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S 4-08 FEDERAL RESERVE ASSISTANCE IN FINANCING SMALL BUSINESS The Board of Governors of the Federal Reserve System has recommended to the Chairmen of the Senate and House Banking and Currency Committees a bill which would provide assistance in financing small business through established banking channels. It was introduced in the Senate on January 27, 1947, and is now before the Senate Committee . The Proposed Legislation The bill (S. /JOB) would repeal section I3b of the Federal Reserve Act ^"adopted in 193^* to mke'Xnc^ , Certain provisions^oF^tHfs" secilon Have prove3Tso~restrictive as seriously to impair the ability of the Federal Reserve Banks to assist in the financing of business. In lieu of section 13b, the new bill would add a paragraph to section 13 of the Federal Reserve Act authorizing Federal.Reserve Banks to guarantee loans made tgTl^ancing institutions to business enterprises on a much more effective basis than that permitted by present law. While the Federal Reserve Banks would no longer have authorityto make direct loans to business> they would be authorized toffuaranCeebusiness loans subject to regulations prescribed by the Board of Governors a M ~ (1) No loan guaranteed could have a maturity of more than 10 years. (2) A Federal Reserve Bank could guarantee up to, but not more than, 90 per cent of any loan. (3) The aggregate amount of all guarantees could not exceed the combined surplus of the 12 Federal Reserve Banks. (4) In order to insure the availability of guarantees for loans to smaller businesses, the aggregate amount of all guarantees which are individually in excess, of $100,000 could not exceed 50 per cent of the combined surplus of the Reserve Banks. (5) The Reserve Banks would utilize their own funds to carry out guarantees made under the bill« The pending bill would repeal the appropriation of about $139,000,000 available under existing law for industrial loan operations of the Reserve Banks, and Government appropriations would no longer be used for this purpose. _ -2- business. Term loans amortized out of profits meet this need. This type of financing is particularly suitable for small businesses that need a substantial period of time to retire loans by gradual repayment from earnings« There has been considerable objection from some of the larger banks to S. 408 on the ground that the, smaller banks, in cases where the amount of the loan was beyond their legal limit, would resort to the guarantee even though the loan waa of such quality that it could be made without the guarantee by giving participations to their correspondent banks or other banks in the community. In order to meet this objection, the Boa^d recommends that the Committee adopt the suggestion of the Federal Advisory Council of the Federal Reserve System by inserting in the bill a provision that the guarantee shall only be available"when it appears to the satijfaction of such Federal^eserve bank^ttet^W^n^jjiess enterprise is unable to obtain requisite financial assistance orTa reasonable fesis from the usual sources»11 ——— The Board also favors the recommendation of the Federal Advisory Council that the bill be amended to provide that the guarantee be restricted to uchartered banking institutions" only and not to "any financing institution" as provided in the bill. It should be borne in mind that the Reserve System has had the authority under 13b for the past thirbemyearg_tP make direct loans or to make commitments to purchase loans madetorprivate banks. On principle, we feel_that_the private banks should originate and make the loarisnBased on their credit judgment, and that neither the Federal Reserve Banks nor any other governmental agency should extend such credits directly. Section 13b, moreover, is not adapted to present day needs. It limits the extension of credit to loans for working capital only and provides that loans cannot be made for more than five years and can be made only to established businesses. The^proposed bill does not callfor Government^appropriations and, therefore, no drain on the Federal^budget is involved. The Reserve Banks wouldjuse their surplus funds as a basis for the guarantees, ancP* should losses be sustained they would first come out of the fund created by the guarantee fees charged. If this were not adequate, losses would be met out of the Reserve Banks* net earnings or surplus. I am sure that this responsibility placed on the officers and directors of the Reserve Banks, under regulations and supervision of the Board of Governors, will not encourage easy and unsound credits on the part of the private banks• Under section 13b Federal Reserve Banks handled some 3500 applications for commitments and advances, aggregating nbout 560 million dollars. Similarly, under the V-loan program, 8771 authorizations for guarantees of war production loans, aggregating nearly 10.5 billion dollars, were handled. The interest and fees collected in connection with this total of about 11 billion dollars of operations were more than BOARD PF GOVERNORS )F THE FEDERALfcESER¥ESYSTEM