Commercial and industrial loans extended by banks to nonfarm nonfinancial corporations have risen sharply since the beginning of 1994, driven by a combination of capital spending, inventory financing and growth of trade credit.

During that period, businesses substantially reduced their issuance of corporate bonds probably in response to sharply rising intermediate-term and long-term interest rates versus readily available and relatively low- cost bank credit.

That process is likely to go into reverse in the months and quarters ahead. We expect business loan growth to slow sharply and possibly even turn negative for a short period.

That will have important implications for the banking industry, the financial health of nonfinancial business, the term structure of interest rates and, indeed, the overall economy.

The accompanying charts illustrate the situation. Corporate bond issuance declined steadily from the second quarter of 1993 through 1994.

The combination of funds raised in the capital market and internal cash flow was sufficient to meet financing needs through the first quarter of 1994.

Thereafter, the situation reversed. Cash flow remained relatively flat while financing needs for ongoing capital expenditures, inventory accumulation, and trade credit accelerated.

Looking ahead, with interest rates now significantly lower, long term financing is once again relatively attractive.

Meanwhile, the inventory adjustment under way is likely to reduce the need for short-term financing.

The slowing of business sales should also reduce the need for trade credit.

The upshot should be an increase in corporate issuance of capital market debt and an abrupt slowing and possible reversal of business loans.

In a macroeconomic sense, that would transfer credit demands from the short-term market to the long-term market, reducing interest rate pressures at the short end of the curve and intensifying them at the long end.

Growth in the banking industry will be weighted more toward consumer and real estate loans, and securities. Meanwhile, American business will once again restructure its aggregate balance sheet, positioning itself for further expansion.

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