Federal Reserve Warns US Banks on Leveraged Lending

US regulators have sounded a warning that financial firms engaged in so-called leveraged lending have begun to revert to the lax standards that provoked the financial crisis of 2008.

In guidance issued by the US Federal Reserve and other regulators, banks engaged in leveraged lending were told that their underwriting and risk-management standards must improve, to ensure they are able to accurately measure risks and perform stress tests on loans.

Regulators expressed concern that banks may not be properly underwriting the loans, which are typically made to an individual or company that already carries a significant debt load. “While leveraged lending declined during the crisis, volumes have since increased and prudent underwriting practices have deteriorated,” said the Fed, in a release issued jointly with the US Federal Deposit Insurance Corporation (FDIC) and the Office of the Comptroller of the Currency (OCC).

The regulators expressed concerns that some banks lack the proper systems to assess their total exposure to such loans, while others have embraced ‘aggressive’ capital and repayment plans in some loans, adding: “It is important that banks provide leveraged financing to creditworthy borrowers in a safe and sound manner”.

The new guidance mostly addresses medium-sized and larger banks, with the joint release noting that smaller, community banks should be largely unaffected.

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