Extreme uncertainty about the economic outlook and the depth of the recession has paralyzed normal lending activity by commercial banks in the United States and elsewhere. Even as the Federal Reserve has added liquidity and boosted bank reserves, the credit creation process has remained stalled as banks struggle to identify good borrowers willing and able to repay in a wide range of future economic conditions.
The attached chart is adapted from the Federal Reserve’s weekly H.8 release on “Assets and Liabilities of Commercial Banks in the United States” (https://customers.reuters.com/d/graphics/US_CRDT1108.gif).
It shows the ratio of loans, leases and interbank lending (risk assets) to vault cash, reserves and Treasury securities (safe assets) held by U.S. commercial banks. In essence it shows the commercial banking system’s appetite for risk and capacity for credit creation.
Credit is clearly cyclical. But the period since 1994 has witnessed a huge increase in credit extension and a massive rise in balance sheet risk overlaid with modest cyclical variations. Following a brief hiatus during the downturn of 2001-2003, explosive credit creation resumed and hit new heights in early 2008.