The Federal Reserve has limited tools when it comes to bolstering the economy—after all, the central banks were created to control inflation and its role as the stimulator is supposed to be secondary to fiscal policy. The Fed has tried to move into the void left by a sluggish economy and gridlocked Capitol Hill, but with very limited success. Part of the problem is that the needs banks' participation to make their policies effective. The setting of low interest rates at the Fed level only work if the nation’s banks get more active in the loan market. Thus far, there has been relunctance on that end.
This is chronic problem with low rates of interest. The lower the rate charged, the more vulnerable the lender is to default or payment problems. They are not making all that much from the loan and therefore have little reserve with which to play. They need the borrowers to be solid and to pay their loans back as expected. The higher the rate, the more wiggle room, and banks can take risks on the assumption that profits will be higher on the loans that are being serviced.
There have been changes in the way that banks are reacting to the government and to the regulators that have taken a renewed interest in bank policy, such as Dodd-Frank bank reform law.
It also has been noted many times before that full economic recovery is not going to take place until the housing market -- because of its domino impact on several other sectors -- recovers. The reason for the reticence is partly reaction to the excesses of the past and the fact that many banks replaced the risk takers with far more cautious executives who now favor a very careful approach to lending.
Unfortunately, this determination to avoid repeating mistakes from the past is leading to a new set of restrictive loan policies, and the economy is having a very hard time catching fire as long as there is no credit flowing to those who want to stimulate various sectors, including real estate. Steep restrictions apply to the business community as companies struggle to refinance the buildings and equipment they purchased in the past. Many companies that would expand and hire additional people are unable to get the loans they need to do so. The new restrictions demand solid economic performance throughout the recessionary years, and it is a rare company that can point back to the last three years and claim constant profit and revenue growth. The vast majority of the population and the business community now have a blemish or two on their credit ratings due to the recession and banks have been avoiding those that now carry that scar. Not much expansion will take place without bank lending, and very little will change until and unless the banks start to open up the proverbial spigot again.
Source: Chris Kuehl, NACM economist