Nearly eight months after some economists declared the global recession officially over, the recovery is still painfully slow in some sectors of the economy and nowhere to be found in others.
Small businesses, usually an engine of economic growth and job creation, are having trouble obtaining the credit they need to expand.
The reason is that some banks and bank examiners, still reeling from the recession and large portfolios of bad loans, have tightened credit standards to unreasonable levels. This must change if we are going to have a sustainable economic recovery.
Part of the problem stems from how federal and state bank examiners review loan risks and value the underlying collateral held by the institutions they oversee. Despite some guidance from federal regulators, examiners do not seem to be getting the message that loan classification must be reasonable.
Since becoming commissioner of the New Jersey Department of Banking and Insurance nearly four months ago, I have spoken to many representatives of state and federally chartered banks. I am hearing that examiners are taking a hard line on risk evaluation, which in turn prompts bankers to keep credit tight, particularly in the small-business sector. Representatives of some of the largest U.S. financial institutions recently told me when asked to comment on current lending activity, "We are lending only to the very best risks."
We can all see the results of this philosophy.
A congressional report issued in June said the value of large banks' loans to small businesses shrank 9% from 2008 to 2009, more than double the 4.1% overall drop in lending.
And in July, the Federal Reserve said only 40% of small businesses that tried to borrow in 2009 had all their needs satisfied.
American Banker recently reported that the loan-to-deposit ratio has declined, underscoring a weak lending environment. One analyst said that loan volume is falling 6% or 7% in most regions. The Federal Reserve says that the last four months have produced the weakest lending period since 1947.
We need to do everything possible to reverse this trend. I have already asked our federal regulatory partners to change their examination approach to evaluating lending risks so that the reality in the field matches guidance from Washington. I specifically requested that federal examiners not move an actively paying loan from "performing" to "classified" when a borrower is unable to refinance a balloon principal payment that was part of the original amortization schedule. Also, the recession-eroded value of underlying collateral should not, in and of itself, negatively affect the status of a loan. In short, let performing loans perform.
Without this change, bankers will remain wary of easing credit restrictions and continue to place an unreasonable burden on our suffering small businesses.
At the same time, I have asked our department's examiners to make more reasonable loan evaluations during examinations. Banks should not be discouraged from loosening credit by overly cautious regulatory risk classifications.
Regarding practices at the banks themselves, I am encouraging banks to boost loan-to-value ratios from the current, draconian level of 60% to a more reasonable level nearer 80%. In the bubble days, LTVs all too often went beyond 100%; risk evaluation remained cursory and underwriting standards were too loose.
Though bankers might take a more reasonable approach to LTV ratios, they must also review collateral value. I am urging our charters to take a more measured approach to risk assessment by considering a three- to five-year running average that should iron out peak valuations and also yield some flexibility during troughs. I hope the nation's largest banks do likewise.
We need cooperation from everyone to make sure small businesses obtain the credit they need and that small-business owners with performing loans are not unfairly punished.
A change by regulators would help many people transfer from the unemployment rolls to permanent work.
It is time that federal and state banking regulators help the financial institutions they oversee return to reasonable credit standards. Banks must resume lending to our small businesses for a meaningful and sustainable economic recovery that creates jobs.