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Taking fewer chances

Banks tighten credit for consumers and small to mid-size businesses.

November 6, 2023

The Federal Reserve’s Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS) for the third quarter revealed tighter standards and weaker demand across all loan categories. Although there was improvement from the second quarter, the share of banks reporting tightening lending standards remains at elevated levels that would typically be associated with economic recession.

For businesses, 34% of banks tightened their lending standards for commercial and industrial (C&I) loans to large and middle market firms (e.g., businesses with annual revenue of $50 million or more) versus 51% in the second quarter. For C&I loans to small businesses (annual sales of under $50 million), 30% of banks tightened standards from 49% in the second quarter. For commercial real estate loans, 66% of banks tightened standards, little changed from 68% in the previous two quarters.

Compared to the Global Financial Crisis, in the first quarter of 2008 when the U.S. economy entered a recession, 32% of banks tightened standards for business loans to large firms, 30% to small firms, and 80% for CRE loans. Those numbers are broadly similar to the numbers reported in the current quarter.

For households, nearly 30% of banks tightened their standards for credit cards to consumers, similar to the 33% observed in the first half of 2023. There was a deterioration in demand for residential mortgage loans. No surprise here given that 30-year fixed mortgage rates recently reached 8%. About 55% of banks reported weaker demand for mortgage loans, up from 33% in the prior quarter. It is now nine consecutive quarters of weaker mortgage loan demand and counting.

While the U.S. economy remains resilient, the forward-looking aspect of the special questions asked in the latest survey suggest more credit tightening is in the pipeline as questions pertain to the U.S. consumer, the driving force behind our economy.

The Fed asked two sets of special questions, which dive deeper into potential lending activity in the quarters ahead. In the first set, banks were queried about approving credit card and auto loan applications by FICO score versus the beginning of the year. A large share of banks indicated they were less likely to approve credit card (43%) and auto loan applications (36%) with FICO scores of 620, which is considered to range between poor and fair credit strength. This is consistent with reports that the sub-prime auto loan market is essentially shut down. A moderate share of banks said they were less likely to approve applications for either category for those with FICO scores of 680. According to one credit agency, 46% of U.S. consumers have FICO scores of less than 720.

We suspect credit card and auto loan delinquencies picked up in the third quarter, which is another reason that banks are tightening credit as loan portfolios deteriorate. On Tuesday, the New York Fed will release its third quarter 2023 Household Debt and Credit Report. The report will detail trends in household borrowing and indebtedness with data on auto loans, credit cards, mortgages and student loans.

In the second set of questions, banks were asked about their reasons for tightening standards over the third quarter. The top three reasons were a less favorable or more uncertain economic outlook, reduced tolerance for risk and deterioration in credit quality. Some banks did report an easing of standards although they were in the minority.

For mid-size and small banks, the reasons for tightening standards included deposit outflows, funding costs, deterioration or desire to improve liquidity positions and concerns about declines in the market value of fixed income securities. 

While the Federal Reserve may take comfort from the resiliency in the economy, 2024 won’t be a cakewalk.

Ken Kim, KPMG Senior Economist

Bottom Line

Lending by small and mid-size banks to businesses is crucial to the economy just as consumers having access to credit without a stellar credit score of 720 or above. The special questions reveal fissures developing in which underwriting scrutiny is likely to get worse for both households and businesses. The Fed’s recent Financial Stability Report noted declining interest coverage ratios as a potential tail risk in 2024. While the Federal Reserve may take comfort from the resiliency in the economy, 2024 won’t be a cakewalk.

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Meet our team

Image of Kenneth Kim
Kenneth Kim
Senior Economist, KPMG US

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