Federal bank regulators issued an interagency statement on November 12 emphasizing the need for all banking institutions to continue lending to creditworthy borrowers.

The agencies said recent government actions to promote financial stability enable banking organizations to better meet the credit needs of households and businesses. “At this critical time, it is imperative that all banking organizations and their regulators work together to ensure that the needs of creditworthy borrowers are met.”

The agencies divided their guidance into four areas:

• Lending to creditworthy borrowers: The economy will rely more and more on banking organizations to provide credit formerly provided or facilitated by purchasers of securities. “If underwriting standards tighten excessively or banking organizations retreat from making sound credit decisions,” the agencies said, “the current market conditions may be exacerbated, leading to slower growth and potential damage to the economy as well as the long-term interests and profitability of individual banking organizations.”
• Strengthening capital: A strong capital position complements a bank’s capacity and willingness to lend. “Banking organizations should not maintain a level of cash dividends that is inconsistent with the organization’s capital position, that could weaken the organization’s overall financial health, or that could impair its ability to meet the needs of creditworthy borrowers,” the agencies said. “Supervisors will continue to review the dividend policies … and will take action when dividend policies are found to be inconsistent with sound capital and lending policies.”
• Working with mortgage borrowers: The agencies said they “expect banking organizations to work with existing borrowers to avoid preventable foreclosures, which can be costly to both the organizations and to the communities they serve, and to mitigate other potential mortgage-related losses… Given escalating mortgage foreclosures, the agencies urge all lenders and servicers to adopt systematic, proactive, and streamlined mortgage loan modification protocols and to review troubled loans using these protocols.”
• Structuring compensation: The agencies called on banks to regularly review their management compensation policies to ensure they are consistent with the longer-run objectives of the organization and sound lending and risk management practices. “Poorly-designed management compensation policies can create perverse incentives that can ultimately jeopardize the health of the banking organization.”

The guidance could scarcely be more explicit. Examiners will review institutions’ performance in making loans, strengthening capital, helping troubled borrowers, and structuring executive compensation. Whether or not community banks had any role in causing the economic collapse, and whether or not they have accepted capital from the government’s Capital Purchase Plan, they are expected to play a leading role in getting the economy back on its feet.