Although the Recent Weakness in Bank Credit Growth May Not Be a Concern to Others, It Is to Me

Although the Recent Weakness in Bank Credit Growth May Not Be a Concern to Others, It Is to Me
Starting around this past December, growth in commercial bank credit (loans and securities) slowed precipitously (see Chart 1). Annualized 13-week growth in bank credit of late is the slowest since the summer of 2013. This weakening in bank credit growth has been noticed and commented on by at least two economic analysts besides me – University of Oregon economics professor Tim Duy and Goldman Sachs economist Spencer Hill. These two analysts have concentrated on the weakness in one component of bank credit – commercial and industrial(C&I) loans – and concluded that there is nothing to get excited about with respect to the pace in U.S economic activity. I do not share their sanguine view. Notice that the data in Chart 2 show that the growth in bank credit excluding C&I loans also has slowed precipitously since this past December. If history is any guide, this weakening in bank credit growth excluding C&I loans is cause for concern with regard to the pace of economic activity.
Chart 1
Chart 2
Professor Duy, employing sophisticated econometrics techniques, elegantly corroborated what the Conference Board told us decades ago – the behavior of commercial and industrial bank loans is a lagging indicator of economic activity. What Professor Duy did not do was explain in Dick and Jane (Mr. Pero, that was for you) or otherwise why this is the case. As the data in Chart 3 show, percentage changes in business inventories have a relatively high contemporaneous correlation (0.57) with percentage changes in bank C&I loans. So, businesses rely heavily on bank loans to finance their inventories. To understand why bank C&I loans are a lagging indicator of economic activity, we need to understand the behavior of business inventories relative to business sales in the business cycle. As business sales start to slow, inventory growth tends to picks up. This is shown in Chart 4. This increase in inventory growth relative to sales growth typically is involuntary. With slower growth in revenues, businesses rely even more heavily on their banks to finance their higher involuntary inventory builds.
So, a surge in inventories and C&I loans often is associated with a slowdown in the growth of final demand for goods and services. Hence, bank C&I loan growth often tens to lag growth in final demand for goods and services. That is, the behavior of bank C&I loan growth provides more information as to where the overall economy has been rather than where it is headed.
Chart 3
Chart 4