Since August 2007, the U.S. and global financial markets have endured the worst crisis since the Great Depression, accompanied by a deep economic recession. At the height of the crisis, whole segments of financial markets froze and market participants hesitated to engage in transactions with even the most creditworthy counterparties.Bank loans ; Commercial loans ; Mortgage loans

Hesna Genay

Robert McMenamin

Sumit Agarwal

English

Research Papers in Economics

Why aren’t banks lending more? The role of commercial  
real estate
by Sumit Agarwal, senior financial economist, Hesna Genay, senior economist and research advisor, and Robert McMenamin, 
senior associate economist
Since August 2007, the U.S. and global financial markets have endured the worst crisis 
since the Great Depression, accompanied by a deep economic recession. At the height 
of the crisis, whole segments of financial markets froze and market participants hesitated 
to engage in transactions with even the most creditworthy counterparties. 
Chicag­ o­Fed­Letter
ESSAYS ON ISSUES                                               THE FEDERAL RESERVE BANK  DECEMBER 2010
  OF CHICAGO                                                          NUMBER 281
1.  Average quarterly growth rate of non-CRE loans
Note: CRE indicates commercial real estate. 
Source: Call Reports.
Low-CRE banks Mid-CRE banks High-CRE banks
–1
0
1
2
3
Pre-crisis period Crisis period
percent
Today,­for­the­most­part,­financial­mar-
kets­are­operating­under­near-normal­
conditions.­However,­the­contraction­
in­total­bank­lending­
is­ongoing.­Since­the­
middle­of­2008,­net­
loans­and­leases­at­
commercial­banks­in­
the­United­States­
have­declined­nearly­
3%,­driving­down­the­
share­of­loans­in­total­
bank­assets­from­over­
57%­to­53%.
There­are­a­number­of­
possible­reasons­for­
the­contraction­in­bank­
lending.­Among­them­
are:­lower­demand­for­
loans­as­households­
and­businesses­seek­to­
reduce­debt;­declines­
in­the­value­of­assets­
that­can­be­pledged­
as­collateral­for­loans;­
banks’­desire­to­conserve­liquidity­and­
capital­in­the­face­of­realized­and­po-
tential­losses;­and­declines­in­the­credit-
worthiness­of­potential­borrowers.­In­
this­Chicago Fed Letter,­we­examine­the­
impact­of­the­large­exposure­of­some­
banks­to­one­of­the­worst-hit­sectors­of­
the­crisis,­the­commercial­real­estate­
(CRE)­market.­We­find­that,­after­con-
trolling­for­other­factors­that­might­be­
correlated­with­loan­growth,­banks­that­
had­large­exposure­to­the­CRE­market­
before­the­crisis­extended­loans­to­other­
sectors­of­the­economy­at­a­significantly­
slower­rate­during­the­crisis­than­banks­
that­did­not­have­such­exposure.1­In­
fact,­while­banks­with­relatively­small­
CRE­exposure­continued­to­increase­
their­non-CRE­lending­during­the­crisis,­
banks­with­high­CRE­concentrations­
reduced­their­lending­to­sectors­out-
side­the­CRE­market,­consistent­with­
the­notion­that­the­CRE­exposure­of­
these­banks­inhibited­their­lending­to­
other­market­segments.
Impact of the crisis on CRE
After­growing­more­than­10%­each­year­
from­2002­through­2007,­U.S.­com-
mercial­property­prices­have­dropped­
40%­since­then.2­In­the­pre-crisis­period,­
activity­in­commercial­real­estate­mar-
kets­was­supported­by­ample­availability­
of­funding.­Between­2002­and­2007,­
commercial­real­estate­loans­on­com-
mercial­banks’­balance­sheets­rose­at­
an­annual­rate­of­10%­to­reach­nearly­
$900­billion.­In­addition,­issuance­of­
securities­backed­by­commercial­mort-
gages­(CMBS)­spiked­from­$52­billion­in­
