TSCI Street Pulse - December 21, 2009

Bankers Caught between Washington & Regulators

The struggles for banks continue as Washington continues toexert pressure on bankers to make more loans to small business so President Obama can lead the country into a nice rosy economic recovery.  The government has been careful not to say “relax, just make the loan”, but more like “ can we check that loan a couple of times for approval?”  The ALCB loan/deposit ratio has fallen off a cliff from the end of 2008.  The ratio had steadily climbed from 0.94 beginning 2005 to 1.02 late in 2008 and has since dropped to 0.88 in 9 short months. While deposit volumes remain level, loan volume has become considerably weaker.  According to the NFIB’s (National Federation ofIndependent Business) November Survey , there are two factors contributing to the weak loan growth:

• Tightened underwriting standards
• Weakened demand. 

While some banks are beginning to relax underwriting standards from last year, businesses and consumers are still spotty on the economic outlook, as it is hard to find or present a profitable plan and reason to acquire additional capital or credit for expansion of plant and equipment, inventories, or mergers and acquisition activity.

While the government pushes for increases in available credit, examiners have presented tightened regulation raising required capital ratios and liquidity requirements.  Of recent, this has led to a change in the way banks operate with respect to portfolio make-up, lending standards, and cash holdings.  As deposit volumes remain steady and lending continues to decrease, this leaves extra cash on-hand for banks to build capital ratios and investments.  Cash holdings had remained very stable for quite some time and at much lower levels than what is currently taking place.  Beginning in late in 2008, cash holdings began rising sharply as a way for banks to remain liquid with adequate capital ratios and to absorb losses as needed.  According to the commercial bank index, cash holdings tripled by 2008-year end and have also risen another 50% from there.

Also, bank portfolios have generally moved away from mortgage backed securities and gone to agencies and treasuries as the government continues to buy up the mortgage backed supply.  Banks have little incentive to get risky, as the fed continues with a friendly cost-of-funding environment and allowing banks an opportunity to recapitulate.  Even as the fed continuesto reiterate an extended low-rate timetable, banks can continue to buy treasuries and agencies to earn risk-free yield spreads on inexpensive deposits.  Even though lending is the primary revenue source for banks, they must account for loan risk in capital ratios, which are being closely scrutinized by regulators. With low costs of funds allowing risk free yields, and examiners questioning every slightly risky loan, combing over capital ratios and questioning liquidity adequacy, where is the incentive to loan money, other than government pressure?

Today it is a much tougher situation for bankers on both the profitability and the regulation side. Washington and regulators are trying to coerce banks to accomplish polar opposite tasks at the same time.  Recently the Basel Committee announced it had decided to delay implementation of rules designed to promote strengthened capital adequacy requirements until after 2020.  Although actual ratios won’t be announced until late in 2010, they will be careful of the effects on any economic recovery as the requirements are put into place over the next decade.

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