For \pmiediate release / / / / April 17, 1947 / STATEMENT OFf CHAIRMAN ECCLES* / )RE //, SENATE BANKING AND CUfRENCY COMMITTEE Mr. Chairman a}^ Members of the Com|attee: I am glad to have an opportunity order to urge the passage of S. 408 >pear here this morning in The bill ha^two sections The^first one repeals section **13b of the Federal Reserve \ct and prov .des /for the return to the Treasury of approximately 139 million^ dollars ^jat/was set aside from the gold increment to enable Federal Reserve iks to make direct loans to industrial and commercial businesses I ^Fe^^cond "gectÌSi "oT'HEES bill stibstitutes for the direct lendmg auJ o ri ena ble Federal Reserve Banks to guaraljte. is by chartered banks particularly to small and medii sisfebusinesses that n e ^ ^ c ^ ^ Ì T for periods up to ten years» It is1 important to/emphas e that the principal purpose of the ¿ o smaller businesses for the purt bill is to make term loans /special .pital that they could not otherpose of providing them witK necessa: wise obtain. It will fill a gap in ri^ate financing that now exists in essential financing. The costs of enabling these enterprises to obta going to the capital markets for a 11 business are prohibitive. Likewise, many banks properly ferel that they annot extend some term credits for from five to ten yea^s without "somefprotecti as provided ty this bill, It amounts to a forp of spreading t h risk ty roviding insurance for a je fee. It is not thè purpose of thisf bill, however, to provide guarantees for either short pr long-term financing which b f J s can and should extend a^c without assistance. The /basic need of the smaller, independents owned business enterprises i s for long-term funds• Some businesses need funds for ! modernization of planband equipment and additional facilities. The need also arise/ from the sharp increasfe in prices and greatlV expanded volume of bu^inees resulting in a much larger volume of accounts\eceivable and of inventories. Because of these various factors many enterprises whose financing needs have ordinarily bfen met through current borrowings now need / funding of their short-term obligations into a term lo£ Owners of small enterprises, as a rule, prefer to obtain funds orj/a loan rather than on an equitir basis because? they do not wish 'weir ^ock ownership to be diluted or po run t i risk of losing control o f the ie t -3sufficient to cover expenses and losses and to show some profit» words, the record is not one of loose lending. In other Thisjbill, of course^does not placethe Reserve Banks in competition wittrthe, pHva^^SnBiM"^s]^ would remain primarily with t i lending bank. Loans guaranteed would fe originate with local banks dealing with local people whom they know and with whose character, capability and capacity they would be familiar. A Federal Reserve Bank could not guarantee any loan unless requested to do sofcythe local bank. If approved by the Reserve Bank the guarantee would a AT be made promptly available without referring the m - r f 1 f n a f b i" f KtY ffl Washington. Each loan would have to be passed uponfcythe Federal Reserve Bank. There would be no td.anket approval. The twelve Federal Reserve Banks and their twenty-four branches provide a regional organization through which local financing institutions in all parts of the country would have convenient access to a guaranteeing agency if needed. The Federal Reserve System, which is a permanent org^-nizati on created ty Congress and responsible to Congress, is especially qualified to provide this service because of its clos^ contacts and daily relationships With banking institutions. Its responsibilities for maintaining sound credit conditions, so far as its powers permit, make it the appropriate agency for this purpose. As in the case of war production loans under the V-loan program. a maximum .interest rate would be set for guaranteed loans. The present maximum rate under section 13b is 5 per cent and it is contemplated that the initial maximum rate under the new legislation would be the same. Within this limit, vihxch may be subject to change with changing conditions, interest rates would be determined " y the borrower and the bank. Guarantee b fees charged would be specified percentagesof the interest rate, /graduated according to the percentage of the loan guaranteed. The method would, be ~ similar to that used in the V-loan '^program, when guarantee fees ranged from 10 to 30 per cent of the interest rate, according to the percentage of the guarantee. This has been and would be the operating procedure. It is evident, therefore, that the lending banks must carry some portion of the loans without guarantee and this will be a deterrent on their making undesirable and risky loans. The steeply graduated guarantee fees will induce banks to carry as much of the risks as possible and thus cause them to exercise careful judgment and prudence in passing upon credits. Business and credit conditions at present and at some other times may not be such as to require extensive use of the guarantee authority. However, the Reserve Banks should have a stand-by service of this kind to render to business and industry when necessary. The amount of long-term funds that individual enterprises may need is often relatively small. Many loan demands do not exceed f10,000 and relatively few exceed $100,000. The bill is intended and designed primarily to help the smaller -4- enterprises. The larger ones, as a rule/'do not need this sortJ& assistance because they can go t © the capital/market and raise^ funda^either ty * rbonds or equity financing. / / The guarantee service»/as, pro3ddM...