2002­to­$230­billion­in­2007.­However,­  2. Bank characteristics as of 2003:Q2
NoteS: Commercial real estate (CRE) concentration type is defined as the top 30% (high), 30-69% (mid), and bottom 
30% (low) of lenders based on 2007:Q2 levels of CRE lending as a share of total assets. Values reported are the median 
of given concentration type for 2003:Q2. 
Source: Call Reports.
Low-CRE 
banks
Mid-CRE 
banks
High-CRE 
banks
0
5
10
15
20
25
Low-CRE
banks
Mid-CRE
banks
High-CRE
banks
0
50
100
150
200
Loans Securities  Deposits
0
30
60
90
C&I 
loans
Consumer
loans
 Loan- 
loss
allowance
Delinquent
loans
Tier 1
capital 
ratio
0
2
4
6
8
10
12
Low-CRE banks Mid-CRE banks High-CRE banks
total­assets,­respectively,­for­banks­in­
the­mid-­and­low-CRE­categories.
To­determine­whether­CRE­exposure­
could­have­inhibited­banks’­ability­to­
lend­to­other­segments­of­the­economy,­
we­first­compare­the­growth­rates­of­
non-CRE­loans­(total­loans­minus­CRE­
loans)­across­the­three­groups­of­banks,­
as­shown­in­figure­1.­Two­patterns­stand­
out.­First,­from­2002­through­the­first­
half­of­2008,­non-CRE­lending­at­high-
CRE­banks­grew­at­a­faster­pace­(2.4%)­
than­at­mid-CRE­banks­(1.6%)­or­low-
CRE­banks­(1.0%).­So,­in­this­period,­
banks­with­high­levels­of­CRE­exposure­
were­also­lending­more­to­other­sectors.­
However,­this­pattern­reversed­during­
the­crisis.­Low-CRE­banks­continued­to­
increase­their­non-CRE­loans­during­the­
crisis,­albeit­at­a­slower­rate­(0.6%­per­
quarter)­than­before.­In­contrast,­high-
CRE­banks­cut­back­their­lending­to­other­
segments­of­the­economy­during­the­
crisis—on­average,­by­0.7%­per­quarter.­
Mid-CRE­banks­also­reduced­their­non-
CRE­lending­during­the­crisis,­but­only­
slightly­(by­0.03%).­Hence,­the­higher­
the­bank’s­CRE­concentration­before­
the­crisis,­the­greater­the­slowdown­in­
its­non-CRE­lending­during­the­crisis.
While­the­patterns­in­figure­1­are­striking,­
they­do­not­tell­us­why­high-CRE­banks­
retrenched­more­than­other­banks­during­
the­crisis.­There­are­a­number­of­possible­
reasons.­For­instance,­high-CRE­banks­
might­have­failed­at­a­higher­rate­during­
the­crisis­than­other­banks,­influencing­
the­pattern­we­observed­in­figure­1.­In-
deed,­of­all­the­commercial­bank­failures­
since­2007,­nearly­50%­are­identified­as­
high-CRE­banks­by­our­definition;­42%­
are­mid-CRE­banks;­and­only­10%­are­
low-CRE­banks.
Characteristics of high-CRE banks
It­is­also­possible­that­banks­with­high­
CRE­concentrations­had­other­character-
istics­that­would­explain­their­different­
non-CRE­lending­behavior­in­the­pre-­
and­post-crisis­periods.­In­figure­2,­we­
show­the­profile­of­a­median­bank­in­
the­three­groups­as­of­2003:Q2.­It­is­clear­
that­banks­in­the­three­groups­have­very­
different­characteristics.­High-CRE­banks­
had­higher­CRE­concentrations­than­
their­peers­four­years­prior­to­the­onset­
CRE loans, percentage of total assets Total assets, millions of dollars
percent percent
the­CMBS­markets­virtually­shut­down­
during­the­crisis,­and­issuance­dwindled­
to­$3­billion­in­2009.3­At­the­same­time,­
delinquencies­on­CRE­loans­rose­rapidly­
during­the­crisis.­For­loans­backing­
CMBS,­60-plus­day­delinquency­rates­
jumped­from­0.3%­at­the­end­of­2007­to­
8.3%­in­September­2010.­Similarly,­at­
the­end­of­the­second­quarter­of­2010,­
the­ratio­of­noncurrent­loans­(loans­that­
are­more­than­90­days­overdue­plus­non-
accrual­loans)­to­total­CRE­loans­was­
4.3%,­up­from­0.9%­at­the­end­of­2007.­
Nonetheless,­CRE­lending­by­banks­has­
continued­to­grow­during­the­crisis.­It­
had­reached­over­$971­billion­by­the­end­
