Picture du Jour: Keep a close eye on lending standards

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The Federal Reserve Board’s Senior Loan Officer Opinion Survey is due to be published on August 17. This is an important document for assessing to what extent credit markets are thawing and confidence is returning to the financial system.

In the meantime, the European Central Bank’s Euro Area Bank Lending Survey has just been published. The net percentage of banks reporting a tightening of credit standards for loans to firms more than halved to 21% in the second quarter of 2009 from 43% in the first quarter – down from a peak of more than 60% in the third and fourth quarters of 2008.

As one would expect, there is a strong correlation between the lending standards in the US and Europe, as shown in the graph below. Based on the historical relationship it seems likely that the number of US loan officers reporting a tightening of lending standards later this month could decline significantly – from 40% to possibly in the region of 20%.

slos-pic1

Source: Federal Reserve Board’s Senior Loan Office Opinion Survey and the European Central Bank’s Euro Area Bank Lending Survey

A decline in the lending standards of US banks should be bullish for the economic recovery and financial markets, but the demand for loans also needs to improve in order for confidence in the world’s financial system to return to more “normal” levels and liquidity to start flowing freely again, fueling a descent economic recovery. The Senior Loan Officer Opinion Survey due out in two weeks’ time should provide quite a few answers.

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