Bank loans

Falling demand for bank loans reflects supply bottlenecks, not a weak recovery

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Banks typically experience weak loan demand during recessions, and the pandemic-induced recession was no exception. However, this weakness in loan demand persisted even as the economy steadily recovered. One explanation for this persistent weakness could be the continued disruptions to supply chains. Disruptions to the movement of goods and materials through complex supply chains began at the start of the pandemic, but escalated in 2021, causing stock-outs in some industries and preventing many businesses from responding to the consumer demand.

Chart 1 shows that retailers faced the biggest declines in inventory to sales during the pandemic (Helper and Soltas 2021). In 2020, all business sectors saw a brief, sharp rise in inventory relative to sales, with sales falling during lockdown restrictions and businesses left with vast inventories of unsold goods. Since the start of 2021, however, the value of business inventories relative to monthly sales has fallen across all sectors (blue line), with particularly steep declines for retailers (green line), which have likely faced the constraints strongest supply. Because retail companies are down the supply chain, they are not only vulnerable to disruptions in the flow of goods to their own warehouses, but also to backlogs from manufacturers and delivery delays from their suppliers. .

Chart 1: Retailers faced the biggest drop in inventory to sales during the pandemic, especially in early 2021

Source: US Census Bureau (Federal Reserve Economic Data).

Lower inventories appear to have disproportionately reduced demand for loans from retailers. Retail companies reduced their drawdowns on revolving lines of credit more than companies in all sectors. Changes in revolving credit balances typically result from changes in business liquidity needs, making drawdowns a particularly useful measure of business credit demand. Chart 2, which is based on loan-level data from major banks, shows that revolving balances rose sharply for all businesses at the start of the pandemic in 2020:Q1, as businesses dipped into their lines of credit to guard against a future tightening of credit standards (Acharya and Steffen 2020). Once fiscal and monetary support measures were introduced in the second quarter of 2020, companies quickly repaid what they had borrowed in the previous quarter as well as some of their pre-existing borrowings, and revolving balances fell. below pre-pandemic levels. When supply constraints intensified in the first quarter of 2021, however, revolving balances remained stable for all companies (blue line), but declined among retail companies (green line). Combined with retailers’ shrinking inventory, lower revolving balances at retail businesses suggest that supply bottlenecks have weighed particularly heavily on their demand for loans.

Chart 2: Revolving balances have fallen sharply among retail companies compared to all sectors

Chart 2 shows that revolving balances rose sharply for all businesses in Q1 2020. When supply constraints intensified in early 2021, however, revolving balances remained flat for businesses overall, but declined among retail businesses.

Sources: Federal Reserve Board of Governors and US Census Bureau.

Demand for loans appears to have been weakest among smaller retail businesses, suggesting they may have been even less equipped to overcome supply bottlenecks than their larger counterparts. Chart 3 shows the changes in revolving balances in 2021:4 compared to 2019 averages by business size based on net sales. The blue bar shows that retail companies with net sales below $50 million have reduced their revolving balances by 95%, while retail companies with larger net sales have committed to reductions of more more weak. In every business size category, however, revolving balances fell more sharply for retail businesses than for businesses in other industries.

Chart 3: Small retail businesses reduced their revolving balances more than large businesses and their peers across all sectors

Chart 3 shows that revolving balances have declined more steeply for retail companies compared to companies in other sectors since 2019.

Source: Board of Governors of the Federal Reserve System.

Although supply constraints appear to have weighed particularly heavily on loan demand in the retail sector, the cash reserves that businesses have built up during the pandemic have also likely dampened loan demand. To capture the effect of corporate cash reserves, we separate companies into quartiles based on changes in their cash-to-asset ratios from 2019 to 2021: 4th quarter (higher quartiles denote companies whose cash balances increased more compared to the assets during this period). Chart 4 shows how the utilization rate, measured as the ratio between revolving outstandings drawn by companies and the limits of their credit lines, has changed for companies in each quartile over the same period. Overall, businesses that accumulated cash balances were more likely to rely on their internal funds and reduced demand for bank loans. Retail firms whose cash reserves grew more significantly relative to assets (third and fourth quartiles, green bars) reduced credit drawdowns significantly more than firms in all industries (third and fourth quartiles, blue bars). These trends suggest that cash balances served as an alternative to bank loans and that retail businesses relied more on their internal funds than businesses across all industries.

Chart 4: Companies whose cash-to-asset ratio increased the most used their credit lines less intensively

Chart 4 shows that retail companies whose cash reserves grew more significantly relative to assets used credit less intensively than companies in all industries.

Note: The graph shows the change in the line of credit utilization rate for each quartile of change in the cash-to-asset ratio among retail businesses and businesses in all industries.

Sources: Federal Reserve Board of Governors and Compustat.

Firm demand for bank loans, particularly at smaller banks, will likely continue to be suppressed by supply bottlenecks as COVID-19 cases reappear in other parts of the world and tensions geopolitics intensify. Supply bottlenecks are expected to weigh particularly heavily on demand for loans from small businesses in the retail sector, as larger companies may be in a better position to use their capital to overcome supply constraints. In this way, supply constraints can exacerbate the trend towards concentration in the retail sector and confer even greater market share to large firms at the expense of small firms which typically borrow from community banks (Smith and Ocampo 2022). As a result, community banks that primarily serve small businesses could continue to face persistent downward pressure on demand for bank loans, even as larger banks begin to meet stronger demand. In addition, the large cash reserves accumulated by many companies during the pandemic are currently weakening their demand for bank loans. In response to tighter monetary policy, companies may choose to continue to draw on their cash reserves for an extended period of time instead of resorting to lines of credit. In summary, even if the economy continues to recover, demand for loans is likely to remain relatively subdued due to supply bottlenecks and corporate cash reserves rather than a weak recovery.