2003 Articles from the Federal Reserve Bulletin
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Articles from the Federal Reserve Bulletin - 2003
Recent Developments in Business Lending by Commercial Banks
William F. Bassett and Egon Zakrajsek
After growing rapidly during much of the 1990s, the real value of commercial and industrial (C&I) loans at domestic commercial banks and at U.S. branches and agencies of foreign banks has fallen 19 percent since the beginning of 2001. The recent contraction in business loans has been concentrated at large banking institutions and appears to stem from the combined effects of weak demand for credit and a tightening of lending standards and terms. The move toward a more-stringent lending posture, although partly cyclical, also reflects a reassessment of the risks and returns of C&I lending. This reassessment, in turn, is due partly to structural changes in the market, including the increased participation of nonbank financial institutions, the growth of the secondary loan market, and the greater use of credit derivatives by some banks.
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Global Integration in the Banking Industry
Allen N. Berger and David C. Smith
Lowered regulatory barriers and advances in technology have reduced the cost of supplying banking services across borders. At the same time, growth in activity by multinational corporations has increased the demand for international financial services. As a result, many observers believe that global integration is under way in the banking industry, that banks are expanding their reach across borders, and that many banking markets will therefore develop large foreign components. The authors report on a study conducted by them, along with Qinglei Dai and Steven Ongena, that examined the nationality and international reach of banks that provide short-term financial services across Europe to affiliates of multinational corporations. The present article also looks at time-series data that provide a more recent look at the progress of integration in Europe.

Based on a 1996 survey of more than 2,000 affiliates, the study found that an affiliate is most likely to choose a bank headquartered in the nation in which it is operating (a host-nation bank) rather than a bank headquartered in the home country of the affiliate or in a third nation. The affiliate is also more likely to select a bank limited to local or regional operations rather than one with global reach. The findings are consistent with the proposition that affiliates most value a bank that understands the culture, business practices, and regulatory conditions of the country in which the affiliate operates, and that host-nation banks possess a competitive advantage over other banks in this regard. The time-series data--on syndicated loans, foreign bank claims, and the dispersion of consumer goods prices across Europe--are also consistent with the picture drawn from the 1996 survey. The article concludes that banking markets evidently need not become more integrated even as economic activity otherwise becomes increasingly
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Recent Changes to a Measure of U.S. Household Debt Service
Karen Dynan, Kathleen Johnson, Karen Pence
Changes in levels of aggregate household debt in the United States may contain information about the current state of the nation's economy and may affect its future direction. A commonly used measure of household indebtedness is the household debt service ratio (formerly known as the household debt service burden), published since 1980 by the Board of Governors of the Federal Reserve System. Recent changes in financial markets have prompted a comprehensive revision of this statistic. This article describes the revision and introduces a new measure, the financial obligations ratio, which adds recurring obligations -- rent, auto leases, homeowners' insurance, and property taxes -- to the traditional calculation of the debt service ratio. In total, these revisions change the level of the debt service ratio but do not substantively alter its trajectory over time.

The article also presents separate estimates of the financial obligations ratio for homeowners and renters. The ratio for homeowners, which may summarize the effects of the recent refinancing boom on the financial obligations of homeowners, has risen gradually over the past decade; the ratio for renters has risen more steeply. The flat contour of the homeowner ratio in recent quarters suggests that homeowners may have rebalanced their portfolios toward lower-cost mortgage debt during the recent period of economic weakness.
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Capital Standards for Banks: The Evolving Basel Accord
The Basel Capital Accord has served as the framework for capital adequacy standards for internationally active banks since 1988. The agreement is widely viewed as having achieved its main objectives, including the promotion of stability in world financial markets. In recent years, however, it has become less appropriate for the world's largest banks, which are increasingly complex and engage in financial transactions unimagined when the agreement was adopted. Now proposals are being considered to refine the framework to take account of the changes in banking and the banking system over the past fifteen years.
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Monetary Policy Report to the Congress
The subpar performance of the U.S. economy extended into the first half of 2003. Although accommodative macroeconomic policies and continued robust productivity growth helped to sustain aggregate demand, businesses remained cautious about spending and hiring. All told, real gross domestic product continued to rise in the first half of the year but less quickly than the economy's productive capacity was increasing, and margins of slack in labor and product markets thereby widened further. As a result, underlying inflation remained low--and, indeed, seems to have moved down another notch. In financial markets, longer-term interest rates fell, on net, over the first half of the year as the decline in inflation and the subdued performance of the economy led market participants to conclude that short-term interest rates would be lower than previously anticipated. These lower interest rates helped to sustain a rally in equity prices that had begun in mid-March.

