Recent changes to the Federal Reserve's survey of terms of business lending

Federal Reserve Bulletin, August, 1998 by Thomas F. Brady, William B. English, William R. Nelson

Thomas F. Brady, William B. English, and William R. Nelson, of the Board's Division of Monetary Affairs, prepared this article. Thomas C. Allard assisted in the preparation of the data. Lisa X. Chen and Adrian R. Sosa provided research assistance.

The Federal Reserve's quarterly Survey of Terms of Business Lending, which has been conducted for more than twenty years, collects information on interest rates and other characteristics of commercial bank loans to businesses. The survey has been changed from time to time to recognize innovations in bank lending practices and to improve the measurement of the desired information. The most recent changes took effect with the May 1997 survey.(1) The major improvement was the addition of an item measuring loan risk. The addition of this item was possible because a large and increasing percentage of banks have adopted the practice of assigning internal risk ratings to their "pass" loans--that is, loans other than those to troubled borrowers. (Loans to troubled borrowers are generally part of workout arrangements.) Further changes were made to the survey to improve the measurement of other important loan characteristics. In addition, the reporting panel, which had been limited to domestically chartered commercial banks, was expanded to include a sample of U.S. branches and agencies of foreign banks. These branches and agencies now account for a significant proportion of business lending to U.S. firms.(2)

This article discusses the most recent changes made to the survey and presents some information now available from the new items being reported. It also summarizes information about the use of loan risk ratings from consultations with a sample of the survey respondents. These consultations were conducted in the process of planning the revisions to the survey and provided much useful information, particularly with respect to risk ratings.

BACKGROUND OF THE SURVEY

Since its inception in 1977, the Survey of Terms of Business Lending (STBL) has provided unique information concerning the terms (both price and nonprice) of commercial and industrial loans made to U.S. nonfinancial businesses by commercial banks. The STBL replaced the Quarterly Interest Rate Survey and portions of the Survey of Selected Interest Rates. It was designed to provide more accurate and detailed information than these surveys on business loans, especially concerning maturity and nonprice terms. (See the box, "A History of Federal Reserve Surveys of Business Lending Terms.")

The STBL collects detailed data on individual loans from a stratified random sample of about 300 institutions. The survey respondents provide information on the stated rate of interest on each loan extended during the survey week and the frequency with which interest is compounded or paid, thereby allowing calculation of the effective interest rate. The respondents also report other important loan characteristics, including loan size, loan maturity, the frequency of repayments, collateralization status, and the size of the commitment (if any) under which the loan was extended.

Data are collected for the first full business week of the middle month of each quarter (February, May, August, and November). These sample data are used to construct estimates of the terms of business loans extended during the reporting week at all domestically chartered commercial banks and U.S. branches and agencies of foreign banks.(3)

RECENT CHANGES TO THE SURVEY

The most recent changes to the survey involved the addition of items on loan risk, the introduction of other new items, the revision or deletion of some items, and an expansion of the coverage of the survey.

Adding Information on Loan Risk

The ability to distinguish among possible reasons for a movement in loan interest rates could contribute to improved monetary policy. If, for example, banks raise or lower loan interest rates for borrowers of unchanged quality, this change could have implications for spending and aggregate demand that would be important in setting monetary policy. Alternatively, a change in the average loan rate resulting from a shift in the composition of bank loans could suggest that banks have modified their lending standards, again with possible implications for monetary policy. For example, a lowering of standards could induce a rise in the average loan rate, as a larger number of risky borrowers received loans at relatively high interest rates.

In the past, however, using the survey data to monitor developments in business loan pricing was hampered by a lack of information on loan risk. For example, when spreads of loan rates over base rates rose sharply in the early 1990s, the increase may have arisen from tighter loan pricing by banks as a result of their desire to limit credit extensions, a worsening of the average quality of new borrowers, or both.

In recent years, an increasing share of banks have assigned internal risk ratings to their business loans. This development provided the Federal Reserve with an opportunity to collect information on banks' assessment of loan riskiness. For this information to be useful, however, three conditions had to be met: First, the proportion of banks assigning risk ratings to new loans reported on the STBL had to be sufficiently large; second, banks had to use more than one rating for acceptable new loans; and, third, the definitions of the ratings had to be independent of the state of the economy.