Bank Lending: Policy Makers Squeezed Tight?

The prescription to cure an economy that choked on too much credit is simple: Less credit. Unfortunately for officials, this is a very unpopular medicine, since it reduces economic activity by reducing leverage among lenders, reducing lending, and propping up medium-term interest rates that affect purchases of durable goods. If you want a bank to increase its capital relative to assets, then assets must shrink, since capital will only be generated over time through earnings. Fewer assets, less lending, fewer lenders who are open to lending.

If you are a public official, the last thing you want to be associated with is reduced lending. Hence our current official set of matched lies: "It is the banks who are refusing to lend" versus "You'd better increase your capital ratio." Calling it hypocrisy would be exact, but then some readers find that to be a loaded term, implying more criticism than is intended.

The key point is understanding how all of the players are influenced. While the economy is in bad shape, banks will be hit with blame from officials for not lending while being given incentives to do exactly the opposite. There is a gap between the genuine true and the printed and perceived words in the press. Bank lending will not increase until the real conditions, not words, are there to support it.

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On the other side of the coin are consumers. If they don't want to borrow, they won't. Right now the prudent action for consumers is to pay down debt and build up savings. Eventually, government encouragement to spend and fail to save will arrive, but don't expect an increase in consumer lending until the mood of frugality has passed.