Banks are turning cautious on lending, according to the Fed. What it means for the economy

U.S. banks are starting to tighten their lending standards amid growing concern over the underlying health of the economy, according to a new Federal Reserve survey.

The Fed's latest Senior Loan Officer Opinion Survey on Bank Lending Practices for October, published Nov. 2, showed an uneven credit backdrop in the third quarter, with smaller businesses, riskier households and commercial property in particular facing a lending squeeze.

The latest quarterly SLOOS study for October — which pulled together responses from 61 domestic banks and 18 U.S. branches of foreign lenders — covered changes in lending standards, terms and demand during the third quarter.

The survey tracks banks' reported lending standards, terms and demand, not actual loan volumes, offering a snapshot of evolving credit conditions and sentiment.

Small businesses feel the squeeze

Commercial and industrial lending to large and middle-market firms was broadly unchanged from the previous survey — but banks tightened lending to smaller businesses.

"Banks reported tightening standards for premiums charged on riskier loans for firms of all sizes," the report noted. Lenders pointed to a less favorable or more uncertain economic outlook, and a worsening of industry-specific problems as the key reason for the shift.

Commercial real estate is also emerging as a pressure point, with banks reporting tightened standards across the board on construction and land development, nonfarm nonresidential properties, and multifamily properties, and weakening demand for loans in all CRE categories.

U.S. banks are also tightening credit standards for nonbank financial firms such as private equity funds and business and mortgage credit intermediaries. The pullback comes amid growing demand for liquidity from private equity funds and business credit intermediaries, with lenders again highlighting prevailing economic uncertainty and concerns over the deteriorating financial strength among NDFI borrowers.

Household credit turns selective

Meanwhile, household credit sentiment appears mixed.

While banks have left mortgage standards broadly unchanged, there has been some easing for jumbo mortgages — but tighter rules for subprime loans — as banks reported weaker demand, on balance, across all residential real estate loan categories.

"Banks reported being more likely to approve credit card applications to super-prime and prime borrowers and less likely to approve applications to subprime borrowers, with small banks driving the trend for subprime borrowers," the report added.

The squeeze comes as borrowing costs moved sharply higher during the third quarter. The 10-year Treasury note yield — the main benchmark for mortgages, auto loans and credit card debt — hit an intraday high of 5.349% on Oct. 5, its highest level since April 2002, amid concerns over rising U.S. debt.

Tiffany Wilding, managing director and economist at PIMCO, said small businesses, housing and debt-laden firms face tighter credit and higher borrowing costs as the AI investment boom squeezes other parts of the U.S. economy.

"Higher government bond yields have catalyzed a broader repricing of credit risk, especially for lower-quality borrowers," Wilding said in a note Oct. 28.

Signals of credit stress among riskier households chime with a recent CNBC and SurveyMonkey poll, which found that one in five Americans who rent or have a mortgage spend at least half of their pretax income on housing, while 49% spend between 25% and 49%. Lender guidance recommends consumers spend 28% to 30% of their income on housing.

A separate Federal Reserve report indicated that U.S. families' ability to address their debts has worsened over the past three years. The Fed's latest Survey of Consumer Finances, released Oct. 9, found that the percentage of families behind on loan payments at the end of 2025 reached almost 20%, up from about 12% in the previous survey in 2022.