reflecting the expansion in access to bank loans across households and corporations. [1] When you divide bank loans by nominal GDP and remove the trend in the series, plotted below, it is clear that lending is still recovering from the sharp decline during the past financial crisis.

image of graph

Second, as discussed in a recent TCH blog post (and shown in the next figure), loan growth has slowed markedly in recent years relative to pre-crisis levels at the large banks subject to the tightest regulations including those required by DFA.   Between the first quarter of 2011 and mid-2016, loans on large banks’ books increased about 25 percent while they rose close to 45 percent at small banks.  This translates into an average loan growth rate of 4 percent per annum at large banks and 7 percent at small banks.  In the period between 2001 and mid-2007, annual loan growth at large and small banks averaged 8 percent and 6 percent, respectively. Thus, loan growth at large banks in the post-crisis period was reduced in half.  Because larger banks account for more than 70 of loans outstanding, the higher growth in small bank lending only partially offset slower growth in large bank lending.  As shown in the blog post, the difference in aggregate loan growth between large versus small banks is mainly driven by differences in loan growth of residential mortgages, credit card loans and small business loans.

image of graph

Third, a recent TCH research note attributes the differences in loan growth between large and small banks to the Federal Reserve stress tests.  In particular, the note finds that U.S. stress tests require banks to hold two-to-three times the amount of capital for residential mortgage loans and loans to small businesses relative to the standards imposed by the Basel Committee – the group of central banks that supervises global banking standards.  As a result, as shown in the next exhibit, the banks subject to the tests, which, as noted above, account for nearly three-quarters of bank lending, are shifting away from lending to household to purchase a home and to small businesses.

image of graph

Finally, while bank loans grew at a solid 6½ percent last year, loans decelerated over the year, and slowed sharply toward the end of the year.  Loans grew at 4¾ percent rate in the fourth quarter, reflecting monthly rates of 6¼, 3¼ and negative ¾ percent in October, November, and December, respectively.  The slowing was evident in nearly all loan categories.

[1] There are a variety of ways to remove the trend in the ratio of bank loans –to-GDP, and for simplicity we followed the detrending procedure used in a recent Bank of International Settlements report which uses the Hodrick-Prescott filter with a smoothing parameter of 400,000.