"Banks that eased standards or terms reported having done so in response to increased competition from other U.S. banks as well as from a wide range of alternative sources of business credit"

The October 2004 Senior Loan Officer Opinion Survey on Bank Lending Practices addressed changes in the supply of, and demand for, bank loans to businesses and households over the past three months. The survey also contained additional questions on recent changes in the degree of competition from alternative sources of funds in the commercial and industrial (C&I) loan market and on banks' outlook for business loan credit quality over the next year. Responses were received from fifty-seven domestic banks and twenty foreign institutions.

Both domestic banks and U.S. branches and agencies of foreign banks further eased lending standards and terms for C&I loans over the past three months. Banks that eased standards or terms reported having done so in response to increased competition from other U.S. banks as well as from a wide range of alternative sources of business credit. A sizable net fraction of domestic and foreign institutions also reported an easing of lending standards for commercial real estate loans. On balance, domestic and foreign banks reported stronger demand for both C&I and commercial real estate loans. Standards and terms on loans to households were little changed. Demand for residential mortgages and consumer loans reportedly declined, on net.

C&I Lending
(Table 1, questions 1-9; Table 2, questions 1-9)

In the October survey, both domestic banks and U.S. branches and agencies of foreign banks reported a further net easing of credit standards on C&I loans. More than one-fifth of domestic banks, on net, reported having eased their lending standards for large and middle-market firms, about the same fraction as in the July survey. A similar percentage of these institutions also indicated that they had eased their lending standards for small firms, a noticeable increase from the 4 percent net easing in the previous survey. The share of U.S. branches and agencies of foreign banks that reported easier lending standards for C&I loans was 35 percent, little changed from the July survey.

Both domestic and foreign institutions indicated that they had continued easing many lending terms on C&I loans over the past three months. On net, about 50 percent of domestic banks reported that they had narrowed spreads of loan rates over their cost of funds for large and middle-market borrowers, and nearly 40 percent had done so for small firms, up from about 30 percent in each case in the July survey. More than half of the foreign institutions reported narrowing spreads on their C&I loans in the latest survey. In addition, roughly one-third of both domestic and foreign respondents indicated that they had eased terms on credit lines by reducing the costs of these lines and increasing their maximum size.

Almost all domestic and all foreign respondents cited more aggressive competition from other banks or nonbank lenders as the most important reason for easing their lending standards and terms over the previous three months. About three-quarters of domestic banks that had eased their lending posture also cited a more favorable or less uncertain economic outlook as a reason. Not as many foreign institutions were optimistic about the economy, but 60 percent, on net, pointed to an increased tolerance for risk as a reason for easing. The few domestic banks that tightened standards or terms over the past three months said they were motivated to do so by a worsening of industry-specific problems or reduced tolerance for risk.

Because respondent banks have consistently reported that they have eased standards or terms in response to increased competition from other sources of business credit, this survey included two special questions on the nature of this competition. Forty-three domestic respondents and fifteen foreign respondents indicating that they had experienced increased competition from other sources of credit this year reported that the greatest increases came from the U.S. commercial banking sector. For domestic institutions, and especially for the largest commercial banks in the sample, the second-most-cited source of increased competition was investment banks. At foreign institutions, the second biggest increase in competitive pressure came from other foreign banks. Both domestic and foreign institutions also indicated greater competitive pressure from a wide range of other sources of business credit. The majority of those respondents expressing an opinion indicated that the increased competitive pressure reflected a permanent, rather than a temporary, change in the structure of the C&I loan market. However, one-half of domestic respondents and about one-third of foreign bank respondents felt that the nature of this shift was not clear at this point.

An additional question asked banks about their outlook for the credit quality of business loans over the next year. A majority of the domestic and foreign respondents indicated that loan quality is likely to stabilize around current levels if economic activity progresses in line with consensus forecasts. On net, the remaining domestic and foreign banks indicated that loan quality would likely continue to improve.

On net, about one-fourth of domestic institutions reported an increase in demand for C&I loans from large, middle-market, and small firms, a smaller fraction than in the July survey. In addition, 38 percent, on net, reported an increase in the number of inquiries from potential business borrowers. In contrast, only 5 percent of foreign respondents, on net, indicated that demand for C&I loans was stronger, while the number of inquiries from potential borrowers at these institutions decreased.
As was the case in previous surveys, most of the domestic respondents that had experienced stronger loan demand cited as important reasons borrowers' increased financing needs for accounts receivable and inventories as well as for investment in plant and equipment. Almost two-thirds of domestic respondents indicated that customer borrowing had shifted to their banks from other banks or nonbank sources of credit because these other sources had become less attractive. On the other hand, a large majority of the domestic banks that reported weaker demand pointed to borrowers leaving their banks for more attractive sources of credit as an important reason. In addition, these banks indicated that their customers' investment activity had declined and that internally generated funds had increased.

The document was prepared by William Bassett and Fabio Natalucci with the research assistance of Arshia Burney, Division of Monetary Affairs, Board of Governors of the Federal Reserve System.