If large financial institutions are withholding needed capital from the economy simply because they can, then the bashing of big banks may be hard to stop.

But what if the continued contraction in lending is actually doing them and the country a favor?

Maybe taxpayers, presumably still on the hook for "too big to fail" institutions, are better off having still-fragile banks put less of their precious capital at risk. Maybe a system that overdosed so spectacularly on leverage could do awhile longer with less borrowing.

The political climate is far too frosty for bankers to say so, of course, and executives were nothing if not diplomatic in sizing up the situation for investors last month during calls to discuss fourth-quarter results.

"We have stepped up our efforts and are giving a second look to credit requests, given the importance of credit to the economic recovery," said James Rohr, chairman and chief executive of PNC Financial Services Group Inc. of Pittsburgh.

U.S. Bancorp Chairman and CEO Richard Davis said he "strongly support[s] the government's efforts" to keep credit flowing through the economy, and would have his Minneapolis company revisit previously rejected loan applications, particularly from small businesses, "to see if there are additional opportunities to provide them with solutions to their financing needs."

Last week's better-than-expected report on gross domestic product growth underscores the logic in giving another look at applications turned down when economic forecasts were bleaker. But companies such as PNC, which reported a 10% drop in loan volume last year, and U.S. Bancorp, where a 5.5% increase in lending came mainly from acquisitions, would have good reason to give their credit committees the benefit of the doubt before loosening their underwriting requirements. After all, the last time the industry went lax on standards, disaster ensued.

"Credit needs to be flowing in order for a good economic recovery to take root, but you want it done in a prudent way," said Christopher Wolfe, a financial institutions analyst with Fitch Ratings.

Elevated loan-loss rates underscore why banks have been more discriminating in their new loan approvals, and why they may feel pressure to keep their capital war chests full.

But the biggest banks are still putting up capital to support their trading businesses and to keep their employees compensated handsomely, if not as obscenely as in the recent past, opening the industry to criticism from an angry public.

"It's not like the banks are saying, 'We're going back in our shell, we're not taking any risk here.' They are taking risk. They just aren't taking risk through lending," said Joe Peek, a finance professor at the University of Kentucky's Gatton College of Business and Economics.

Loan volume last year fell more than 3% at Bank of America Corp. and 9% at Wells Fargo & Co. At Citigroup Inc. and JPMorgan Chase & Co., declines approached 15%. At the 10 largest regional banks, loan volume fell 8.2% in 2009, according to FBR Capital Markets Research.

But whether tight-fistedness by lenders is to blame depends on whether banks, "relative to the health of their borrowers, have become unreasonably cautious as opposed to just being reasonably cautious," said James Wilcox, a professor at the University of California Berkeley's Haas School of Business.

Wilcox, a former chief economist in the Office of the Comptroller of the Currency, said it is entirely plausible that banks burned by bad loans have now swung the pendulum too far in the other direction. But there are two other potential, immeasurable factors in the loan-volume data to consider, Wilcox said: the extent to which banks are being cautioned by their supervisors to be conservative; and the extent to which the contraction in loans is being driven by a contraction in demand.

Industry executives' recent comments have done nothing to illuminate the notoriously private conversations between bankers and their regulators. But yearend results at the big banks yielded evidence that depressed loan volumes can be tied at least in part to a drop-off in demand for credit.

At Wells Fargo, commercial customers in the fourth quarter were using only 35% of the credit available to them through revolving commitments, compared with typical utilization rates of 40% to 50%. At Fifth Third Bancorp, the 33% commercial line utilization rate was "the lowest I have seen in my career," Fifth Third Chairman and CEO Kevin Kabat said.

Rather than drawing on credit lines, the largest commercial borrowers, many of which went into the downturn with ample cash balances to begin with, have simply been slashing costs, delaying projects and, more recently, accessing the freshly thawed capital markets.

Bank credit "is theirs if they want it — it's preferred rate — and they don't," said Davis at U.S. Bancorp, where line-utilization rates set a new low of 30%, down from 32% in the third quarter. "That's your best proxy for what the real loan demand is, out in the real world. And we're not seeing it."

But small businesses do not have as many options as large borrowers, and it is their cause that has been taken up by many of the politicians and interest groups that have been critical of banks.

"There are really two economies out there. There's the economy that has access to equity and securities markets, and then there's the small businesses," said Charles Calomiris, a finance professor at Columbia University.

Whether it be out of political pressure or a sense that the economy is turning around faster than initially forecast, small businesses are getting a second chance from some banks to make their case for credit lines.

In the meanwhile, small banks with the financial wherewithal have been happy to provide their larger rivals' castoffs with a refuge.

Ronald Paul, chairman of Eagle Bancorp in Bethesda, Md., said he has "never, ever, seen, as a percentage of loans, the new-relationship volume that we're seeing right now, and probably 50% of it is the result of the frustration that substantial customers have with the big banks."

Some of the recently acquired clients say they their credit lines with larger institutions are not being renewed, or that their banking relationships have been affected by turnover in personnel at the big lenders.

Either way, Paul said he is unfazed by the fact that some of his new customers have been rejected by larger banks.

"I know the developers being turned down by [banks such as] PNC aren't being turned down because it's a lousy deal — they're being turned down because [the banks] don't want the balance sheet risk," said Paul, who also is a real estate investor.

Of course, there is no way to disaggregate loan volume to determine how much of it was determined by supply and how much by demand. But Matthew O'Connor, an industry analyst with Deutsche Bank, said he sees reason to be optimistic now about both sides of the equation.

"The economy is showing signs of improving, interest rates are low and there's a lot of government stimulus out there to incent businesses to borrow and expand, so I think there's a good opportunity for commercial loan growth at reasonable spreads," he said. Meanwhile, "more and more banks we talk to want to make loans. And I think they're pretty genuine in what they're saying."

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