Dom’s Quick Take: Bank Lending Recovery, Is Fed Support Working ‘Too’ Well?

Despite the higher cost of funding, small banks’ credit growth has been stronger than large banks’. This is possibly because support to banks is working so well that it is impeding the transmission of monetary tightening. 

Bank lending growth has resumed since July (Chart 1). Prior to that, bank lending had been flat since the March banking failures. Relative to GDP, bank credit has been falling since end-2022 and remains below its pre-pandemic level. 

A breakdown of lending by sector (Chart 2) shows that since March: 

• Bank lending to non-financial institutions has seen the strongest increase. These loans, which highlight the dependency of the non-bank financial sector on banks, have been on a long-term upward trend, growing from 5% of total bank loans in 2018 to currently 8%. 
• Bank lending to businesses (C&I) has been contracting since end-2023. This is not necessarily a sign of economic weaknesses: a recent survey of small firms does not signal a credit crunch. Rather, the contraction in credit could reflect corporate borrowers attempting to rebuild their balance sheets. Indeed, bank lending to businesses often falls after recessions. 
• Consumption and residential real estate lending dipped in Q2 but since then has started growing again. The recovery in residential real estate lending is taking place despite a steady increase in mortgage rates from 6.4% (30yrs fixed rate) at end 2022 to 7.2% currently. It follows the recovery of home prices that troughed in Q2 2022. 
• Commercial real estate (CRE) lending has been growing steadily through the bank failures, if more slowly since mid-2023.  This reflects mainly mufti family housing (Chart 3). Nonfarm non-residential CRE lending has been flat since Q2 2023. 

Finally, when broken down between domestic and foreign banks, the lending data shows a sharp contrast between foreign and domestic small banks (Chart 4). Lending by foreign banks has been contracting since March, likely due to increased funding costs. Foreign banks lack access to insured deposits and instead fund themselves with wholesale, interest rate sensitive deposits (Chart 5). As a result, they have been facing a steeper increase in the cost of funding than domestic banks. Since early July, however, even foreign banks lending has been expanding, possibly because, with the Fed slowing the pace of hikes, their cost of funding has stabilized. 

When it comes to domestic banks lending, however, the contrast between small and large banks is striking. Since the bank failures, small banks lending has turned out more resilient than large banks lending. This is surprising since small banks face a higher cost of funding as they rely more on large, interest rate sensitive time deposits than large banks. In addition, since small banks tend to have weaker balance sheets than large banks, they could be expected to be more impacted by Fed tightening than large banks.   

Stronger credit growth at small banks could reflect greater efficiency than at large banks but also that Fed support is working ‘too well’. The implicit government guarantee of deposits  and the Fed liquidity backstop have turned out as strong at small than at large banks. This could be because, due to social media, the impact of bank failures on depositors’ confidence is no longer tied to bank size. An implicit deposit guarantee and liquidity backstop could be weakening the impact of higher interest rates on banks’ willingness to supply credit. This suggests a trade between the Fed inflation and financial stabilization mandates. 

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed, the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

Photo Credit: depositphotos.com

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