Banks will likely be reluctant to make new business loans if tight credit conditions persist, hampering capital spending and the economy in the coming months, according to Goldman Sachs.
The credit turmoil led to a surge in business lending since August with the growth rate of commercial and industrial loans on commercial bank balance sheets running at a 50.2 percent annualized rate, its fastest in more than 20 years.
Higher commercial and industrial lending typically signals economic strength, but that has not been the case in recent weeks, Goldman Sachs's chief U.S. economist Jan Hatzius wrote in a research report published late on Monday.
Hatzius reckoned neither more corporate demand nor bank willingness has led to the swell in business loans.
Instead, the jump in lending was fallout from a combination of factors stemming from the credit turmoil: investors shunning debt instruments that fund business operations and investment like commercial paper; liquidation of some collateral held by asset-backed commercial paper programs and banks holding on to bridge loans issued for leveraged buyout deals, according to Hatzius.
Since August, U.S. commercial paper outstanding shrank by $370 billion, with roughly a quarter coming from unsecured commercial paper. This type of short-term debt is often supported by bank credit lines to hedge against the kind of market turbulence seen recently.
Hatzius estimated at least some of the $100 billion decline in unsecured commercial paper has appeared on bank balance sheets.
From a macroeconomic perspective, unplanned balance sheet expansion is likely to constrain banks' willingness to make loans to borrowers that do not have prearranged liquidity lines, Hatzius said.
This transfer of liabilities from the capital market to the bank system will be temporary if credit conditions continue to improve in the wake of the Federal Reserve's massive liquidity infusion, including a half-percentage-point interest rate cut on September 18, according to Hatzius.
On the other hand, if credit conditions tighten again, it may become tougher for corporations to fund projects, Hatzius said.
Such a financing constraint could weigh on capital spending and real GDP growth in 2008, he wrote.