Bank lending has tightened considerably in recent weeks. Why?

As the lifeblood for the economy, the availability of credit is an important source of support for operating capital for businesses and short-term liquidity for consumers. Moreover, it’s critical to business investment and the housing market. Naturally, a more restrictive environment characterized by tighter lending standards and/or higher interest rates will weigh on spending and can significantly curtail investment, leading to a slowdown in the economy.

As shown in the chart above, in response to recent events, banks have pulled back on lending in recent weeks. As of the week ended April 5, total bank lending had declined by around $90 billion (on a seasonally adjusted basis) from its recent peak in early March. Why is credit extension beginning to contract? As we discussed in a previous commentary, banks had already tightened lending standards to a degree over the past year given the higher rate environment and increased recession concerns. More recently, stresses in the banking sector following the collapse of Silicon Valley Bank have led to a further tightening of standards as many smaller and medium-sized banks face questions about their balance sheets and an outflow of deposits.

The bottom line? Tighter lending conditions are a byproduct of the softening economic outlook, the increasingly attractive nature of other savings alternatives (such as money market funds), and the need for many banks to fortify their balance sheets. They’re also a direct result of the Fed’s historically rapid rate hiking cycle. Tighter lending standards will create challenges in terms of more restrictive loan covenants and higher borrowing costs for some, while making access to credit more difficult on the whole. It’s a meaningful sign that after a year of aggressive hikes, the Fed’s actions are starting to bite.