Banks’ Tight Lending Standards Could Indicate A Recession

The senior loan officer opinion survey (or “SLOOS”) is a quarterly review conducted by the Federal Reserve, revealing how easily banks are lending money to folks and firms. The graph above shows the percentage of banks reporting that they’ve tightened their lending standards to commercial and industrial customers, according to results of the April survey published this week. And when that line goes up, as it’s been doing since the start of 2022, it means banks are becoming more cautious about dishing out business loans. That’s not all, mind you: the latest survey showed a higher percentage of banks were tightening their lending standards over the first quarter of 2023, not only to business customers, but also to households across all loan categories – mortgages, auto loans, credit cards, and so on.

The survey also asked some special questions about banks' expectations for the rest of 2023, assuming economic activity evolves in line with consensus forecasts. The answers were hardly reassuring: banks widely reported that they expect to tighten their lending standards over the rest of the year to both households and businesses and across all loan categories. That’ll only fuel fears about a looming “credit crunch” – especially after the recent turmoil in the banking sector. Credit, after all, is the lifeblood of the economy: when it gets harder to borrow cash, consumers spend less and businesses don’t invest as much, derailing economic growth and increasing the odds of a recession.

You can see that play out in the graph below from Goldman Sachs. The blue line plots the results of the SLOOS survey – specifically, the percentage of polled banks reporting that they’ve tightened their lending standards to commercial and industrial customers (the same data as the graph above). The red line shows actual bank lending four quarters in the future. When the red line goes up, it means bank lending fell in the future, and the gray-shaded areas indicate recessions. Importantly, you can see that the red line shoots higher during all the shaded gray areas. Here’s what that means: when the SLOOS survey indicates that banks are turning more cautious in their lending practices, it often precedes a decrease in actual lending in the future – a harbinger of a recession.

The relationship between banks’ reported lending practices, actual lending four quarters later, and economic recessions. Source: Goldman Sachs.