Firstly, simply saying “make more loans” is too generic. Make loans to whom?

Broadly speaking, banks make loans to two types of clients, businesses and consumers. Loans to businesses are captured in total commercial and industrial loan data, as shown below.

As you can see, after an initial spike higher at the onset of the pandemic in March 2020, commercial and industrial loans have plummeted over the past year, with YoY growth rates turning negative at the end of the first quarter of 2021.

At first glance, the huge spike in loans in March 2020 seems counterintuitive – why are businesses borrowing and banks lending so much, so quickly given the extreme uncertainty and fear?

Quite simply, businesses were fully drawing down whatever revolving credit facilities they had with their banks precisely because of the fear and uncertainty.

There was fear that banks wouldn’t lend in the future, even on previously agreed facilities, and fear that banks might not survive that chaotic period of time. Not forgetting the extreme uncertainty that was cast over future business conditions by global economic shutdowns, which meant that companies urgently needed to hoard as much capital as they possibly could.

That does not mean to say that the economy avoided the shrinking of loan volumes and tighter credit availability that are hallmarks of recessions – the shrinking was just delayed. 

The spike lasted only two months, from the end of March ‘20 to the end of May ‘20, after which total loans and growth rates began to rapidly shrink.

It is very important to note that this decline in loans occurred in spite of trillions in fiscal and monetary stimulus that has already been deployed, open ended monetary stimulus that the Fed is still willing to deploy, and perhaps another trillion in fiscal stimulus from a possible infrastructure spending bill.

Which begs the question, why aren’t banks lending as much to businesses?

Simply put, growth prospects just are not that great in the current economy.

This is reflected in the bond and labor market. In the former, real yields still remain mired in negative territory, while the US yield curve flattens.

In the latter, stubbornly continuing claims for unemployment insurance and pandemic emergency aid are still major causes of concern, even as initial jobless claims come down and payroll numbers continue to recover.

Furthermore, it is important to remember that low rates tell their own story, especially if we consider that central banks really don’t control interest rates.

Low rates are in and of themselves reflective of lower growth prospects, simply because borrowers, barring extraordinary circumstances, will not borrow at a rate higher than the rate of return they think their businesses can generate.

Given such an environment, can private sector enterprises, that is banks, really be expected to take on more risk by significantly increasing the amount of loans they make? No, of course not.

Which brings us to the crux of the problem, and also the solution, by showing us where government intervention can make a difference. 

To be continued…