The Federal Reserve expects economic activity to strengthen later this year and in 2004, in part because of the accommodative stance of monetary policy and the broad-based improvement in financial conditions. In addition, fiscal policy is likely to be stimulative as the provisions of the Jobs and Growth Tax Relief Reconciliation Act of 2003 go into effect and as defense spending continues to ramp up. Severe budgetary pressures are causing state and local governments to cut spending and to increase taxes and fees, but these actions should offset only a portion of the impetus from the federal sector. Moreover, the continued favorable performance of productivity growth should lift household and business incomes and thereby encourage capital spending. Given the ongoing gains in productivity and the existing margin of resource slack, aggregate demand could grow at a solid pace for some time before generating upward pressure on inflation.
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Household Financial Management: The Connection between Knowledge and Behavior
Marianne A. Hilgert, Jeanne M. Hogarth, and Sondra G. Beverly
Consumer financial literacy has become a growing concern to educators, community groups, businesses, government agencies, and policymakers. Correspondingly, there has been an increase in the number and types of financial education programs available to households. Many of these programs focus on providing information to consumers and operate under the implicit assumption that increases in information and knowledge will lead to changes in financial-management practices and behaviors.

This article focuses on four financial-management activities--cash-flow management, credit management, saving, and investment. Data from the Surveys of Consumers are used to analyze some of the connections between knowledge and behavior--what consumers know and what they do. Overall, financial knowledge was statistically linked to financial practices: Those who knew more were more likely to engage in recommended financial practices. In addition, certain types of financial knowledge were statistically significant for particular financial practices--knowing about credit, saving, and investment was correlated with higher probabilities of engaging in recommended credit, saving, and investment practices respectively. Although the causality could flow in either direction, this finding indicates that increases in knowledge may lead to improvements in financial-management practices. Thus, financial education in combination with skill-building and audience-targeted motivational strategies may be one way to elicit the desired behavioral changes in financial-management practices.
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Profits and Balance Sheet Developments at U.S. Commercial Banks in 2002
Mark Carlson and Roberto Perli
Despite the lackluster performance of the U.S. economy, the profitability of the U.S. commercial banking industry was again high in 2002, and the return on bank assets reached its highest level in more than three decades. Profitability was spurred in considerable part by declines in market interest rates to extraordinarily low levels. Short-term interest rates were low throughout 2002 as a result of the Federal Reserve's aggressive easing the year before in response to economic weakness, and longer-term rates fell to multidecade lows by year-end. Nevertheless, the yield curve steepened on average, benefiting net interest margins. The decline in longer-term interest rates also boosted realized gains on securities. The low interest rates strengthened the ability of households and businesses to service their debt, which also supported bank profitability. Finally, a change in accounting rules that largely eliminated the requirement to amortize goodwill caused a one-time drop in expenses. Despite the largest decline in commercial and industrial loans since the 1990-91 recession, the expansion of bank balance sheets quickened last year, driven primarily by real estate lending and substantial acquisitions of securities. Equity capital rose slightly faster than assets, and regulatory capital ratios also improved a bit, benefiting from an increased share of assets with low regulatory risk weights.
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U.S. International Transactions in 2002
Steven B. Kamin
After slightly narrowing during the cyclical slowdown of 2001, the U.S. current account deficit widened in 2002, as it had over the previous decade. Two-thirds of the increase in the deficit last year was attributable to an increase in the deficit for trade in goods and services. In addition, net investment income receded as receipts from abroad declined more than payments on foreign investments in the United States. The record $503 billion U.S. current account deficit registered in 2002 was financed by continued high levels of private capital inflows and stepped-up foreign official purchases of U.S. assets.

If economic activity picks up in the United States and in its major trading partners later this year, as most forecasters expect, the U.S. external deficit likely will widen as U.S. imports of goods and services rise by a greater amount than U.S. exports of goods and services. The decline in the dollar from early 2002 to date is unlikely to restrain the widening of the deficit by much, as it has been relatively small and its effects will be spread over a number of years.
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Industrial Production and Capacity Utilization: The 2002 Historical and Annual Revision
Carol Corrado
In late 2002, the Board of Governors of the Federal Reserve System published a revision to its index of industrial production and the related measures of capacity utilization. The primary feature of the revision was the reclassification back to 1972 of production and capacity indexes for individual industries from the Standard Industrial Classification System to the North American Industry Classification System. The revision also reflects the incorporation of newly available, more comprehensive source data, and it introduced improved methods for measuring the annual real output of communications equipment manufacturing.

