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borrowing from the federal reserve bank
—some basic principles
small business in an age of big business
Additional copies of this issue are available
upon request to the Department of Research,
Federal Reserve Bank of Philadelphia,
Philadelphia 1, Pa.
BORROWING FROM
THE FEDERAL RESERVE B A N K -
^rr----------II
11 SOME BASIC PRINCIPLES
By Karl R. Bopp, President*
I propose to discuss borrowing from the Federal
Before I discuss borrowing as such I would
Reserve Bank. I have selected this topic for dis
like to describe briefly some of the economic
cussion today precisely because few member
developments and bank lending and investing
hanks have occasion to borrow at this time. The
policies that may lead to it.
amount of borrowing is low in part because the
Federal Reserve System has provided reserves
Why some banks borrow
liberally and cheaply in other ways as an impor
The ebb and flow in the demand for loans at
tant contribution to economic recovery.
commercial banks is a reflection of the ebb and
Why, then, talk about such borrowing now?
There are several reasons:
1. If experience is any guide, this will not he
a permanent state of affairs.
2. We all wish to know the basic principles
flow in economic activity itself. In periods of
rising business and inflation, the demand for
loans increases and the commercial banker won
ders where to get the funds to lend, how to keep
customers content with less money than they wish,
on which we operate.
3. We are more apt to establish valid prin
ciples when our immediate profit position
is not affected by the decisions we reach.
*An address before the 64th Annual Convention
of the Pennsylvania Bankers Association in Atlantic
City, New Jersey, May 28, 1958.
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business review
and how to maintain good will while denying
adequately that any investor assumes a risk when
some applicants altogether. In periods of declin
he buys the longer bond. It is the possibility that
ing business, on the other hand, the banker seeks
yields may go higher with a consequent loss of
customers who will borrow as well as other ways
capital value. Even a relatively small change in
to employ idle funds.
yield will mean a relatively large change in the
These alterations in demand and supply would,
market value of a long-term bond. Although an
of themselves, produce corresponding alterations
investor is more likely to remember this when
in interest rates. Action of the monetary authori
the time for liquidation comes, it is more profit
ties who are pursuing a flexible policy adjusted
able to remember it when the initial investment
to current conditions reinforces such changes in
decision is made. Some short-term investors delib
erately buy long-term bonds with the expectation
interest rates.
When demand for loans is slack a banker pre
of liquidating just in time to secure a maximum
fers to invest his excess funds in short-term
return. This approach has possibilities, but it has
securities so that the early maturities will provide
hazards as well. Sometimes these individuals
the funds to meet his needs when loan demand
develop a dual standard. They take credit when
again picks up. The same is true of bankers gen
erally and of other lenders. As a consequence,
developments follow their expectations, but they
blame others when subsequent developments are
short-term rates usually move down much more
adverse.
than long-term rates, and the structure of interest
The prices of long-term bonds, bought to se
rates takes on an upward slope. This slope is con
cure income in a period of weak loan demand and
firmed when the market anticipates that rates will
easy money conditions, decline as money tightens.
rise. The reason is that anyone who wishes to
And, just when money tightens in response to
borrow or lend for a long period can do so either
economic expansion, the problem of the banker
by means of a single contract for the entire term
shifts from trying to find profitable outlets for
or by means of a series of short-term contracts.
excess funds to finding funds with which to meet
If the market anticipates a rise in rates, borrowers
expanding demands. The risk that was assumed
will prefer the long contract to beat the rise and
when the long bonds were bought becomes a
lenders will prefer the short contracts so as to
loss on the books. In seeking funds to meet
secure funds from maturities for reinvestment
expanding demands it is understandable that the
when the rise occurs. In other words, the supply
banker might prefer not to sell the bonds because
of funds will concentrate in the short market and
this would convert the book loss into an actual
the demand for funds in the long market, thus
loss.
confirming the upward slope in rates.
