Dismissing fears of a credit crunch, acting Comptroller of the Currency Julie L. Williams said Friday that banks must continue tightening underwriting standards.
"We must not succumb to the temptation to declare victory over lax underwriting of new loans," Ms. Williams said at a risk management conference sponsored by the Federal Financial Institutions Examination Council.
The near collapse of Long-Term Capital Management shows just how far underwriting standards have fallen, she said. Bankers extended billions of dollars of credit based on the reputations of the hedge fund's managers, without regard for its financial health, she said.
"No banker should suspend critical judgment of a loan's riskiness based on assurances that some fancy new computer program or automated gadget makes that judgment superfluous," she said.
The cost of ignoring sound underwriting practices can be enormous, she said, adding that creditors had to put up $3.5 billion to rescue Long-Term Capital. "That's a lot of money that is now unavailable for good loans to productive borrowers," she said.
Though Ms. Williams did not mention him by name, her comments responded to a plea made two weeks earlier by William J. McDonough, president of the Federal Reserve Bank of New York. He said that if regulators went overboard with warnings about credit quality they could spur banks to choke off lending.
"The strength of our economy does not depend upon bankers' making bad loans," Ms. Williams said. "In fact, poorly underwritten loans are one of the best ways that I know of to weaken financial institutions and the communities that depend upon them."
Her comments were well received.
"Now is the time to watch our credit standards," said Robert A. Jung 2d, president of business banking at Norwest Bank, New Mexico. "History has shown that banks that stick close to their underwriting policies have fewer problems when a recession rolls around."
Paul Ulrich, senior vice president for asset quality at Sky Financial Group, Bowling Green, Ohio, said credit quality warnings would not cause him to stop making loans. "I don't associate not overreacting with a credit crunch," he said.
Tom Kramer, chief credit officer at Foothill Independent Bank, Glendora, Calif., said the industry should be criticized for deteriorating underwriting standards, arguing that too many banks are cutting prices and terms to get business. "You have to be a strong bank to stick to your credit-quality guns," he said.
Ms. Williams said banks should have learned about the importance of underwriting standards during the 1980s, when poor practices left the industry unable to provide credit to worthy borrowers.
"When we needed banks to help support the economy, too many of them were fighting for their own survival and were therefore incapable of providing the stimulus that might have made a big difference," she said. "So when we express concerns about lending standards, we do it because we are determined that this history must not repeat itself."
Banks should exploit the relatively healthy domestic economy to strengthen underwriting standards, Ms. Williams said.
"This is the time to renew your focus on any weaknesses that may have already become embedded in your loan portfolio and to develop contingency plans for dealing with existing credit risk in the event that the economic climate does change," she said. "Depending upon the institution, that may involve bolstering reserves, stepping up collection efforts, reviewing collateral, and upgrading workout capacities."
Ms. Williams played down the significance of global economic woes for most U.S. banks, saying losses in overseas lending and trading affect few institutions.
"The fundamental conditions that led to the slippage in underwriting still exist," she said. "Unemployment, inflation, and interest rates remain at historic levels. Consumer spending continues at vigorous levels."
Later at the conference, Joseph W. May, executive vice president at Whitney National Bank, New Orleans, said banks can prevent their stock prices from falling if they focus on credit quality. For instance, Wachovia Corp.'s stock price is near its record high because investors know of its strong credit-quality culture.
"Now is the time to do things right," Mr. May said. "No short cuts."
He warned that most loan officers have never experienced a recession. "We have green front-line troops," he said. "They have never seen an adverse time."
Speaking to reporters after her speech, Ms. Williams said lawmakers should start from scratch next year on financial reform. Safety and soundness, rather than tearing down the barriers separating banking from securities and insurance businesses, should be the primary goal, she said. She declined to comment further.
