U.S. banks tightened lending standards for businesses at a record pace in the third quarter, according to the Federal Reserve's July Senior Loan Officer Opinion Survey on Bank Lending Practices.

In the three months ending in October, a record 85% of banks tightened lending standards to businesses, up from 60% in July.

The survey showed 84.6% of firms with annual sales of $50 million or more raising standards and 14.5% indicating "considerable" tightening.

"What I fear is a sharp contraction in willingness to lend. That would suggest we're now cutting into the muscles and bones," said T.J. Marta, fixed income strategist at RBC Capital Markets, prior to the report's release.

Demand was a key issue in the report with about half the banks surveyed reporting weaker demand for prime mortgages and less demand for commercial loans.

The survey showed that 70% of domestic banks raised standards for prime mortgages in the quarter after 75% reported doing the same in the previous quarter.

In the seven categories on willingness to lend and collateral requirements, none of the 55 banks surveyed reported easing standards. The top reasons for tighter standards were the uncertain economic outlook and reduced tolerance for risk.

The problems appear to be hitting the large banks hardest.

"Responses differed somewhat by bank size, with about 80 percent of the largest banks, but only 55 percent of the smaller banks, reporting tighter standards for prime borrowers," the Fed said.

By Adam Button and edited by Sarah Sussman
©CEP News Ltd. 2008