At this point hope often enters the picture—
That is not the whole story, however. Slack loan
hope that the tightness will be only temporary.
demand and low rates of interest put pressure on
And, of course, experience shows that although
bank earnings. There is, therefore, a strong temp
the decline in prices continues as money tightens,
tation to meet the immediate problem of earnings
eventually a peak in yields or a trough in bond
by reaching out for longer maturities because of
prices is reached from which both move in the
the relatively higher yields, even though prices
opposite directions.
are high. At such times it is not always recognized
4
Why not, therefore, tide over this period by
business review
borrowing? If the cost of borrowing is not too
with the maintenance of sound credit condi
great, this might appear to be a method of eating
tions; and, in determining whether to grant
one’s cake, the higher yield, and having it too,
or refuse advances, rediscounts or other
not incurring a capital loss.
credit accommodations, the Federal Reserve
The discount window is not an automatic
escape route
mation.”
Bank shall give consideration to such infor
I want to indicate why member banks should not
One reason for not relying on the rate exclu
seek funds for this purpose from the Federal
sively is that the appropriate rate would have to
Reserve Bank. Suppose we look at the responsi
be comparatively high. The same rate would have
bilities of the Federal Reserve System under the
to be charged to all members; yet the primary
conditions that have been described. It is the
purpose would be to discourage the relatively
central bank which must adjust its monetary
small number of banks that tend to borrow exces
policy to economic developments. It tightens
sively. This is not to say that the discount rate is
credit to restrain inflationary expansion. One evi
unimportant. On the contrary, it is an indispens
dence of tighter money is the higher interest rates
able tool of monetary policy. Its level and changes
that have been mentioned and the higher discount
in it influence the tone of the market, including
rates that the Reserve Banks themselves would
market rates. I do not, however, have time to dis
charge under the circumstances. Another is a
cuss it adequately today.
reduced availability of reserves.
The discount window of the Federal Reserve
The effectiveness of the System’s efforts to
restrain would be blunted if reserves were made
Bank is like a safety valve that enables a member
to secure funds temporarily to meet needs that
available freely, if member banks had no hesi
could not reasonably be anticipated. It should not
tancy in borrowing, and the Reserve Banks never
be necessary to charge a member that finds itself
asked any questions about continuous borrowing.
in such a condition the high rates that would be
As an economist, I appreciate that the Reserve
necessary to discourage the complacent borrower.
Banks probably could discourage, even to the
The principles and rules that govern loans to
point of preventing, such borrowing by charging
member banks are published as Regulation A of
a high enough rate. But that is not the kind of
the Board of Governors. I would like to read from
the foreword to that Regulation:
rate policy on which the Federal Reserve Act is
based. The Act requires each Federal Reserve
“Federal Reserve credit is generally
Bank to refuse credit accommodations for any
extended on a short-term basis to a member
purpose inconsistent with the maintenance of
bank in order to enable it to adjust its asset
sound credit conditions. It provides specifically:
position when necessary because of develop
“Each Federal Reserve Bank shall keep itself
informed of
ments such as a sudden withdrawal of
the general character and
deposits or seasonal requirements for credit
amount of the loans and investments of its
beyond those which can reasonably be met
member banks with a view to ascertaining
by use of the bank’s own resources. Federal
whether undue use is being made of bank
Reserve credit is also available for longer
credit. . . or for any . . . purpose inconsistent
periods when necessary in order to assist
5
business review
member banks in meeting unusual situations,
to withdraw the reserves when the loan is repaid.
such as may result from national, regional
I should stress that the System always views the
or local difficulties or from exceptional cir
net result of total borrowing, when deciding
cumstances involving only particular mem
whether to add more to, or subtract from, bank
ber banks. Under ordinary conditions, the
reserves through open market operations. So the
continuous use of Federal Reserve credit by
discount window is not an automatic escape route
a member bank over a considerable period
that nullifies the effects of open market opera
of time is not regarded as appropriate.