of­the­second­quarter­of­2010,­represent-
ing­about­15%­of­total­bank­lending.
Impact of CRE on other loans
The­increase­in­CRE­lending,­combined­
with­significantly­higher­delinquencies­
on­these­loans,­could­have­inhibited­
banks’­willingness­or­ability­to­lend­­
to­other­segments­of­the­economy—
particularly­when­banks’­demand­for­
liquidity­and­capital­was­high.­We­shed­
light­on­this­issue­by­comparing­the­lend-
ing­behavior­of­banks­with­large­levels­
of­exposure­to­commercial­real­estate­
with­the­lending­behavior­of­banks­with­
relatively­small­levels­of­CRE­exposure.­
In­particular,­we­ask:­Did­banks­with­
large­CRE­exposure­at­the­beginning­
of­the­crisis­reduce­their­non-CRE­lend-
ing­during­the­crisis­more­than­banks­
with­relatively­low­CRE­exposure?
Based­on­the­ratio­of­CRE­loans­to­total­
assets­right­before­the­onset­of­the­crisis­
(second­quarter­of­2007),­we­sort­bank­
holding­companies­into­three­groups:­
high-CRE­banks­(top­30%),­mid-CRE­
banks­(30%­to­69%),­and­low-CRE­banks­
(bottom­30%).­Under­this­definition,­
as­of­2007:Q2,­the­median­bank­in­the­
high-CRE­category­allocated­25.6%­of­
its­assets­to­CRE­loans;­such­loans­ac-
counted­for­only­13.2%­and­3.8%­of­Charles­L.­Evans, President  ; Daniel­G.­Sullivan,­
Executive Vice President and Director of Research; 
Spencer­Krane, Senior Vice President and Economic 
Advisor ; David­Marshall,­Senior Vice President, financial 
markets group  ; Daniel­Aaronson,­Vice President, 
microeconomic policy research; Jonas­D.­M.­Fisher, 
Vice President, macroeconomic policy research; Richard­
Heckinger,­Assistant Vice President, markets team; 
Anna­Paulson,­Vice President, finance team; William­A.­
Testa,­Vice President, regional programs, and Economics 
Editor ; Helen­O’D.­Koshy­and­Han­Y.­Choi, Editors    ; 
Rita­Molloy­and­Julia­Baker, Production Editors  ; 
Sheila­A.­Mangler, Editorial Assistant.   
Chicago Fed Letter­is­published­by­the­Economic­
Research­Department­of­the­Federal­Reserve­Bank­
of­Chicago.­The­views­expressed­are­the­authors’­
and­do­not­necessarily­reflect­the­views­of­the­
Federal­Reserve­Bank­of­Chicago­or­the­Federal­
Reserve­System.­
©­2010­Federal­Reserve­Bank­of­Chicago­­
Chicago Fed Letter­articles­may­be­reproduced­in­
whole­or­in­part,­provided­the­articles­are­not­­
reproduced­or­distributed­for­commercial­gain­
and­provided­the­source­is­appropriately­credited.­
Prior­written­permission­must­be­obtained­for­
any­other­reproduction,­distribution,­republica-
tion,­or­creation­of­derivative­works­of­Chicago Fed 
Letter­articles.­To­request­permission,­please­contact­
Helen­Koshy,­senior­editor,­at­312-322-5830­or­
email­Helen.Koshy@chi.frb.org.­Chicago Fed 
Letter and­other­Bank­publications­are­available­
at­www.chicagofed.org.
­­
ISSN­0895-0164
3. Non-CRE loan growth, controlling for bank characteristics
Source: Authors’ calculations.
percent
Low-CRE banks Mid-CRE banks High-CRE banks
–1
0
1
2
3
Pre-crisis period Crisis period
of­the­crisis.­Moreover,­compared­with­
low-CRE­banks,­high-CRE­banks­are,­on­
average,­larger;­devote­a­greater­percent-
age­of­their­assets­to­loans­and­a­smaller­
percentage­to­securities;­lend­more­to­
businesses,­but­less­to­consumers;­have­
higher­loan-loss­allowances,­but­lower­
loan­delinquencies­as­a­percentage­of­
assets;­and­have­lower­Tier­1­capital­ra-
tios.4­However,­there­is­no­noticeable­
difference­between­banks­with­different­
CRE­concentrations­in­terms­of­the­frac-
tion­of­assets­funded­by­deposits.­The­
other­differences­are­statistically­signif-
icant­and­generally­hold­true­in­later­
periods­(as­of­2007:Q2­and­2010:Q2).5­