-4lLJthis bi3^ would be avails able , as~it has jKthe^past? withouFd^^ banks, whether memberiTcrfT^^ serviTI?^ It would be ill-advised and shortsighted^ inrayopinion, for Congress to repeal section 13b in order that th^T-39 million dollars of Government funds theiwider may be returned t<y£he Treasury and fail to provide this proposed alternative authority j^o the Federal Reserve Banks. The proposal is the result of long and extensive experience which the Federal Reserve System has had in connectioiymth the loan guarantee principle It is a tried a m tested principle exemplified in Federal Housing Administration loans/as well as in loans to yfterans. This bill is a means of aiding the jfrivate banking system of/%his country to meet particularly the longer te^m financing needs of the/smaller business institutions without assuming'excessive" risks. / 4 -t Although large corporations secure a substantial amount of funds through term loans, the greater part of their need for long-term funds is met through security issues, a source not available to small concerns. The amount of long-term funds that the individual enterprise needs is relatively snail. Many of these loan demands do not exceed $10,000 and relatively few exceed $100,000. It is recognized that business and credit conditions at present and at other times may not be such guarantee authority which this bill providesTliowever, the Reserve Banks should, nave a stand-by authority of this kind in order that partial guarantees may be promptly available whenever needed. The Federal Reserve System, which is a permanent organisation created by Congress and responsible to Congressi^iF especially qualified" to j^qvide this service became of^xts close contact^ business relationships with^barSinS institutions? Moreover its responsibilities for maintaining sound credit conditions make it the appropriate agency for this purpose. Guarantees Are a Tested Method The system of providing financial assistance through partial guarantees of loans no longer involves untried principles and procedures. For many years the Federal Reserve System has had experience in making an^niuaranteeing business loans uncier section I3b of the Federal Reserve AcrTI Although the authority of the I^ederal'Reg^ve Banks under that section was restrict'eSy they approved 3* 542 applications for comxV^nts and advances amounting t oH| 5TO,OOOTOOOTancTtheir personnel gained a fund of knowledge and training in this type of financing. Interest and fees collected exceeded expenses and losses. During the war the Federal Reserve System acquired valuable experience in the administration of the V-loan program for guaranteeing war production loans. Under that program they processed 8,771 guarantees, aggregating nearly 10-1/2 billion dollars. The guarantee fees collected far exceeded expenses and losses sustained and the operation resulted in a very substantial profit for the Government. The pending bill follows the guarantee principle which was applied under that program, and financing institutions are already familiar with the services of the Reserve Banks in that field. The President has recommended that funds heretofore received by the Federal Reserve Banks for their industrial loan operations be returned to the Treasury. Consequently, it seems probable that the first section of the pending bill, which would carry out the President's recommendation, will be enacted. That section, however, would also repeal the existing industrial loan authority of the Reserve Banks. Accordingly, unless there is sufficient support for the second section of the bill r 4enterprises. The larger ones, as a rule, do not need this sort of assistance because they can go to the capital market and raise funds either fcy bonds or equity financing. The guarantee service, ag provided in this bill, would be available in the futureT as -it has'in the past«, without discrirrdnation for all banks, whether members of the Federal Reserve System or not. It would be ill-advised and shortsighted, in my opinion, for Congress to repeal section 13b in order that the 139 million dollars of Government funds thereunder may be returned to the Treasury and fail to provide this proposed alternative authority to the Federal Reserve Banks. The proposal is the result of long and extensive experience which the Federal Reserve System has had in connection with the loan guarantee principle. It is a tried and tested principle exemplified in Federal Housing Administration loans as well as in loans to veterans. This bill is a means of aiding the