Why aren’t Banks Lending More? The Role of Commercial Real Estate

Today, for the most part, financial markets are operating under near-normal conditions. However, the contraction in total bank lending is ongoing. Since the middle of 2008, net loans and leases at commercial banks in the United States have declined nearly 3%, driving down the share of loans in total bank assets from over 57% to 53%.

There are a number of possible reasons for the contraction in bank lending. Among them are: lower demand for loans as households and businesses seek to reduce debt; declines in the value of assets that can be pledged as collateral for loans; banks’ desire to conserve liquidity and capital in the face of realized and potential losses; and declines in the creditworthiness of potential borrowers. In this Chicago Fed Letter, we examine the impact of the large exposure of some banks to one of the worst-hit sectors of the crisis, the commercial real estate (CRE) market. We find that, after controlling for other factors that might be correlated with loan growth, banks that had large exposure to the CRE market before the crisis extended loans to other sectors of the economy at a significantly slower rate during the crisis than banks that did not have such exposure.1 Infact, while banks with relatively small CRE exposure continued to increase their non-CRE lending during the crisis, banks with high CRE concentrations reduced their lending to sectors outside the CRE market, consistent with the notion that the CRE exposure of these banks inhibited their lending to other market segments.