To­analyze­the­importance­of­these­bank­
characteristics­in­explaining­lending­
behavior,­we­estimate­an­ordinary­least­
squares­regression­of­loan­growth­con-
trolling­for­these­factors.­Specifically,­we­
estimate­a­model­that­captures­the­dif-
ferences­between­the­lending­behavior­
of­mid-­and­high-CRE­banks­over­the­
entire­sample­period­and­that­of­low-
CRE­banks.­We­also­identify­possible­
differences­in­lending­behavior­of­banks­
during­the­post­2008:Q2­period­relative­
to­the­earlier­period­and­relative­to­each­
other.­In­addition,­we­relate­the­quar-
terly­growth­rate­of­non-CRE­loans­to­
bank­size,­Tier­1­capital­ratio,­fraction­
of­assets­funded­by­deposits,­the­ratio­
of­total­loans­to­total­assets,­and­the­ra-
tio­of­delinquent­loans­to­total­loans.­
We­control­for­economic­conditions­by­
including­the­growth­
rate­of­real­gross­do-
mestic­product­(GDP)­
and­changes­in­com-
mercial­real­estate­
prices­in­our­model;­
we­take­into­account­
possible­persistence­in­
loan­growth­by­includ-
ing­four­lags­of­the­
dependent­variable.­
Figure­3­shows­the­es-
timated­growth­rates­of­
non-CRE­lending­at­
low-,­mid-,­and­high-
CRE­banks­after­con-
trolling­for­all­the­
above-mentioned­fac-
tors.6­First,­note­that­
even­after­controlling­
for­bank­characteristics­and­other­fac-
tors,­the­general­patterns­from­figure­1­
still­hold.­That­is,­in­the­pre-crisis­period,­
there­is­a­positive­correlation­between­
the­growth­rate­of­non-CRE­lending­and­
CRE­exposure.­Moreover,­the­difference­
between­the­lending­behavior­of­high-
CRE­banks­and­that­of­other­banks­
during­the­crisis­becomes­even­starker­
once­we­control­for­bank­characteristics:­
The­average­estimated­growth­rate­of­
non-CRE­loans­at­low-­and­mid-CRE­
banks­in­the­crisis­period­is­positive­and­
around­1%.­Hence,­banks­with­low-­and­
mid-CRE­concentrations­continued­to­
extend­loans­to­other­segments­of­the­
economy­during­the­crisis,­albeit­at­a­
relatively­subdued­pace.­In­contrast,­
banks­with­high­CRE­concentrations­
prior­to­the­crisis­reduced­their­lending­
to­other­segments­of­the­economy­during­
the­crisis,­on­average,­by­0.5­percentage­
points­per­quarter.­These­estimated­
differences­in­the­lending­behavior­of­
banks­with­low-­and­high-CRE­exposure­
levels­cumulate­to­significant­amounts­
over­the­entire­crisis­period.­Specifically,­
we­estimate­that­non-CRE­loans­at­banks­
that­entered­the­crisis­with­low­CRE­ex-
posure­increased­by­more­than­8%­from­
the­second­quarter­of­2008­through­the­
second­quarter­of­2010.­Similarly,­non-
CRE­lending­at­mid-CRE­banks­grew­by­
6.5%­over­the­same­period.­In­contrast,­
high-CRE­banks­reduced­their­lending­
to­non-CRE­sectors­by­4%­cumulatively.7­
In­dollar­terms,­these­percentage­changes­
translate­to­a­nearly­$82­billion­cumulative­
increase­in­non-CRE­loans­at­low-­and­
mid-CRE­banks­(combined)­during­the­
crisis­and­about­a­$15­billion­dollar­decline­
in­non-CRE­loans­at­high-CRE­banks.­
Turning­to­the­other­factors­we­include­
in­our­analysis,­bank­size­is­positively­and­
significantly­correlated­with­growth­in­
non-CRE­lending.­In­addition,­banks­
with­higher­Tier­1­capital­ratios­and­
lower­loan­delinquency­rates­had­faster­
loan­growth,­consistent­with­previous­
evidence­on­the­effects­of­higher­capi-
talization­and­higher­credit­quality­on­
loan­growth.­Higher­real­GDP­growth­
and­greater­appreciation­in­commercial­
real­estate­prices­are­also­associated­with­
significantly­higher­loan­growth­at­all­
banks,­again­consistent­with­our­expec-
tations­and­previous­evidence.­Moreover,­