“ In considering a request for credit
tions. On the contrary, these tools function to
accommodation, each Federal Reserve Bank
of pressure throughout the banking system that
gether, to achieve the degree and the distribution
gives due regard to the purpose of the credit
fulfills at any particular time the objectives of
and to its probable effects upon the mainte
monetary policy.
nance of sound credit conditions, both as to
the individual institution and the economy
Misconceptions clarified
generally. It keeps informed of and takes
I would like now to try to clear up a few misun
into account the general character and
derstandings that I have heard about the admin
amount of the loans and investments of the
istration of our discount policy. One of these is
member bank. It considers whether the bank
belief and repetition of an occasional rumor that
is borrowing principally for the purpose of
I have heard phrased in these words: “ Boy, the
obtaining a tax advantage or profiting from
Fed sure is tough.” It is difficult to trace such
rate differentials and whether the bank is
rumors to their source. On occasion we have
extending an undue amount of credit for the
found that they begin with a banker whose bor
speculative carrying of or trading in securi
rowing record in terms of frequency, amount, and
ties, real estate, or commodities, or otherwise.”
duration concerned us sufficiently to warrant a
I would like to call to your attention the signifi
discussion. We do not, in these discussions, tell
cant analysis of the functioning of the discount
mechanism that appears in the latest Annual Re
the banker how he should manage his own insti
port of the Board of Governors (pp. 7-18).
bility to manage the Federal Reserve Bank in
tution. We do point out that we have a responsi
Borrowing at the Reserve Bank is significant
accordance with the law and that he should take
to the member bank and to the Reserve Bank. To
into account that frequent or continuous borrow
the member it is a privilege of obtaining addition
ing is not appropriate except in unusual circum
al reserves to meet unexpected needs. Ordinarily
stances. I mention this because unfounded rumors
such needs would be for short periods though in
may have kept some members from applying for
exceptional cases they may be more extended. In
advances for legitimate purposes. My suggestion
any event, borrowing gives the bank time to make
is that when you hear such a rumor either ignore
orderly adjustments in its assets should that
it altogether or investigate it until you have ascer
become necessary. To the Reserve Bank appro
tained all relevant facts in the case. When the rele
priate borrowing has the advantages of supplying
vant facts are known, I would leave to your judg
additional reserves directly to the banks that have
ment whether we acted tough and capriciously
legitimate need for them and of attaching a string
or responsibly.
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business review
There has been some misunderstanding concern
rowing that calls for correction even in recessions.
ing the distinction I have drawn between manag
Now, every real craftsman in the field knows
ing our own Reserve Bank and managing the
that credit cannot be administered according to
member bank. As a result, we have at times
mechanical rules. Among the important factors
received unmerited praise and blame. Usually the
that are considered in evaluating the position of
praise is some variant of the following observa
a particular bank are the following:
tion: “ Thanks a lot for forcing me to sell those
What is the nature and extent of its loan
bonds to repay our debt to you. The bonds have
expansion?
since gone down several more points.” The blame
is some variant of these statements: “ Your atti
tude cost my bank plenty. Those bonds you made
me sell have since recovered several points.”
Is it confronted with seasonal requirements
for credit beyond those which could reason
ably be anticipated?
Actually, we do not tell a banker how to adjust
To what extent has it liquidated other assets
his position so that he can repay. That is his prob
to meet the loan expansion?
lem. The nature of that problem will vary among
banks, depending in part on earlier investment
Has it been subjected to unusual withdrawals
of deposits?
decisions. The results of action taken will also
vary, depending on subsequent developments that
Has the community in which the bank is
cannot be foreseen.
located experienced economic adversity or
Another misunderstanding is that the adminis
tration of discounting varies over time. I can
other unusual developments that require time
for solution or adjustment?
appreciate how this misunderstanding arises. In
Officers of the Federal Reserve Bank are gener
a period of easy money most banks will be seeking
ally familiar with the managements and policies
ways to employ idle funds, relatively few will be
of most of the member banks in the District.
