loans and money

The macro-economic and interest rate outlook will affect the level of loan demand, the ability and willingness of banks to meet that demand and whether it is better to make fixed or floating rate loans. It will also have a significant impact on the level of delinquencies and resulting credit losses.
When an economy is experiencing strong growth this is likely to be accompanied by investment in new capacity and robust consumer demand. Demand for credit is likely to be strong and, in the absence of inflation, interest rates low. Economies are cyclical, however, and investment starts to turn into overinvestment. With signs of an overheating economy and concerns about inflation increasing the central bank is likely to start to increase the discount rate and take action to tighten money supply.
If this is accompanied by a demand side shock (whether domestic or export oriented) capacity utilization levels are likely to fall as will investment in new capacity. The strongest demand for loans is likely to come from companies that became overextended when the economy was expanding and to whom banks are reluctant to increase exposure. In many cases they will be trying to reduce it. Layoffs will start to have an impact on unemployment levels and hence consumer confidence and spending. The central bank is likely to change its bias for interest rates to neutral and then start to cut them in order to give the economy a boost. Supply and demand eventually come back into balance.
We have already noted how difficult economists find identifying turning points. The old wry comment is that “economists have forecast 10 of the last four recessions”. Extrapolation represents the triumph of hope over experience, however. Management has to have a view, whether that view is contrarian or consensus.
The general rules of thumb for a bank anticipating a sharp slowdown are as follows. Cut back exposure to the industries and sectors that have enjoyed the strongest growth. Cut back exposure to companies with stretched balance sheets (high net debt to equity ratios) or where debt servicing depends on continued growth and to those that require a high level of capacity utilization to break even. Increase exposure to defensive sectors such as fast moving consumer
goods and utilities. Reduce the term of new loans (if the ship is going to sink it is best to be one of the first to the lifeboats). Increase the level of collateral cover and quality. All of these actions are easiest to achieve with the benefit of hindsight, of course.