I was having an conversation with my BIL the other day regarding the unavailability of loans and he claimed that banks weren’t making as many new loans due to increased reserve requirements. Is that accurate?
I ultimately want to know if it is a good idea to increase reserve requirements or limit risk taking by banks during a credit crunch, but that is really a GD question. So let’s get the facts first.
Thanks,
Rob
The amount and types of reserves that banks are now requiring now are more realistic. Several years ago my wife and I purchased a property in Nevada. For reserves we were allowed to use money in a retirement account that I can not touch while I am still working. And we only had to have reserves for the new loan.
Last year we purchased a rental house. The money in the retirement account could not be used. I had some money in another account and they subtracted the amount of taxes that would be due on that money. And in reserve I had to have 6 months of payment on all outstanding loans, not just the new loan.
Do I think it is a good idea, yes it is. It is possable to have up to 10 loans outstanding, and if you have 6 months of reserves for one loan. If you lost your cash flow you would not be able to make it through one month.
I think reserves requirements in the OP refers to capital reserves of the lender bank, not the borrower consumer.
The FDIC has not increased the reserve requirements for all institutions.
That being said, a few things are affecting banks that are making capital a precious thing.
Any bank that has suffered big losses has will want to maintain their capital. Uncertainty in the CRE market, as well as continuing stress on the residential market requires increased capital to be placed into the Allowance for Loan Loss.
Banks that are under Cease and Desist orders (C&Ds) are generally required to maintain a higher than satisfactory level of capital.
As the residential market continues to decline (or even stays stagnant), banks are required to re-appraise their collateral more often. When the appraisals come back lower… more money into Allowance for Loan Loss.
There are of course many more reasons, but those are some of the ones I’ve been dealing with the last couple of years.
You have gotten a little bit technical here, but I am guessing that Allowance for Loan Loss means that they are not allowed to lend X due to the higher expected default rate. Do I have that right? How much is X? Do you happen to know the percentage of a typical bank’s portfolio that is made up of real estate?
Thanks,
Rob
Sorry… The Allowance for Loan Loss is a portion of capital that is set aside to offset the losses that are expected from loans that a bank has outstanding. If you ever read a quarterly release from a bank, they will usually have some type of wording similar to this
The ALL cannot be considered when calculating the captial of a bank or the liquidity (how much money they have). It also cannot be used to lend against, which is how banks make money.
You deposit $1000 in your savings account.
Your neighbor also puts $1000 into his account.
The bank pays you both 1.00% APR
They lend it out at 7% APR, but they can lend $10,000 against your $1000.
Now the loan looks doubtful to be reapid.
Instead of using your neighbor’s $1000 to lend against, they have to put it into the ALL in case they don’t get paid back.
The portion of a banks portfolio that consists of RE differs based on each bank’s lending criteria, business focus, and market area. You can see for yourself though by looking at a bank’s call report at the .FFIEC’s (Federal Financial Institutions Examination Council) website. The call report is a erquired quarterly statement of income and the financial condition of the bank. Just look it up by name and date range and you can see a lot of stuff there.
If you start on pg. 15, it will tell you exactly the type of loans on the books. It’s broken down by several different categories and types of loans, but you can tell which type are secured by RE.
Hope this makes a little sense. I’m sitting in a meeting…
It is important to note that every loan at a bank has a loan loss provision. For example, when a bank closes a brand new loan they may set aside 1% as a provision for future losses. The amount that they set aside will differ depending upon the type of loan (corporate, commercial real estate, energy, homebuilder, etc), type of collateral (unsecured, land, office building, oil & gas wells, inventory, accounts receivable, etc), and how they grade the risk of a loan. It might vary between 0.3% up to 2%. Banks then periodically regrade these loans to determine if any additional reserves need to be taken. That is what you are seeing now.
This really isn’t correct and intuitively doesn’t make any sense. How would the bank have the money to lend out $9,000 more than they brought in? Clearly they need to have the liquidity of $10,000 in order to make a $10,000 loan. Bringing in $1,000 in deposits sure doesn’t provide that. Now a bank can borrow using their assets (the loans they make and securities they own) as collateral, but if you look at a typical bank’s balance sheet, usually the amount of deposits and the amount of loans are pretty close in dollar amount. In fact, many banks strive to have greater than a 1:1 ratio of deposits to loans.
The capital ratios of banks are rated as “well capitalized”, “adequately capitalized”, or “under capitalized”. There are various levels of being under capitalized. Depending upon how a bank is categorized would limit what they are allowed to do. For example, they might now be permitted to solicit brokered deposits or increase their outstanding loan portfolio.
The benchmarks required to be considered well capitalized are a tier 1 (core) Capital Ratio of 5.00%, a Tier 1 Risk-Based Capital Ratio of 6.00%, and a Total Risk-Based Capital Ratio of 10%. To be considered adequately capitalized these ratios nead to be 4%, 4%, and 8%, respectively. These benchmarks have not changed. However, that does not mean that the banks regulator can’t require a bank to have higher capital ratios. As mentioned previously on this thread, a bank might be put under a cease and desist order, and as part of that I have seen banks required to hold a Tier 1 (core) Capital Ratio of 8% and a Total Risk-Based Capital Ratio of 11%. Banks can also be pressured to hold higher capital ratios without being under a cease and desist order. It has been common recently for banks to be “required” to hold ratios significantly higher than what is considered well capitalized. This would be a reason why people that know anything at all about banking believe that Obama and other politician’s calls for banks to increase their lending is populist bull shit. What is a bank supposed to do when one part of the governement is telling them to lend more in the press and another part of the government is telling them to lend less. I think I would listen more closely to what my regulators had to say than what Obama says in a 60 Minutes interview so he can gain some political points.
The confusion you’re trying to address is one that I keep seeing–you are exactly right that a bank just can’t lend out $10,000 unless it has $10,000. That’s such a simple concept that it’s hard to justify citing it, but here goes (bolding mine)
http://www.newyorkfed.org/aboutthefe...int/fed45.html
From what I can tell, this wrong idea about how banks loan money comes stems from a misunderstanding of how the money multiplier works in the context of fractional-reserve banking (often seen in the arguments of those who hold the dumb idea that a fractional-reserve banking system is fraudulent).
The OP asked about required reserves. Required reserves are set by the Federal Reserve Board of Governors and have nothing to do with the FDIC.
Here is a complete history of reserve requirement changes. The most recent one is #103, at the bottom. Required reserves haven’t been raised since December 20, 2007; the only two actions in 2009 had the effect of lowering reserves.