borrowing at all, and very few, if any, may be
Nevertheless, our discount officers find it desir
borrowing inappropriately. In a period of tight
able from time to time to supplement our knowl
money, on the other hand, few banks will have
edge by means of direct inquiry. Raising questions
idle funds, relatively more will be borrowing, and
is at times a necessary part of proper administra
some may be complacent about their borrowing.
tion of discounting. It is not the questions but the
In other words the discount department of the
answers that influence our judgment. You appre
Reserve Bank will usually be busier in a period
ciate that I cannot cite specific cases because these
of tight money than in a period of easy money.
relationships are confidential, but I know of
More banks may approach the continuous bor
instances in which the facts demonstrated that
rower category as sanguine expectations do not
even extended borrowing was appropriate.
materialize. And so we have to make more tele
phone calls. This results, however, from mainte
Commercial banks are different
nance of standards by the Reserve Bank and not
I move now to the reasoning that leads some
from a change in standards or administration. An
indication of uniformity of standards is the fact
observers to very different conclusions with
that occasionally we do find inappropriate bor
banks, especially in recessions. Since many of
respect to the investment policies of commercial
7
business review
the ingredients are the same as those I have men
pressure on banks. I have a hunch, however, that
tioned, I can be brief.
they are more expert at constructing economic
Most analysts of business fluctuations would
agree that lower long-term interest rates contrib
models than at managing either commercial or
central banks.
ute to economic recovery from recession by stimu
I do not mean to suggest that commercial banks
lating construction of public works, of houses,
should confine their investments exclusively to
and of plant and equipment. Since a rising
securities of very short maturity. I am well aware
demand for long-term bonds would tend to pull
down long-term rates, some analysts would
substantial amounts of savings deposits and, to
of the fact that many commercial banks hold
encourage all investors, including commercial
pay reasonably competitive rates on such deposits,
banks, to purchase such bonds. A few observers,
they must invest in longer-term obligations, espe
if I understand their reasoning, would even single
cially when short-term rates are low. I also recog
out commercial banks particularly
such
nize the problem of maintaining earnings in
encouragement. They reason that such action by
periods of slack loan demand and low rates. What
for
the commercial banks would contribute not only
I do suggest is that, in expanding its investment
to the recovery but also to restraining later pos
portfolio at such times, a bank should aim for
sible inflationary developments. It would help
such a maturity distribution as will meet its fore
restrain inflation because the losses in capital
seeable needs, and not sacrifice adequate liquid
values that accompany inflation would tend to
ity for immediate earnings, nor look to the Fed
freeze the bonds into the banks.
to rescue it from its errors.
The logic behind this view has cogency. Never
Such a policy, generally followed by commer
theless, I am not convinced that commercial banks
cial banks, would not mean that the banks were
should be encouraged to ignore their internal
not doing their share to promote recovery. By
liquidity positions even in recessions. Their essen
investing their available funds in whatever matur
tial role differs from the role of those whose essen
ities were most appropriate for them, they would
tial function is long-term investment. The genuine
be helping to finance Government expenditures
long-term investor can ride out a temporary loss
and providing funds for investment by others.
in capital values. The commercial banker, on the
other hand, is always faced with the possible
Concluding remarks
demand for deposit withdrawal and with pros
I have no desire to tell you how to run your insti
pective demands from his borrowing customers.
tutions. That is your responsibility. On the other
Particularly these latter demands— and for indi
hand, I do have a responsibility with respect to
vidual banks the former as well, as we have
the Federal Reserve Bank. In the nature of the
learned in the Third Federal Reserve District—
case there is a reciprocal relationship between
are apt to come precisely when long-term bond
our operations. When you borrow from the
prices are depressed.
Federal Reserve, the Federal Reserve lends to
This does not disturb the analysts I have men
you. That is why it seemed appropriate to discuss
tioned. On the contrary, they see it as a great
Federal Reserve Bank lending policy at a time
advantage; because it would make a restrictive
when loans are few and we can be most objective.
monetary policy more effective by putting greater
I cannot close without expressing what we all
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business review
know and feel. We share a common goal of
needed in many areas. Nevertheless, appropriate
reasonably full use of our resources and a reason
monetary policy by the Federal Reserve System
ably stable level of prices. The banking system
and appropriate policies of the commercial banks
alone cannot achieve this goal. Much else is
are indispensable parts of the common effort.
