Are US Banks Playing with Fire in the Commercial Loan Market?

As interest rates remain historically low, the biggest U.S. banks are seeing the need to increase the volume of lending to businesses. The dramatic uptick in commercial and industrial loans is adding significant risks for banks that have with fire in the past and gotten burned. Regulators are aiming to tighten restrictions before severe damage can be done.

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The very small margins have been troubling for banks like Wells Fargo (NYSE:WFC) and Bank of America (NYSE:BAC) since the beginning of the year. In order to make more on the lowest margins in over 50 years, banks have had to push big in commercial lending, according to The Financial Times. Regulators have noticed dangerous trends developing for the first time since the financial crisis of 2008. Consequently, the Fed has issued new standards for leveraged lending practices among banks. Citigroup (NYSE:C) and JPMorgan (NYSE:JPM) join BofA and Wells Fargo in having to comply with the new Fed guidelines by Tuesday May 21.

How can the top banks put their own business and the economy at risk? According to Moody’s, the problems come from the banks’ refusal to discipline themselves and stay away from loans to businesses already saddled with debt. Other risks are general overexposure and the potential to create an asset bubble. Amid calls for banks to increase the amount of capital in their portfolios, the lending practices so far in 2013 have reflected a trend in the opposite direction.

Business loans have surged to $1.55 trillion this year, a 10 percent increase when compared to the first four months of 2012. Though positive economic indicators have emerged recently, the interest rates have remained at levels that challenge big banks’ ability to make the profits its investors want. In this situation, banks are seeing the only way out of the trap is through widening the pool of potential borrowers.

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In order to pull off an increase in commercial and industrial lending, banks have needed to lower standards. Companies that might not have qualified in previous years are being loaned money that might never be paid back. Are the Fed’s efforts another example of government intervention when banks are finally giving out the loans many economists have called for? In the case of big banks’ current lending habits, many will argue the constraints in place are not nearly adequate.

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