Borrowers wanted

The Straits Times

Nov 11, 2008 | 11:08 AM

Borrowers wanted

NEW YORK - BILLIONS of federal bailout dollars are flooding the financial system and many banks say they are ready to lend. But a crucial piece needed to solve the credit crisis is still missing: borrowers.

Banks are seeing a big decline in the number loan-seekers because nervous consumers and small businesses are scaling back their borrowing.

The slide in loan demand has been a hallmark of past downturns, and it could thwart the government's attempt to increase lending with an injection of US$250 billion (S$ 374 billion) in emergency cash. This is one problem that has nothing to do with whether a bank is healthy.

'It's not us saying we won't lend money - it's borrowers saying they don't want it,' said Mr William Dunkelberg, chairman of Liberty Bell Bank, which in the past year has seen loan demand cut by about half across its four branches. 'We're letting people know that the credit crunch isn't here. That's a Wall Street problem.'

The borrowing drought has been most dramatic among small businesses, which employ half of all private-sector workers.

In fiscal 2008, the number of small business loans issued by banks plunged 30 per cent compared with the previous year, according to the US Small Business Administration. Over the same period, the dollar value of those loans fell from US$20.6 billion to US$17.96 billion.

The pullback reflects a big drop in consumer spending that is forcing small businesses across the country to put off expansion plans and cancel orders for new equipment.

Dentist Mark E. Harris would like to upgrade equipment, but is wary of taking out a loan. He said: 'It's just too hard to predict my cash flow from month to month.'

Business is down about 25 per cent over the past year.

The reluctance to take on loans boils down to fear.

Mr Ilya Bodner, owner of Initial Underwriting Group, said he's noticed a sharp increase in anxiety among his roughly 1,500 US clients, who hire his company to help secure startup and expansion money and handle debt restructuring.

One of his clients recently scuttled plans to buy out a competitor and pulled out of US$5 million in loan agreements because of worries that business could dry up.

The skittishness applies to banks as well.

Since the mortgage meltdown, fears that borrowers won't repay loans have forced banks to tighten lending standards. Those concerns have also hurt demand for loans that banks package and sell to investors.

If they can't sell the loans, banks have to hang onto them for longer, reducing their ability to lend more money.

Hoping to spur banks into ramping up lending, the Treasury Department last month rolled out its historic US$700 billion financial bailout plan. A US$125 billion chunk began flowing into nine major banks last week. And more than a dozen sizable regional banks have preliminary agreements to share a part of an additional US$125 billion.

In return for the attractively priced capital, banks are giving the government preferred shares that can be bought back in the future.

The Treasury's goal is to revive lending - and thereby stem the credit crisis - by freeing up potentially massive amounts of loans.

For every dollar a bank keeps as capital, it can lend out as much as US$10, which means the US$250 billion injection could in theory result in US$2.5 trillion in available loans.

But banking experts say lending such a vast amount would be almost impossible given the economic downturn.

If they can't make loans, many banks may hold on to the government capital until stability returns - or use the money to finance takeovers of weaker rivals.

If banks don't increase lending, Washington may turn up the pressure on them or try to retroactively impose guidelines about how the government capital is used - regardless of the weak loan demand.

'Policymakers in Congress may overlook this and say 'We don't care. We want to you to lend the money out anyway,'' said Mr Bert Ely, an independent banking analyst in Alexandria, Virginia. He added: 'More strings are going to be put on this money.' In the meantime, banks are already bracing for a drop in business.

So what could break the lending logjam? Time, for one thing.

If small businesses see that the bailout is starting to take hold and confidence is returning, they will be more likely to seek loans, helping kick-start the economy's recovery, according to experts.

In a hopeful sign, interbank lending rates have been falling in the last three weeks, showing that banks are more willing to lend to one another. The interbank lending rate known as the London Interbank Offered Rate, or Libor, fell to 2.29 per cent last week - the lowest level since November 2004 - for three-month dollar loans.

That's down sharply from a peak of 4.82 per cent on Oct 10. -- AP