Bernanke: Mortgage Lending an Exception to Improving Picture

Since the financial crisis banks have made considerable progress in repairing their balance sheets and building capital Federal Reserve Chairman Ben S. Bernanke told attendees at the 48^th Annual Conference on Bank Structure and Competition.  Risk-based capital and leverage ratios for banks of all sizes have improved materially and the latest Comprehensive Capital Analysis and Review (CCAR) conducted earlier this year demonstrated, through a stress scenario that he described as quite severe, that most of the 19 participating firms would likely have sufficient capital to withstand a period of intense economic and financial stress and still be able to lend to households and businesses. </p

The banking sector overall also has substantially improved its liquidity over the past few years with large banks in the aggregate more than doubling their holdings of cash and securities since 2009 and reducing their collective dependence on short-term wholesale funding.  Many are flush with retail deposits, which tend to be a more stable funding source.   Liquidity challenges remain however; some large firms still rely heavily on wholesale short-term funding and some of the securities issued by the FDIC under its Temporary Liquidity Guarantee Program are coming due while its unlimited insurance program expires at the end of the year.  </p

The profitability of large banks has been edging up as credit quality has firmed and banks have trimmed noninterest expenses.  The condition of community banks has also improved.  </p

The Chairman said that banks still face a number of significant challenges as they adapt to the post-crisis economic environment and to new domestic and international regulatory requirements. The most systemically important financial firms will face higher capital and liquidity requirements and continue to undergo regular supervisory stress tests and will be required to submit so-called living wills to facilitate their own orderly resolution if necessary.  These new requirements are critical to safeguard the stability of the financial system and to help prevent another costly crisis. </p

Regulators do appreciate that the new rules impose significant burdens on banks so many of the most significant rules are being phased in gradually and only after consultation with industry and other stakeholders.  It is also worth noting that most new regulation are intended for the largest and most interconnected institutions and, Bernanke said, regulators are working to ensure that community banks are not burdened by them. </p

Banks are also facing market demands for more resilient business models.  Counterparties are demanding greater security in the form of more and better-quality collateral or higher margins and lenders to banks may be seeking greater compensation for risk.</p

The economic recovery has been halting at times so demand for credit has remained sluggish and the creditworthiness of some potential borrowers remains impaired.  These factors, along with tighter credit policies have restrained the expansion of bank credit.</p

Still credit conditions have improved significantly in a number of areas and many businesses and households are finding it easier to borrower than they did a few years ago.  Large businesses with access to capital markets and consumers with strong credit histories have both been able to borrow to meet their needs.  Banks also supply credit by purchasing securities and these purchases have picked up recently, especially those of agency-guaranteed mortgage-backed securities (MBS).</p

Still, in some areas, especially mortgage lending, credit conditions remain tight.  Since its peak, home mortgage credit has contracted about 13 percent and many factors are working against a quick turn-around. These include the slow recovery of the economy and housing market, continued uncertainty about Fannie Mae and Freddie Mac, the lack of a healthy private-label securitization market, and cautious attitudes by lenders.  </p

While commercial and industrial lending has been rising sharply, domestic banks are picking up European bank customers and auto lending is strong, mortgage lending remains sluggish because of tight lending standards and terms.  A return to pre-crisis lending standards wouldn’t be appropriate but the current standards may be hampering lending to many creditworthy borrowers.   This may also be impacting some small business lending where borrowers would typically refinance their homes for funding or use the house for collateral for a business loan.</p

In an attempt to understand how shifts in loan supply, demand, and borrower quality may be affecting lending and by extension the broader economy the Federal Reserve has examined cyclical changes in banks’ lending standards as reported in the Senior Loan Officers Opinion Survey.  The analysis attempts to determine how much the changes were a “typical” response to macroeconomic and bank-specific factors and how much was “atypical” or unexplained.”  The analysis suggests that the tightening between 2007 and 2009 was much greater than historical experience would predict and contributed to the subdued pace of lending. These results are consistent with other evidence that the crisis caused exceptionally high levels of risk aversion and uncertainty in both borrowers and lenders, constraining the flow of credit.</p

While some bankers and borrowers believe that enhanced supervision and regulation have impeded expansion of lending, the Bernanke said the Fed takes seriously maintaining the balance between protecting bank safety and soundness and constraining lending to creditworthy borrowers.  For example, Bernanke said, some analysis has indicated that, all else being equal, banks with lower supervisory ratings tend to lend less; so the Fed has directed supervisors to issue appropriate upgrades promptly. Indeed, in the fourth quarter of 2011 and the first quarter of this year, the number of ratings upgrades for banks and bank holding companies supervised by the Federal Reserve exceeded the number of downgrades for the first time since 2005. </p

The Fed has also looked into specific concerns about the examination process and its effect on banks’ willingness to lend and has conducted reviews of examiner records to determine how well they were weighing all factors in determining the regulatory treatment of loans.  </p

Bernanke said in conclusion that conditions in the banking system and the whole financial sector have improved significantly in the past few years and as the recovery gains greater traction, increasing both the demand for credit and the creditworthiness of potential borrowers, a financially stronger banking system will be well positioned to expand its lending. Improving credit conditions will in turn help create a more robust economy.

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