Now and Then: The Evolution of Loan Quality in U.S. Banks, the latest edition of the New York Fed's Current Issues in Economics and Finance, is available.
Authors Kevin J. Stiroh and Christopher Metli find that although bank balance sheets weakened and loan quality declined in recent years, the banking industry remains much stronger than it was during the banking crisis of the late 1980s and early 1990s.
The authors present persuasive evidence that the recent deterioration in loan quality is less of a threat to both the banking industry and the U.S. economy than the problems a decade ago. The increase in troubled loans over the 1999-2002 period was relatively modest and was concentrated heavily in large-bank commercial and industrial (C&I) lending to the telecommunications industry and a handful of other industries. This "concentration of the problems in particular sectors," the authors note, "reduces the risk of an economy-wide ‘credit crunch’ and should allow bankers and supervisors to focus their attention on the troubled industries."
The authors compare loan performance from fourth-quarter 1999 to third-quarter 2002 with that from fourth-quarter 1988 to second-quarter 1991—both periods of economic contraction. Using as their measure the aggregate nonperforming loan (NPL) ratio—nonaccrual loans plus loans ninety days past due as a percentage of total loans—the authors find that both the level of, and the increase in, loan quality problems were considerably smaller during the recent period.
Stiroh and Metli show that real estate lending drove the decline in the ratio in the early 1990s, while C&I lending was largely responsible for the more recent decline. According to the authors, "these differences reflect the divergent nature of the two economic slowdowns: The recession in the early 1990s was exacerbated by the developing-country debt crisis and overbuilt commercial real estate, while the recent downturn was linked to the high-tech bust and large declines in business investment." The authors also find that loan quality problems in the 1999-2002 period were entirely at large banks, while loan quality was weak for banks of all sizes in the earlier period.
To determine whether the C&I loan problems at large banks originated with a particular group of borrowers, Stiroh and Metli draw on data from the Shared National Credit (SNC) Program, an interagency effort to review the performance of large syndicated loan commitments. The SNC data lead the authors to conclude that recent credit quality problems have been concentrated in specific industries—most notably, broadcasting and telecommunications. The majority of borrower industries, by contrast, have strengthened their credit quality since the early 1990s.
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