Why Can't Banks Learn Their Lesson?

There they go again. Having recovered from most of their asset-quality problems in recent years, banks are lending like there's no tomorrow. Companies that would have been denied credit just three years ago are starting to see banks compete for the privilege of supplying them with credit. Federal Reserve statistics show large bank loans to commercial and industrial companies up 10% so far in 1994.

Unfortunately, though, there is a tomorrow in the loan market. In order to win business, banks are undercharging for some loans and asking for too little collateral on others--practices that will come back to bite them when the economy slows down. Federal Reserve Chairman Alan Greenspan warned bankers in a recent speech that current industry loan practices "give a central banker and supervisor pause."

Why can't banks learn their lesson? The ups and downs of credit availability since the late 1980s are just the latest turns in a cycle that stretches back years. Rarely, if ever, do banks as a group lend at rates that reflect their true risk. It would help if banks were more rigorous about lending at different rates to customers of different credit quality. Some big banks regularly use credit scoring on large loans, but many others don't. When the economic cycle turns down, as it always does, they will deserve the problems they will almost certainly face.

Before it's here, it's on the Bloomberg Terminal.