Leveraged loans have been on the rise in the years since the Great Recession, attracting scrutiny from federal regulators. As this blog reported two weeks ago, that increased examination has already begun to have an effect, but authorities are still concerned. On Friday, the Federal Deposit Insurance Corporation, Federal Reserve System and the Office of the Comptroller of the Currency issued a joint statement warning that these loans can be harmful to the nation's economy.
The three agencies published their report as part of a yearly review into banks' lending practices. They say that about one third of leveraged loans so far this year have been to borrowers with low credit scores, and that financial institutions are not following the guidelines that were published in March 2013 to cut down on subprime commercial lending. They also published a list of answers to frequently asked questions to help banks achieve compliance.
"Banks must not heighten risk by originating and distributing poorly underwritten and low quality loans," reads the report. "The agencies believe that an institution unwilling or unable to implement strong risk management processes will incur significant risks and should cease their participation in this type of lending until their processes improve sufficiently."
Authorities have not been as strict with leveraged loans as they have been in other areas, especially mortgages, but they have taken measures to hold lenders more accountable. Banks now face greater financial consequences if a loan they issue is not repaid.
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