Fed survey of loan officers shows rising impact of higher interest rates

REAL ECONOMY BLOG | August 03, 2023

Authored by RSM US LLP

The Federal Reserve’s latest survey of bank loan officers confirms that the dampening effect of monetary-policy tightening on borrowing and lending continued in the second quarter.

This implies that the residual impact of interest rate increases and the banking turmoil that engulfed local and regional banks in March has not yet reached its peak.

In our estimation, this remains the major risk to the economic outlook.

As expected, the end product of the Fed’s regime change—increasing its overnight rate from near zero to 5.5% in only 17 months—continues to be tighter lending standards and weaker demand for loans.

But the one encouraging note that can be taken from the Senior Loan Officer Opinion Survey for the second quarter is that demand for commercial and industrial loans did not decline further for the first time in 12 months.

The tighter In the commercial sector, the survey indicates that tighter standards and soft demand for commercial and industrial loans to firms of all sizes continued through the second quarter.

At the same time, banks reported tighter standards and weaker demand for all commercial real estate loan categories.

For households, banks reported tighter lending standards across all categories of residential real estate loans, especially for loans not sponsored by government agencies and for home-equity loans, the survey found. Demand also weakened for all residential real estate loan categories.

Finally, standards tightened for all consumer loan categories and demand weakened for auto and other consumer loans. Demand remained basically unchanged for credit card loans.

What’s ahead?

The level of accommodation or risk inherent in financial assets will determine the willingness to borrow and lend, and that willingness will affect economic growth. But it takes time—roughly six months—for higher interest rates to be felt in the economy

While the Federal Reserve reported that banks reported tighter lending standards compared with a year ago, the economy has yet to go into recession.

Households are still spending, corporate earnings have held up, and inflation and geopolitical trauma still exists.

Those economic factors suggest that we might expect another rate hike by the Fed or at least a pause before any rate cuts begin.

The uncertainty over further disruptions to the economy lines up with banks expecting to further tighten standards on all loan categories in the second half of the year.

According to the loan officer survey, banks most frequently cited “a less favorable or more uncertain economic outlook and expected deterioration in collateral values and the credit quality of loans as reasons” for expecting to tighten lending standards further this year.