loan­growth­is­highly­persistent.­Faster­
loan­growth­in­one­period­is­associated­
with­significantly­higher­loan­growth­
in­subsequent­periods.­We­found­no­
statistically­significant­relationship­be-
tween­non-CRE­loan­growth­and­the­
propensity­to­fund­assets­with­deposits.­
On­the­other­hand,­banks­that­have­
higher­loan-to-asset­ratios­have­lower­loan­growth­in­subsequent­periods­for­
all­non-CRE­loans.8
Conclusion
Over­the­past­three­years,­global­financial­
markets­have­undergone­extreme­stress.­
Today,­most­financial­market­segments­
have­stabilized­and­are­operating­under­
near-normal­conditions.­However,­loan­
growth­at­commercial­banks­has­yet­to­
resume­after­a­large­contraction­during­
the­crisis.­There­are­numerous­reasons­
for­the­lack­of­loan­growth­at­commer-
cial­banks.­In­this­article,­we­focus­on­
one­possible­factor:­whether­the­large­
CRE­exposure­of­some­banks­prior­to­
the­crisis­and­the­severe­contraction­in­
CRE­markets­during­the­crisis­adversely­
affected­banks’­willingness­or­ability­to­
extend­loans­to­other­sectors­of­the­
economy.­At­first­glance,­higher­CRE­
concentrations­prior­to­the­crisis­appear­
to­be­associated­with­much­slower­loan­
growth­to­other­sectors­during­the­crisis.­
However,­a­portion­of­the­differences­in­
lending­behavior­of­high-,­mid-,­and­
low-CRE­banks­can­be­explained­by­other­
bank­characteristics,­the­economic­en-
vironment,­and­the­dynamics­of­loan­
growth.­Nonetheless,­even­after­con-
trolling­for­these­factors,­we­find­that­
banks­with­high-CRE­concentrations­prior­
to­the­crisis­reduced­their­lending­to­other­
segments­of­the­economy,­while­banks­
with­lower­CRE­exposure­continued­to­
expand­such­lending.­
1­­We­also­examined­the­growth­rates­of­
commercial­and­industrial­(C&I)­loans­at­
banks­with­different­CRE­exposure­levels.­
The­results­for­C&I­lending­were­similar­
to­those­reported­here.
2­­These­numbers­reflect­changes­in­the­
Moody’s­Real­Commercial­Property­Index­
(obtained­from­Haver­Analytics),­which­is­
designed­to­measure­price­changes­in­repeat­
transactions­of­commercial­properties.
3­­CRE­Financial­Council,­2010,­Compendium of 
Statistics,­October,­available­at:­
www.crefc.org/uploadedFiles/CMSA_Site_
Home/Industry_Resources/Research/­
Industry_Statistics/CMSA_Compendium.pdf.­ ­
4­­The­ratio­of­Tier­1­(core)­capital­to­risk-
weighted­assets,­as­defined­by­bank­regulators.
5­­The­differences­between­mid-CRE­and­
high-CRE­banks­are­generally­similar­to­
those­between­low-­and­high-CRE­banks.
6­­The­full­regression­results­are­available­
from­the­authors­upon­request.
7­­The­estimated­differences­between­the­
growth­rates­of­non-CRE­lending­at­high-
CRE­banks­and­those­at­the­other­two­groups­
are­statistically­significant­at­the­1%­level.­
However,­once­we­control­for­other­factors,­
there­is­no­statistically­significant­difference­
in­the­non-CRE­lending­behavior­of­low-­
and­mid-CRE­banks­during­the­crisis.
8­­The­results­we­present­here­are­robust­to­
adjusting­for­the­effects­of­mergers­and­bank­
failures.­We­also­explored­the­possibility­that­
our­model­is­not­the­correct­specification­
to­capture­differences­in­the­characteristics­
of­banks­in­the­three­groups­by­estimating­
a­two-equation­system­that­explicitly­modeled­
the­propensity­to­have­higher­CRE­concen-
trations.­We­obtained­results­similar­to­those­
presented­here.

Why aren't banks lending more? the role of commercial real estate

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Why aren't banks lending more? the role of commercial real estate

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