Cycles in Lending Standards?

T he lending activity of commercial banks has long received considerable attention as an important contributor to the performance of the economy. This attention has, perhaps, become sharper in the wake of the difficulties experienced by the banking industry in the 1980s. In recent years, the public perception of bank lending seems to have swung through a cycle. In the early 1990s, the prevailing view was that the bank loan market was experiencing a credit crunch in which banks set unreasonably high credit standards, denying credit to qualified borrowers.1 By late 1994, with growth in bank loans picking up, some voiced concerns that banks were possibly becoming too loose in their standards for acceptable credit risks. These concerns appeared in the pages of the American Banker and other professional journals and in speeches by the Chairman of the Federal Reserve Board and the Comptroller of the Currency.2 Do swings from tightness to laxity in credit standards constitute an inherent part of bank lending activity? Some observers have suggested that such cycles can be caused by an imperfection in bank credit markets that results in a systematic tendency for banks to overextend themselves during general expansions of lending. In some expressions of this view, the imperfection is the result of government intervention in banking markets, while in others it results from the very nature of credit markets. In any case, the implied consequence is a cycle in lending behavior that is distinct from and may exert an independent influence on the general business cycle. The existence of a systematic cycle in lending standards could have important public policy implications. If lending displays a bias toward too much