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Bank Examination Policy and Loans
to Business
In June of 1958 the Federal bank supervisory agencies—
in otlier words, the Board of Governors of the Federal Reserve System,
the Comptroller of the Currency, and the Federal Deposit Insurance
Corporation—reviewed their policies and regulations in order to determine in what respects they might be improved and coordinated in
order to facilitate the flow of credit to commerce, industry and agriculture. As a result, unanimous agreement was reached on a program
designed to produce uniformity in the treatment of loans and securities
by the Federal agencies in the administration of bank examinations.
One of the fundamental purposes of the program was to broaden the opportunity for small and medium sized business concerns to obtain credit
from banks on a sound basis. With this purpose in mind, the regulations of the Comptroller of the Currency regarding the purchase of investment securities by national banks were liberalized, the so-called
"slow" classification in examination reports of banks was abolished,
and concise definitions were given with respect to the classifications
to be applied to loans»
It was felt at the time that the program agreed upon was
substantially all that could be accomplished within the framework of
the law in encouragement of the extension of credit to business. The
program has on the whole worked very satisfactorily and it is doubtful
whether any further changes in bank examination policies and procedures
would bring about any substantial increase in loans by banks to small
The banking laws of the United States and of the States
prescribe the limits within which the supervisory authorities make
policy decisions with regard to bank examinations. Such laws express
broad public policy with regard to bank assets and management through
numerous detailed provisions. Many banking laws are necessarily in
general terms, however, and authorize the supervisory authorities to
implement their provisions by issuing regulations and to exercise a
certain amount of discretion in the process. Nevertheless, neither
legal restrictions nor general regulations attempt to define in detail the circumstances under which all loans and investments must be
made. Bank management must exercise its own discretion and credit
judgment within the framework of the prescribed limitations*
There are some previsions of the law which by their nature
are restrictive upon the lending functions of banks but this does not
mean that these laws should necessarily be repealed or substantially
modified. For example, national banks are subject under Federal law
to limitations in making loans secured by real estate. Such loans may
not exceed 50 per cent of the appraised value of property or be for a


longer term than five years except that if amortized they may go up
to 60 per cent of the appraised value and may run for ten years if
40 per cent is paid off within that period. National banks are likewise subject to a basic limitation of 10 per cent of capital and surplus
on loans to one borrower. But even though all such statutory restrictions
were eliminated or substantially modified, there is little reason to believe that the volume of business loans would be greatly increased. This
is because of the fact that when banks hesitate or decline to make loans,
they do so because in their judgment such loans are not good credit risks,
rather than because of bank examination policy or statutory restrictions.
It is believed that, all too frequently, bankers find it
convenient to say to would-be borrowers that examiners would criticize
them for making loans as requested rather than to advise borrowers of
the real reason for declining such loans or to point out the unsound
characteristics thereof. Thus the impact of examinations on the extension of credit by banks is greatly exaggerated, although it is perfectly true that many loans declined for such reasons would be criticized
by examiners if made. The point is that the borrower is not given the
banker's reason for considering the loan unsound and gains the impression
that the examiner is prone to criticize loans which, in the opinion of
the borrower at least, are entirely sound.
In this connection, Congress in 1942 enacted a law exempting
from the 10 per cent limitation on national bank loans to one borrower
obligations guaranteed by the United States or by a Federal Reserve
Bank, and a similar statute has been passed in nearly all of the States
with respect to State banks. This has been of assistance in connection
with the guaranteed V-loan program under which the War and Navy Departments and the Maritime Commission guarantee loans for war production
purposes through the agency of the Federal Reserve Banks. This legislation, however, affects primarily larger loans rather than loans to
small business.
As a matter of interest in this connection, it may be mentioned that in November 1942 the Federal bank supervisory agencies
announced a joint policy with reference to investments in and loans
upon United States Government securities. This provided that there
would be no deterrents, in examination or supervisory policy, to investments by banks in Government securities, nor to short term loans
by banks to finance the purchase of such securities.
Hihile a close coordination of bank examination policy among
the Federal supervisory agencies and frequent consultation among such
agencies is, of course, most desirable, such consultations are constantly
taking place on questions which are arising from day to day. It seems
unlikely that there is any considerable field of latitude in which any
revision of bank examination policy as it presently exists could, through
meetings of the supervisory agencies or otherwise, bring any substantial
increase in volume of business loans made by the private banking system.