Were You Denied a Loan? There’s a Silver Lining

It might seem like adding insult to injury. 

Banks continued to tighten their lending standards in the third quarter, making it harder for consumers and businesses to borrow money that already carried much higher interest rates than before, the Federal Reserve’s latest survey of U.S. bank lending officers shows. 

But the silver lining to a tougher credit market is that when fewer people use their credit card, finance a car or borrow for a home renovation, it slows down the entire economy. And that gives the Federal Reserve less reason to keep raising the benchmark interest rate that powers so many other lending rates consumers pay. 

“This report makes it all the more likely that the Fed will not need to hike interest rates further since tighter lending conditions and reduced loan demand points to a credit credit contraction that will inevitably take heat out of the economy,” James Knightley, the chief international economist at ING, wrote in a commentary Monday.

Taking the heat out is exactly what the central bank has been aiming for since soaring inflation took hold of the economy in 2021 and 2022, pushing up the price of seemingly everything. 

Because it’s harder to spend money if it’s more expensive to borrow it, the Fed raised its benchmark interest rate — known as the fed funds rate — from virtually zero to its highest point in 22 years in just 16 months. Mortgage rates have risen to nearly 8% and the average credit card carries a rate of over 20%. Now the big question is whether or not Fed officials will see the need for any more increases. 

“It is important to remember that it isn’t just the cost of borrowing that acts as a brake on activity,” Knightley wrote. “Restricting access to credit is also hugely influential.”

The Fed gauges lending standards by how many banks are making it harder versus easier to borrow. 

Citing the risk that they wouldn’t be repaid if there’s a downturn in the economy, more of the 81 banks surveyed said they made it harder to get consumer loans, including credit cards, auto loans, home equity lines of credit, and most categories of mortgages over the past three months. They typically chose “somewhat” rather than “considerably” harder when answering the survey. 

For example, 24% of banks said they were “somewhat” less willing to make installment loans like auto or personal loans in the third quarter, while just 3.7% said they were “somewhat” more willing. The rest said they hadn’t changed their standards.

When asked about standards for approving credit card applications, 31% said they had tightened “somewhat,” 2.2% said they had tightened “considerably” and 4.4% said they had eased “somewhat.” The rest said things hadn’t changed. 

For both new and existing credit card accounts, banks said they were more apt to restrict credit limits, raise minimum credit scores and be less flexible when applicants didn’t meet credit scoring thresholds, the survey showed.

On balance, banks were less likely to approve credit card and auto loan applicants with FICO scores of 680 or less and more likely to approve credit card applicants with FICO scores of 720, the survey showed.

The survey included 62 domestic banks and 19 U.S. branches and agencies of foreign banks, the Fed said.