Banks are quietly turning off the money tap

As interest rates bite and fears rise over an impending credit crunch, bank lending shows the first signs of contraction, according to new research from UBS.

The data includes all types of lending to individuals except for mortgages and credit cards—as well as business loans.

“Overall bank lending growth is slowing, consistent with the rapid pace of rate hikes but also potentially due to reassessment of lending within the banks themselves,” wrote UBS economist Jonathan Pingle in a note to clients.

The underlying forces

According to UBS analysts, lending is shrinking for two key reasons: higher interest rates and tighter lending standards.

In the wake of post-Covid inflation, the Fed hiked rates at the fastest pace since the ‘70s. In just over a year, rates surged by 5%—making credit more costly and less appealing.

In addition to the impact this aggressive tightening has had, banks are now ultra-cautious about who they lend money to.

Since the failure of Silicon Valley Bank, the banking sector has been on edge. Banks fear the slightest rumor of instability could lead to the dreaded bank run.

In fact, according to the Fed’s latest loan officer survey, most US banks have tightened standards for business and consumer loans.

The market is on notice

After the banking turmoil earlier this year, the Fed warned of an impending credit crunch.

“A sharp contraction in the availability of credit would drive up the cost of funding for businesses and households, potentially resulting in a slowdown in economic activity,” the Fed said in the Financial Stability Report.

Analysts seconded the Fed.

Goldman Sachs forecasted that the turmoil may lead to a 2% to 5% drop in lending in the U.S. Moody’s chief economist, Mark Zandi, said tighter credit could shave 0.3% off growth this year.

JP Morgan said next year could be even worse, with up to 1.0% of growth at risk.

Credit drives the economy

With the U.S. economy teetering on the brink of recession, economists pay close attention to signals from the banking sector.

Credit is the lifeblood of the economy. It allows money to flow through the system and powers the consumers that drive it. When credit dries up, a slowdown in the economy often follows.

But not just yet. Consumer spending—which makes up the lion’s share of the U.S. economy—remains resilient despite the slowing in lending, according to UBS.

“The real resilience in the expansion really rests squarely on consumer spending in our view,” Pingle said. “The level remains elevated and growth continues—and it is a big contribution to economic activity.”

The question is for how long?