Banks Still Fear a Run on Assets, Expert Says

Last week, the Federal Reserve’s Senior Loan Officer Opinion Survey on bank lending practices was released, and for the sixth consecutive quarter, banks have tightened the lending on commercial real estate.

Reasons for the continual tightening vary, but are mostly good as it relates to commercial real estate, according to John Chang, Director Research, Client Services, Marcus & Millichap, speaking on a recent news video by the firm.

“One would think it would be tied to delinquency rates,” Chang said. “If lots of borrowers are late on their payments, it would make sense for banks to tighten their lending standards. We saw that during the global financial crisis.”

But as of the second quarter of 2023, the commercial real estate delinquency rate was just 0.84%, according to Marcus & Millichap. That’s lower than any quarter in the 25 years from 1991 to 2016.

While there’s a belief that commercial real estate faces significant delinquency risk, it hasn’t shown up yet, Chang said, and the media’s focus on the risk commercial real estate poses to the banking system is probably overstated.

“But as we saw earlier this year, just the perception that a bank is at risk of elevated commercial real estate delinquencies is enough to create a run on the bank, and that is the real risk for banks,” he said.

“Maybe it’s the fear of a potential bank run that caused lenders to dramatically tighten their loan criteria.”

According to the Senior Loan Officer Survey, more smaller banks tighten their commercial real estate lending than large banks.

The top reasons small banks cited for tightening standards were deposit outflows, funding costs, deterioration in or desire to improve their liquidity positions, and concerns about declines in the market value of fixed-income assets.

So, commercial real estate delinquencies haven’t been the problem, Chang pointed out.

“As the report cited, the real challenge is a fear of deposit outflows and a desire to increase bank liquidity to mitigate the risk of a run on the bank,” he said. In the mind of bank executives, it’s better to reduce commercial real estate lending than risk being labeled the next First Republic Bank, but that’s actually good news.

“It’s far better for lending to have tightened because of an abundance of caution rather than because of real problems that emerged. If delinquencies remain contained as they have thus far, then the fear and caution levels should begin to abate. And when that happens, lending criteria could begin to ease.”

Chang said the timing will largely depend on four macro factors.

First, there can’t be any more bank runs. A bank run would be a major setback.

Second, the signs of an economic soft landing have to continue. A recession would cause banks to keep lending tight.

Third, the Federal Reserve can’t raise the overnight rate again.

And fourth, there can’t be any major financial market disruptions.

Those are the four major factors investors should monitor to assess the prospects of an easing lending climate.