Troubled banking industry sharply reduced lending in 2009

By Binyamin Appelbaum
Washington Post Staff Writer
Wednesday, February 24, 2010; A08

Lending by the banking industry fell by $587 billion, or 7.5 percent, in 2009, the largest annual decline since the 1940s, as the number of troubled financial institutions rose sharply, the Federal Deposit Insurance Corp. reported Tuesday.

FDIC Chairman Sheila C. Bair said that some small banks have reduced lending because of financial weakness, a problem the Obama administration aims to address with a proposal to pump $30 billion in new federal aid into community banks.

The FDIC considered 702 banks to be in some danger of failing as of the end of 2009, more than double the number at the beginning of the year.

But Bair said that the vast majority of the lending decline was the result of cutbacks by the nation's largest banks, which have tightened qualification standards for borrowers and increased the proportion of money that they hold in reserve against unexpected losses.

"Large banks do need to do a better job of stepping up to the plate here," Bair said.

The decline in lending is a looming issue as the economy begins to recover. Companies start by returning to full capacity, filling open desks with new workers or running equipment more hours each day. But for the recovery to continue, for businesses to expand and employment to grow, lending must begin to expand, too.

The decline also has become a major political issue amid broad public anger that the federal rescue of the banking industry has restored profitability but not the flow of loans.

The FDIC, which reports every three months on the health of the banking industry, said Tuesday that the nation's 8,012 banks posted an aggregate profit of $12.5 billion in 2009, up from the depths of 2008 but far below the profits recorded during the golden age of the mid-2000s.

The largest banks accounted for most of those profits as a growing number of smaller banks have struggled to survive losses on commercial real estate loans. Almost 30 percent of all banks lost money in 2009, the largest share of losers in the 26 years of available data.

Regulators closed 140 banks in 2009, and Bair said she expected the number to rise this year.

There were modest signs of better days ahead. The FDIC continues to project that loan delinquencies will peak this year. But the industry's health tends to lag behind that of the broader economy as banks absorb losses from lending mistakes, and Bair said banks would continue to convalesce through 2010.

"We're still bumping along the bottom of the credit cycle," she said.

The amount of money that banks extend to customers has fallen for six consecutive quarters. The drop in the last three months of 2009 was about $129 billion.

Banks cut back most sharply on funding for construction and development, reducing the volume of such loans by 23.6 percent. Business lending followed close behind, down 18.3 percent. The reductions in those two categories accounted for most of the overall decline. Lending to individual borrowers declined more modestly.

James Chessen, chief economist for the American Bankers Association, said banks are building strength so they can increase lending as the economy recovers.

"The banking industry continues to buttress its financial position to assure it can meet the credit needs of communities throughout the country," Chessen said. "Banks are increasing their capital levels, and the industry continues to set aside strong reserves to cover problem loans created by the high levels of unemployment and business failures."

The FDIC reported an improvement in its own financial health in the fourth quarter.

The agency's insurance fund, which repays depositors in failed banks, has been drained by the largest wave of failures since the early 1990s. The agency estimates that the 140 failures in 2009 will cost the fund $37.4 billion.

But a special assessment on the industry raised the FDIC's cash reserves to $66 billion at the end of the year, and Bair said she is confident that the fund has enough money to cover the current round of failures. Historically, most banks on the troubled list do not fail, but the 702 on the list still represent the largest number since the early 1990s. The agency does not disclose the names of banks on the list.

The FDIC reported that its insurance fund had a negative balance of $20.9 billion at the end of the year, but there are two differences between that number and the agency's cash reserves. First, the fund balance does not include $44 billion already placed in a separate reserve to cover expected losses. Second, the FDIC is delaying the inclusion of some of the money collected through the special assessment to limit the accounting impact on the banks that provided the money.

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