Stricter Lending Standards and Rising Interest Rates Could Impact Economic Growth.
In the past year, banks have significantly tightened lending standards for commercial, consumer, and real estate loans. This widespread and consistent tightening has resulted in a reduction of credit supply. Banks have achieved this by implementing stricter measures, such as higher creditworthiness requirements, increased risk premiums, reduced loan and credit line sizes, shorter maturities, more stringent collateral and loan-to-value requirements, and more restrictive loan covenants.
The effects of these tightened lending standards may not be immediately evident, but they are likely to impact economic activity and the financial markets, as we have already seen with the most recent market volatility. We anticipate that recent banking stress will contribute to further tightening of lending standards and a decreased credit supply. Additionally, interest rates have been rising, with the Federal Reserve recently increasing rates by another quarter point. Consequently, loans in various categories, such as commercial & residential real estate, auto, consumer loans, working capital, and loans for funding mergers, are becoming costlier.
From a macroeconomic perspective, the potential reduction in credit extended by banks, combined with the increased cost of new loans through higher interest rates, may hinder economic growth. This could lead to slower growth and a contraction of corporate earnings throughout 2023 and into 2024. Additional tightening by the Fed, along with further tightened bank lending, could place extra strain on the economy, and contribute to a recession.
Conversely, if the Fed were to cease quantitative tightening or expand its balance sheet, the resulting liquidity injection could potentially boost the economy and equity prices, providing stability. However, this is unlikely to occur if persistent inflation remains an issue. With inflation pressures above the targeted 2% level, it would be challenging for the Fed to justify stopping quantitative tightening and expanding its balance sheet.
We believe the current credit environment will serve to increase uncertainty and volatility in the financial markets. We commit to keep you updated.
Have a good week ahead,
Dennis P. Barba, Jr.
CEO & Managing Partner
Michael P. Finkelstein, CFA
The opinions expressed in this report are those of the author(s) and are not necessarily those of Wells Fargo Advisors Financial Network or its affiliates. The material has been prepared or is distributed solely for information purposes and is not a solicitation or an offer to buy any security or instrument or to participate in any trading strategy. CAR-0323-04170