Monday, October 20, 2008

Bank Lending Rates over Time

It has been alleged that banks these days are unable to loan to their business customers. A reduction in the supply of bank loans to businesses should decrease the quantity of bank loans to businesses and increase the interest rate on those loans. Whether most of the bank-loan-supply shock shows up as higher rates rather than lower quantity depends on the elasticity of demand for bank loans (I think that the elasticity of demand is high because there are good substitutes for bank credit, but put that aside for the moment).

I just posted information on the amount of bank lending, which shows evidence of bank customers' hoarding liquidity, but does not suggest that banks have reduced lending (a reduction might be hidden in the data somehow, but if the effect were hidden you have to wonder how big it really is).

Now take a look at banks' prime lending rate. It rose during the housing boom and was flat or falling since the housing crash. It was just cut another half percentage point less than two weeks ago. That tells me that major bank customers had to compete with residential loans during the boom, and now they no longer do (the prime rate also follows the fed funds rate -- I'll leave it to another day to discuss whether supply and demand determines that rate, as opposed to the fed itself).

If a bank does not intend to lend, why doesn't it at least charge more on the loans it does make? You might say that it has to compete with other banks, but that's both true and proves my point. Banks DO intend to lend: they cut their rate to retain and attract customers.

15 comments:

finelycultured.com said...

The LIBOR rate's been what's been cited as evidence of a credit freeze, but we know the banks have capital (Paulson's been giving it to them), and, if your analysis is right, they're still lending to customers. Does this mean the banks are afraid of each other, but not their actual customers?

Steve Waldman said...

Hi.

The "Prime Rate" is meaningless, and has been since the early 1990s. It is fixed at precisely 3% above the Federal Funds rate.

The IBORs are poor measures. But at least they are variable.

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