9
SMALL BUSINESS
IN AN
AGE OF
BIG BUSIN
Observations on a New Comprehensive
Study o f Small Business Financing
This is the age of the big. Large nations dominate
Arguments are seldom settled, often because the
the world. Large cities control culture and com
right information isn’t available. True, many
merce. From cigarettes to basketball centers to
studies have been made but for the most part they
movie screens, size stands out.
are inconclusive, even contradictory. Many chinks
Size is important in business, too. There are
more than 4 million small firms but a relatively
remain to be filled in our knowledge of small
business.
few corporate giants hold dominant positions in
Thus, Congress requested the Federal Reserve
our economy. Big business now enjoys lion’s
System to undertake a major survey of small
share leadership in many industries.
business financing. The System readily agreed
Small firms may be overshadowed but they are
and, last autumn, a number of economists and
not overlooked. Their problems are widely dis
field men began asking questions and analyzing
cussed, their potentials debated. Columnists and
answers.
economists, politicians and professors expound
The survey has three general objectives: (1)
their views. And they ask crucial questions. Is
to assemble existing information; (2) to clarify
small business a healthy institution or are its days
any financing gaps, i.e., to find out if small busi
numbered? Can small firms satisfy their legiti
ness is in an inferior position to obtain funds;
mate financial needs? Do they need help, and
and (3) to explore the effects of the tight-money
what kind of help?
policy on small business.
There are answers but there is little agreement.
10
The first report has been issued. Its 550 pages
business review
are filled with background material on financing
A number of factors have helped small business
practices and policies. But it doesn’t pretend to
hold its own. Some of the most important are
give all the answers. This is a very difficult prob
related to strong, basic developments in our
lem. Also, the current report is of an interim
economy.
nature. Research continues, and surveys are still
income has set record after record. Education has
During
the past
decade,
personal
to be made. In fact, the most important one of all
become much more widespread, particularly on
cannot be ready until 1959. This will involve
the college level. These trends have spurred the
going to the small businessman himself — the
demand for individualized, quality products. The
borrower. Trained interviewers all over the coun
handmade, the artistic, the “ something special”
try will talk with him and peer at his financial
has been selling very well. So have new items and
statements.
ideas. Small firms are well suited to satisfy these
Meanwhile, there is much of interest in the first
changing tastes. They can emphasize quality
report. What follows is merely an attempt to hit
instead of quantity; they can dream up, innovate,
the highlights. Anyone interested in more detail
and pioneer. And they are often more flexible
should examine the full report (see Note, Page 17).
than their giant competitors. Decisions can be
made and quickly changed. Turns can be made on
New vitality
a dime to keep up with the fickle whims of “ King
When the country was young, all businesses were
Consumer.”
small; now huge corporations are common. Since
Washington’s day, or even Lincoln’s the relative
importance of small business has slipped— and
TH E EX PA N D IN G B U SIN ESS PO PU LA TIO N
MILLIONS
badly. But recently, small business generally has
been growing in step with the economy as a
whole. Its share of over-all economic activity has
not diminished in the postwar period.
There are now about 4 million small businesses
— 10 per cent more than in 1948. Over 350,000
new firms are started every year, and more than
99 per cent are small. Of course, many of these
tyros quickly fail, but enough survive to increase
the business population an average of 50,000 a
year. Since the 1930’s, the share of national in
come received by small businesses has been rela
1946
1948
1950
1952
1954
1956 '57
tively stable. Similarly, employment in small
firms, as a percentage of the labor force, varied
The post-war population also is buying more
but slightly from 1939 to 1948. As one writer puts
services. Higher living standards which mean
it: “ The attractions and rewards of indepen
more things to fix, greater leisure, larger families,
dent enterprise must be varied and substantial,
etc., are responsible. Service is a specialty of
and the obstacles to entry not so formidable as
small business. Over 700,000 small firms are
some have claimed.”
engaged in the service trades.