Along with the updating and the restatement of the data using the North American Industry Classification System, all production and capacity indexes are now expressed as percentages of output in 1997. The new information resulted in an upward revision to the rate of increase in industrial production and capacity from 1997 to 2000. For that period, the average rate of industrial capacity utilization is 0.7 percentage point higher than previously reported. The most recent business-cycle peak is still June 2000, at 116.2 percent of 1997, with the low being the fourth quarter of 2001. The rate of industrial capacity in the third quarter of 2002, at 76.2 percent, is essentially unchanged from previously reported data. The rate is more than 5 percentage points below its 1972-2001 average and about 3 percentage points below the trough in the 1990-91 recession but 5 percentage points above the trough in the 1982 recession.
Full text (193 KB PDF)

Monetary Policy Report to the Congress
The economy of the United States has suffered a series of blows in the past few years, including the fall in equity market values that began in 2000, cutbacks in capital spending in 2001, the horrific terrorist attacks of September 11, the emergence of disturbing evidence of corporate malfeasance, and an escalation of geopolitical risks. Despite these adversities, the nation's economy emerged from its downturn in 2001 to post moderate economic growth last year. The recovery was supported by accommodative monetary and fiscal policies and undergirded by unusually rapid productivity growth that boosted household incomes and held down business costs. The productivity performance was also associated with a rapid expansion of the economy's potential, and economic slack increased over the year despite the growth in aggregate demand.

On net, the economy remained sluggish at the end of 2002 and early this year. Mindful of the especially high degree of uncertainty attending the economic outlook in the current geopolitical environment, the members of the FOMC believe the most likely outcome to be that fundamentals will support a strengthening of economic growth, and inflation pressures are anticipated to remain well contained.
Full text (266 KB PDF)

An Overview of Consumer Data and Credit Reporting
Robert B. Avery, Paul S. Calem, Glenn B. Canner, and Raphael W. Bostic
For some time, the Board of Governors of the Federal Reserve System has sought to obtain more detailed and timely information on the debt status, loan payment behavior, and overall credit quality of U.S. consumers. For decades, information of this type has been gathered by credit reporting companies primarily to assist creditors in evaluating the credit quality of current and prospective customers. To evaluate the potential usefulness of these data, the Federal Reserve Board engaged one of the three national consumer reporting companies to supply the credit records, without personal identifying information, of a nationally representative sample of individuals.

This article describes the way the credit reporting companies compile and report their data and gives background on the regulatory structure governing these activities. This description is followed by a detailed look at the information collected in credit reports. Key aspects of the data that may be incomplete, duplicative, or ambiguous as they apply to credit evaluation are highlighted in the analysis. The article concludes with a discussion of steps that might be taken to address some of the issues identified.
Full text (151 KB PDF)

Recent Changes in U.S. Family Finances: Evidence from the 1998 and 2001 Survey of Consumer Finances
Ana M. Aizcorbe, Arthur B. Kennickell, and Kevin B. Moore
Data from the Federal Reserve Board's Survey of Consumer Finances show a striking pattern of growth in family income and net worth between 1998 and 2001. Inflation-adjusted incomes of families rose broadly, although growth was fastest among the group of families whose income was higher than the median. The median value of family net worth grew faster than that of income, but as with income, the growth rates of net worth were fastest for groups above the median. The years between 1998 and 2001 also saw a rise in the proportion of families that own corporate equities either directly or indirectly (such as through mutual funds or retirement accounts); by 2001 the proportion exceeded 50 percent. The growth in the value of equity holdings helped push up financial assets as a share of total family assets despite a decline in the overall stock market that began in the second half of 2000.

The level of debt carried by families rose over the period, but the expansion in equities and the increased values of principal residences and other assets were sufficient to reduce debt as a proportion of family assets. The typical share of family income devoted to debt repayment also fell over the period. For some groups, however--particularly those with relatively low levels of income and wealth--a concurrent rise in the frequency of late debt payments indicated that their ability to service their debts had deteriorated.
Full text (174 KB PDF)

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Last update: December 11, 2003