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Why Aren't Banks Lending More? What Both Sides Say

Banks need to lend more. That is what regulators in Washington have been saying for months, even years now.

Banks retort they might lend more if regulators were not being so tough on them, either by layering on new capital requirements that tie up funds or by in-house examiners taking a hard line with the banks’ loan portfolios.

Speaking to regulators and bank executives across the country, CNBC found the weak lending environment can't be blamed solely on the banks: Regulators have a hand in it too. There is a difference between what officials in Washington say and what regulations and bank examiners allow.

That’s the point JPMorgan Chase CEO Jamie Dimon has been trying to make about the new regulations. “Has anyone bothered to study the cumulative effect of all these things?” a frustrated Dimon asked Federal Reserve Chairman Ben Bernanke at an international monetary conference in Atlanta last June. “Is this holding us back at this point?”

Bernanke acknowledged no analysis had been done on how new regulation might be crimping lending. Former FDIC Chair Sheila Bair went a step further in congressional testimony last month, downplaying the impact of higher capital standards.

"“Regulators are not being as reasonable as they used to be,”" -CEO of a small midwest bank

“It is a fallacy to think thinly capitalized institutions will do a better job at lending,” Bair said. “A well-capitalized bank will keep functioning even when the business cycle turns downward.”

Keeping banks functioning has been the primary goal of regulators in the wake of the financial crisis, even if it comes at a cost to businesses and consumers who are having more difficulty getting loans.

The balance sheets of the nation’s four largest banks—JPMorgan Chase, Wells Fargo , Bank of America and Citigroup —show total loans dropped 5 percent to $3.03 trillion as of the third quarter of last year from the post-crisis peak of $3.19 trillion in the first quarter of 2010. FDIC data show lending for these top banks is down 8 percent from its peak in 2007.

Small wonder the Fed’s latest lending officer survey shows a tightening of credit standards.

“You’re being examined right now, not on what the agencies are saying in Washington,” said one executive of a small northeastern bank who, like others in this article, asked not to be identified. “You are being examined in light of an examiner not wanting to have their name associated with another bank failure.”

From 2008 through 2011, 414 banks have failed in the U.S, according to the FDIC and as of the third quarter of last year 844 remain on its “troubled bank” list. Bank executives told CNBC it is no surprise examiners on the ground are being more conservative in assessing a bank’s loan portfolio, given the memories of the 2008’sfinancial crisis are still fresh in their heads. Still, three years on, they said, you would expect examiners to lighten up.

“Regulators are not being as reasonable as they used to be,” said one CEO of a small midwest bank. He recalls how they were back in the 1980s after the savings and loan crisis. Then regulators would work with his bank to figure out ways a farmer could make good on a bad loan. Today, he says, regulators are not practicing forbearance.

Instead, bank executives told CNBC, examiners are rigidly focused on global cash flow, or knowing what exactly the loan will be used for, and where a client is getting the money to repay the loan. These are factors in good credit analysis, but they don’t always outweigh other equally important considerations such as track record, or personal knowledge of a borrower.

The executive at the small northeast bank describes a loan he gave to a longstanding client with a good current relationship with the bank. The three-year loan was to buy equipment needed for a two-year construction. Given the client’s history, the bank OK’d the loan. But the bank examiner felt it was risky, given the loan was a year longer than the construction project.

The examiner questioned where specifically the client would get the money to repay the loan after the last year. Because of his relationship with the client, and knowledge of the client’s business, the banker felt confident the client would have the money to repay. The examiner felt otherwise. Now the loan is “classified”, meaning the examiner thinks it is risky so the bank has to put more capital aside for the loan. That leaves the bank less money to lend elsewhere.

Regulators, who declined to be named, acknowledged given that the economy has gone through some dislocation, there is a tendency to overreact, but they also defend the examiners on the ground. One regulator noted an internal review of more than 300 loan write-ups found little to no evidence of examiners being tougher than the guidelines mandated by regulators in Washington D.C.

Still, in the wake of the crisis, regulators said they felt there was room for improvement in how real estate, particularly commercial real estate loans were being assessed.

Bankers consternation with in-house examiners may stem from the added scrutiny and additional capital requirements some of the loans merited, one regulator noted. They emphasized examiners do not say to a bank “You can or cannot make certain loans”, rather the examiner provides general guidance on lending.

But the new way in which these commercial real estate loans are being assessed appears to be impacting overall lending. in a note to clients on January 11, 2001, Wells Fargo economist John Silvia writing, “Retrenchment in real estate lending has been much greater this cycle and appears to be more sustained than most prior cycles..”

Silvia goes on to add, “Perhaps once real estate values recover, lending will return to a rapid pace of growth.”

That might be optimistic. Regulators’ hard line on these loans does not appear to be softening, and for banks, there is no way to get around the fact mandated higher capital requirements and lower leverage ratios will ring-fence their lending activities.