Stress test relief seen unlikely to spur lending

Results of a government test of how the biggest U.S. banks would fare in an even more punishing economic environment are unlikely to spur a major pick-up in lending, though they may remove some of the uncertainty in the banking system.

While banks may be less hesitant to lend to each other if they feel their rivals' books have been credibly vetted, that does not translate into confidence to make new loans to small businesses and consumers, analysts said.

Thursday's announcement may therefore have a limited effect on the broader economy.

It makes banks access to liquidity easier, but it doesn't necessarily make them more prone to lending to other businesses, said Michael Feroli, economist at J.P.Morgan.

Feroli said the state of the economy means many borrowers' creditworthiness has dropped, while demand for new loans has also waned. Consumers faced with losing their homes or losing their jobs are likely to hunker down rather than take out loans for new cars, for example.

There are three constraints. The demand side is going to be weak because of the economy and on the supply side you have the reduced creditworthiness of borrowers and capital constraints, so you're only presumably taking away one of those, Feroli said.

So I wouldn't expect a big pick-up in lending after the stress tests, he said.

The Fed's most recent survey of bank loan officers showed further weakening of demand for commercial and industrial loans, Fed chairman Ben Bernanke noted in his May 5 testimony to the congressional Joint Economic Committee. It also showed that the net fraction of banks that tightened their business lending policies stayed elevated, he said.

The stress tests are just one step in the Treasury and Federal Reserve's plan to recapitalize the banking system and support the economy which contracted 6.1 percent in the first quarter.

This is just the beginning and we are going to keep working to try and make sure this financial system is in .. a strong enough position so it can provide the credit necessary for the recovery, U.S. Treasury Secretary Timothy Geithner said on Thursday.

Federal Reserve officials have pointed to some recent signs of stabilization in the economy, but warn that any recovery will likely be slow.

The stress tests, I believe, are meant to engender confidence in the banking system among the investing public. I think it would be too much to ask that they would encourage banks to increase their lending, said Jack Ablin, chief investment officer at Harris Private Bank in Chicago.

I think some of the other Fed and government programs are more likely to spur lending.

Those programs include a plan to remove up to $1 trillion of so-called toxic assets from bank balance sheets with the help of private investors has yet to be launched.

Meanwhile, a Federal Reserve lending program to spur consumer lending by reviving the asset-backed securities market is only just beginning to gain traction after a slow start.

However, a U.S. congressional watchdog for the U.S. government's massive financial rescue effort questioned on Thursday whether the Fed's Term Asset-Backed Securities Loan Facility (TALF) is doing much to help small businesses and households.

Another reason why the stress tests may not help spur lending is that the majority of the banks seen as having sufficient capital are not, in fact, the biggest lenders, said Steven Ricchiuto, economist at Mizuho Securities.

Also, the need for capital has to be weighed against their potential forward losses if they put on more bad loans at this point in the business cycle, said Ricchiuto.

So I think they will still be focusing on higher quality borrowers.

But, said Lou Crandall, economist at Wrightson ICAP, it is possible that some institutions hunkered down as they awaited the results of the stress tests.

The question is, did the stress tests constitute a collective timeout for the industry which made people less willing to commit to all sorts of things? All in all, getting them out of the way can't hurt, he said.

(Reporting by Kristina Cooke)