Why banks aren't lending to business: Is the monetary policy-credit channel broken?

Why aren’t banks lending to private business for their own portfolios when they have had the largest ever increase in bank reserves since 2009 or is the traditional monetary policy-credit channel broken? This study identifies and analyzes several important reasons for banks willingness or inability to lend to commercial enterprises. Their willingness stems from a combination of bad loans on their books and fear on behalf of their regulators that lending to business in a slow economy is “too” risky. As we show, banks are flush with funds and should be able to make loans in their respective markets. At present banks face low borrowing costs, and have chosen to invest in U.S. Treasury securities or make residential mortgages with guarantees from Freddie Mac and Fannie Mae and sell these loans to these same agencies to place in the secondary mortgage market. In contrast, if banks are unwilling to lend to business, perhaps business can borrow elsewhere, such as the commercial paper market or from each other via trade credit (accounts payable). After considering these alternative sources to bank credit based on models of both firms demand for credit and bank supply, we find that firms need bank credit to expand and grow productive capital investments which cannot be supported by short-term commercial paper borrowings or trade credit. Our models are based on data from the Federal Reserve’s Weekly Reporting Bank series which allows development of data on bank lending and bank balance sheets on a monthly basis consistent with other available government data sources. To model demand and supply of bank loans to business on a quarterly basis using the National Income and Product Accounts and Flow of Funds quarterly data, we also data from the quarterly Reports of Bank Income and Condition. Based on our findings that the banks have massively sufficient resources to foster vigorous lending programs to business, we make four recommendations based on our analysis: 1. Congress should encourage regulators to be more lenient to allow banks to amortize write downs of nonperforming loans over a 5 year period. 2. Congress should eliminate the prepayment penalty banks must pay the Federal Home Loan Banks on advances. 3. Bank regulatory policy should move to ease the regulatory pressure on banks from the “play it safe” strategy. And, 4. The Fed should allow interest rates to rise so as to encourage banks to make profitable commercial loans.