private banking system of this country to meet' particjjlarly the longer term financing needs of the smaller business institutions without' assuming excessive risks. -3sufficient to cover expenses and losses and to show some profit. In other words, the record is not one of loose lending. This bill, of course, does not place the Reserve Banks in competition with the private banking system. Credit judgment and responsibility would remain primarily with the lending bank. Loans guaranteed would originate with local banks dealing with local people whom they know and with whose character, capability and capacity they would be familiar. A Federal Heserve Bank could not guarantee any loan unless requested to do so by the local bank. If approved ty the Reserve Bank the guarantee would be made promptly available without referring the matter to any agoncy in Washington. Each loan would have to be passed uponfcythe Federal Reserve Bank. There would be no blanket approval. The twelve Federal Reserve Banks and their twenty-four branches provide a regional organization through which local financing institutions in all parts of the country would have convenient access to a guaranteeing agency if needed. The Federal Reserve System, which is a permanent organization created ty Congress and responsible to Congress, is especially qualified to provide this service because of its close contacts and daily relationships with banking institutions. Its responsibilities for maintaining sound credit conditions, so far as its powers permit, make it the appropriate agency for this purpose. As in the case of war production loans under the V-loan program, a maximum interest rate would be set for guaranteed loans. The present maximum rate under section 13b is 5 per cent and it is contemplated that the initial maximum rate under the new legislation would be the same. Within this limit, which may be subject to change with changing conditions, interest rates would be determined by the borrower and the bank. Guarantee fees charged would be specified percentages of the interest rate, graduated according to the percentage of the loan guaranteed. The method would be similar to that used in the V-loan program, when guarantee feus ranged from 10 to 30 per' cent of the interest rate, according to the percentage of the guarantee. This has been and would be the operating procedure. It is evident, therefore, that the lending banks must carry some portion of the loans without guarantee and this will be a deterrent on their making undesirable and risky loans. The steeply graduated guarantee fees will induce banks to carry as much of the risks as possible and thus cause them to exercise careful judgment end prudence in passing upon credits. Business and credit conditions at present end at some other times may not be such as to require extensive use of the guarantee authority. However, the Reserve Banks should have a stand-by service of this kind to render to business and industry when necessary. The amount of long-term funas that individual enterprises may need is often relatively small. Many loan demands do not exceed $10,000 and relatively few exceed $100,000. The bill is intended and designed primarily to help the smaller Excerpt fron the President's Budget Message for lS&Q "The Corporation Supplement to the 19U7 Budget indicated that the Federal Deposit Insurance Corporation oould soon begin to retire its capital stock* The continuing rapid growth in the Corporation's resources and the exceptionally strong position of the insured banks now make it possible to propose a substantial amount of capital redemption in the fisoal year I9I48. Accordingly, I reoossaend that the Congress authorize the Corporation to repay all of the 139 million dollars of capital furnished by the Federal Reserve System. Since the Reserve banks have already replaced these funds from earnings in recent years, the Board of Governors of the Federal Reserve System has proposed that the Congress at the same time authorise the payment to the Treasury of the 139 million dollars. I also recommend that the Congress authorise the Corporation to repay 100 million dollars of the 150 million dollars furnished by the Treasury Department. "By the close of the fiscal year 19U8, after these repayments, the Corporation will still have capital surplus and reserves of about 1 billion dollars — the objective set several years ago. "The Board of Governors has made a further reoonmendation, in which I also concur, that the Congress repeal the existing, largely dormant, authority of the Federal Reserve banks to make direot loans to industry, releasing to the Treasury the funds reserved for this purpose. The gold increment fund now includes 112 million dollars reserved for such loans, and an added 28 million dollars has been advanced to the Federal Reserve banks. These sums will be transferred to miscellaneous receipts. "These transfers from the Federal Deposit Insurance Corporation, the Federal Reserve banks, and the gold increment fund will add a total of 379 million dollars in miscellaneous receipts in the fisoal year 19146."
