Bank Lending and the Economy

Without a doubt bank lending has a huge impact on the overall economy. When bank lending becomes difficult, then any expansion of economic activity is difficult and slow. When you have a contraction of lending, no economy can grow. This is the reason for TARP and several government programs. The goal was to increase lending of banks. Recently we have seen the Obama Administration allow banks to repay TARP under terms that will hurt the overall economy. For example, BOA has been allowed to use bank capital to repay the TARP and this decreases the amount of capital they have for lending. The other large banks are following suit as soon as they can. When the banks are allowed to use bank capital to repay TARP there should be a DECREASE in overall lending. Sure enough the following chart shows the decrease starting just as some of the banks starting paying back TARP.


Let's look closer at the chart:

Notice we are now below 2008 in total commercial lending at large banks. As the TARP continues to be repaid, expect lending to continue to fall. If you look at the economic history of any country, when bank lending falls like this a recession will follow.
So far TARP has kept the banks lending and kept a total wipeout of the economy. But with bank lending now falling like a rock, it is hard to see how the economy can grow in 2010.

What's more the bank lending to consumers has also started a trend down. Note that the first banks to repay TARP were large commercial lenders (few consumers bank with Goldman or Morgan Stanley). But they do bank with BOA and Citibank. As these banks pay back TARP with bank capital, their consumer lending will also fall. Notice in the following chart the fall in consumer lending in the past month or so:


So as several consumer banks repay TARP, the expectation would be for the decline in consumer lending to continue. With consumers borrowing less, the economy is going to have a hard time rebounding. Thus, forecasts of an 2010 recovery may be too optimistic. While a double dip is hard to predict, with the repaying of TARP by consumer banks, it becomes more of a risk.