My favorite movie is It’s a Wonderful Life and I usually get a chance to watch it this time of year. This year, I am reminded of the “bank run” scene on the Bailey Savings & Loan. We quickly forgot the bank runs of 2023 that put Silicon Valley Bank out of business and threatened a contagious downward spiral with grave implications.
Banks purchased bonds with the deposits from their customers. Checking accounts, savings accounts and CDs are deployed as loans to other customers or sometimes used to purchase bonds and other “safe” assets. Well, when rates went up, the bond values declined dramatically. It would be similar to a manufacturer building inventory of hundreds of units at $10,000 a piece, and then watching the value decline to $5,000 each…and then their lender called their loan to be repaid. The same thing happened to the banks. The depositors wanted their money out, the banks needed to liquidate bonds at a loss to repay their depositors, and the bank run was on.
So, with liquidity at a premium, what did banks do with their loan programs in 2023? They demanded higher interest rates, higher FICO scores, or some combination of both to entice them to deploy their deposits into consumer loans.
Banks periodically review and adjust their lending standards based on various factors, including economic conditions, risk assessments, and regulatory requirements. If banks are increasing FICO score standards for consumer loans, it could be influenced by several reasons:
Risk Management: Banks aim to manage their risk exposure, especially during economic downturns or uncertain times. Raising FICO score requirements can be a way to ensure that borrowers have a stronger credit history, making them less likely to default on loans.
Regulatory Requirements: Financial institutions are subject to regulations that may influence lending practices. Regulators may encourage or require banks to maintain certain capital levels, and adjusting lending standards is one way banks can manage their capital positions.
Market Conditions: Changes in the economic environment, such as rising interest rates, can affect the cost of funds for banks. Adjusting lending standards, including FICO score requirements, allows banks to adapt to changing market conditions.
Credit Risk Assessment: If banks perceive an increase in the overall credit risk of borrowers, they may adjust their lending standards to mitigate potential losses. This could involve raising FICO score requirements to ensure a more creditworthy borrower pool.
Like many industries, banking has its cycles, but conditions changed dramatically in 2023. Demands for liquidity and loan underwriting are as tight as they have been since the financial crisis of 2008-09. But, like all cycles, this too shall pass. Banks are most profitable when they loan their deposits to other customers. Rates will decline in 2024 and beyond. The demand for liquidity will fade. And, banks will get hungry again for loan volume.