Banks have been cutting their prime lending rates but that doesn't mean it's getting easier or cheaper for consumers to get a loan, according to a Feb. 8 Reuters story by Ellen Freilich.

The rate reductions have occurred in conjunction with the Federal Reserve which, under the direction of Alan Greenspan, cut its lending rates twice in January in an attempt to prevent the slowing U.S. economy from slipping into recession.

But while banks are cutting their prime rate -- the lending rate reserved for their most creditworthy customers -- they are also tightening standards and terms on consumer loans of all kinds, including automobile loans, making them more expensive and harder to obtain.

The Federal Reserve's most recent survey of senior bank lending officers showed that lending conditions had "firmed noticeably" on the consumer side since its previous survey, released in November.

A much larger fraction of domestic banks than in the November survey reported tightening standards and terms on non-credit-card consumer loans, according to the Fed.

About 15 percent of banks said they anticipated some tightening in their standards and terms on all types of consumer loans before the end of 2001.

Some said they were less willing to make consumer installment loans than they were three months ago. More than 10 percent said they had tightened standards on credit card loans.

For other types of consumer loans, almost 20 percent of domestic banks reported tighter standards, and about 25 percent increased spreads, a difference the Fed termed "significant."

Lenders Focus on Loan Losses

While the Fed has cut short-term borrowing costs and is expected to cut them more, for now lenders are focused on loan losses -- both the ones they see now and the ones they fear could emerge in the future.

Industry insiders say lenders have experienced higher than expected losses in credit card and auto lease portfolios.

As a result, there has been a tightening of standards in the consumer sector, including increased margins between the cost of funds and the cost of the loan.

Slowing Economy Creates Concern

Industry analysts say the tightening reported in the Fed's most recent survey predated the Fed's January rate cuts.

However, market rates were already falling during the survey period in anticipation of Fed rate cuts and Fed policy-makers had publicly expressed their concerns about further slowing in economic growth.

Also, on Dec. 5 Fed Chairman Alan Greenspan urged bankers not to become too restrictive and to continue to provide credit to credit-worthy customers.

But those developments were not sufficiently soothing for bankers, who remain cautious about business credit quality and increasingly concerned about consumers' financial health.

Consumer Caution Slows Demand for Loans

While bankers are lending more cautiously, consumers also are thinking twice about borrowing, Fed data show.

In the Fed's survey of senior loan officers, almost 35 percent of domestic banks reported that demand for all types of consumer loans had weakened over the past three months, compared with only 13 percent that observed weaker demand in the November survey.

And the Fed reported on Feb. 7 that U.S. consumer installment credit rose just $3.0 billion, or at a 2.4 percent annual rate, in December, versus a revised $13.9 billion increase (an 11.1 percent annual growth rate) in November.

The December rise was the smallest since a $1.78 billion gain in September 1999.

Many financial analysts believe consumers are now choosing to slow their spending and rebuild their savings.

Bank Regulators Influence Lending Practices

While Greenspan has urged bankers to keep the money spigots open for credit-worthy customers, the definition of who bank regulators think is credit-worthy is getting more stringent, according to bankers.

Last week, bank regulators (the Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Office of Thrift Supervision, and the Board of Governors of the Federal Reserve System) issued "expanded guidance for subprime lending programs."

"Subprime" refers to individual borrowers with credit histories that include payment delinquencies (two or more 30-day delinquencies in the last 12 months), and possibly more severe problems such as charge-offs or bankruptcies.

The overall impact of the new "regulatory guidance" is to send a chill through lenders who lend to people who have slightly imperfect credit, according to industry analysts, who say that's due to the "very stringent" definitions in that regulatory guidance apply the "subprime" label to a significant percentage of the American population.

The guidance will reduce availability of loans to people with imperfect credit, according to some industry analysts.