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business review
SELF-EM PLO YED B U SIN ESSM EN
able and the amount that small business could use
HAVE PRO SPERED
“ without prohibitive risk.” Let’s examine some
Increases in median nonfarm income— 1951 to 1956.
specific types of financing.
PER CENT
Short-term credit
Evidence indicates that most small businesses are
able to satisfy their legitimate needs for short
term credit (loans for less than a yea r). Commer
cial banks are a source of credit of major impor
tance. The vast majority of banks are small them
selves and lend almost exclusively to small firms.
In the fall of 1957, there were over $7 billion out
standing in bank loans to small businesses. By
number, this averaged almost one loan for every
two firms in the country.
In addition to banks, larger firms lend huge
sums to small businesses for short periods. This
David-Goliath cooperation arises out of everyday
commercial transactions. Large firms sell their
Source: Federal Reserve Surveys of Consumer Finances
products to smaller ones and permit them to delay
Population shifts, both regional and suburban,
payment for 30 to 60 days and longer. It is esti
have benefited many small businesses. Firms in
mated that one-half of small business’ inventory
sparsely settled areas may suddenly find them
requirements is financed in this manner.
selves in the mainstream of migration. Almost
overnight, new demand swirls all about them.
Factors and commercial finance companies are
institutions that specialize in financing accounts
Notice that many of these basic boosts, these
receivable for small business. These lenders sup
factors favoring small business, are born of pros
plement rather than compete with commercial
perity. Incomes, education, and population move
banks. For the most part, they accommodate
ment are strongly influenced by economic condi
firms that are unable to get bank credit. Factors
tions. One of the report’s authors, therefore, con
and finance companies are small compared to
cludes: “ The best help for small business would
other lenders but they have grown greatly in the
be the maintenance of an expanding, reasonably
past decade. All together they now do a $2 billion
stable economy.”
business.
Though plenty of short-term credit seems avail
THE DOORS TO FINANCING
able to the small businessman, he is at a disadvan
In general, small firms seem to have adequate
tage when it comes to interest rates. He generally
access to financing. The majority are going con
pays more than the large borrower for his bank
cerns with good credit connections. In particular,
loans. Call this discrimination if you will but it
however, there are problem areas. Certain gaps
has strong economic justification. There are two
appear to exist between the amount of funds avail
reasons— administrative costs and risk.
12
business review
HOW SMALL IS SMALL?
There is no standard definition of small business. Size, after all, is relative. It often depends on
who is doing the measuring, and why.
Th is is the general yardstick the survey used to determine if a business is small.
In these industries:
A firm is small if it has:
Retail trade
Total assets less than $50,000.
Public utilities (mostly taxes)
Construction firm s
Service firm s
Wholesale trade
Total assets less than $250,000.
Commodity dealers
Real estate firm s
Manufacturing and mining firm s except those listed below
Manufacturers of:
Total assets less than $1,000,000.
Food-liquor-tobacco products
Textile-apparel-leather products
Sales finance companies
Firm s producing:
Total assets less than $5,000,000.
Metal and metal products
Oil-coal-chemical-rubber products
Investigation and servicing costs per dollar of
self, whereas the large firm can employ specialists.
credit extended are much higher on small loans
The small businessman apparently makes many
than on large. These overhead charges have to be
mistakes, for bankers rate “ poor management”
spread over a smaller base, thus the lender must
far and away the most important blotch on the
charge more to wind up with the same percentage
credit rating of small business. Lenders, therefore,
of profit.
charge higher interest rates in order to build
Small firms, in general, are poorer credit risks
— more likely to get in trouble, less likely to repay
larger reserves as a buffer against the extra risk
of small business lending.
— than large firms. Size in itself has a lot to do
with it. The small company is dependent on the
Intermediate credit
abilities and the limitations of one man— the
The availability of one- to five-year loans appears
owner. He must make all important decisions him
to be getting better all the time. Banks are now
13
business review
making many term loans to both large and small
Most small businesses just don’t offer this kind
businesses. The Small Business Administration
of potential. About two-thirds of all small firms
and other Government agencies also provide
are engaged in the routine, highly competitive
intermediate credit. Their greatest contribution,
service trades and retailing where rapid growth
however, probably has been their stimulating
is unlikely.
effect on term lending by banks and other private
Changes in the financial structure of our econ
institutions. Consider, too, the rapid growth of
omy have tended to dry up the flow of equity
equipment financing by lenders and manufac
capital to small business. Once upon a time, frugal
turers and the supply of intermediate credit seems
fairly sufficient.
individuals invested their savings in the busi
nesses of friends and relatives. There were rela
tively few alternatives — except the mattress.
Long-term credit
Today, most people deposit their savings in finan
Mortgages, for all practical purposes, are the only
cial intermediaries. Institutions like building and
source of long-term credit for small business.
loan associations, pension funds, banks, and
They are available from commercial banks, sav
insurance companies collect individual nest eggs
ings institutions, and insurance companies. If the
and reinvest them— but not in small businesses.
business has proper assets to pledge, mortgages
Responsible for large sums of other people’s
usually are easy to get.
money, these institutions require safe investments
The trouble is, many small businesses don’t
in big blocks.
have the right assets. They rent their quarters,
Seekers and suppliers are often at cross
and their equipment is highly specialized. These
purposes and this has further reduced the avail
firms usually must do without long-term credit,
ability of capital. Let’s say a small businessman
for small business finds it far too costly to sell
has hit on a new product, or discovered a new
bonds on the market.
market. He decides to expand and he needs money
to do it. He wants a long-term loan because, to
Equity capital
get equity capital, he would have to give up some
Finding somebody to put up equity funds— to
of the ownership and control of his business—
buy into his business— is the small operator’s
and a share of future profits, too. On the other
most pressing financial problem.
hand, investors are loath to loan, for then they get
A few institutions, investment firms, develop
only a fixed return, taxable as income, and they
ment corporations, and the like, furnish equity
don’t have a say in running things. They demand
capital to firms too small to use the stock markets.
the slice of control and profits that the owner is
Wealthy individuals, however, are the principal
so reluctant to give. Negotiations often end in a
source. These investors are after capital gains and
stand-off and the investor looks elsewhere.
they are a well-informed, sophisticated lot. They
demand a high return to compensate for the extra
New businesses
risks and the fact that their investment is usually
It’s a disadvantage to be small if you are after
“ locked in” for a number of years. The prospect
long-term equity funds. But it’s worse to be new,
of a 15 to 20 per cent annual appreciation usually
as well as small. In fact, in business, the “ just
is necessary to loosen these purse strings.
born” and the “ toddlers” seem to have more diffi
14
business review
culty in getting credit of all types. And, since
compares two surveys of the business loans of
most new businesses are small, many of the sup
member banks— one taken in 1955, the other in
posed difficulties of small business are often really
1957. The over-all increase in loans was substan
difficulties of new business.
tial, for the period almost spans the late-lamented
Lenders and investors put a lot of faith in
business boom. The dollar volume of loans to
experience and demonstrated ability. They like to
large business, however, swelled much faster than
know what management can do before they risk
loans to small business. The percentage increases
their money. New firms just haven’t had time to
were roughly:
show off their capabilities, or lack of them. Yet
medium-sized, 28 per cent; small, 10 per cent.
large business, 50 per cent;
new firms do manage to raise money, and the
It looks as though tight money hit small busi
amounts must be substantial. After all, 350,000
ness hardest. But let’s take a closer look. Remem
new businesses are started every year.
ber, there are two sides to every coin, and to
every question. In business the sides are called
WHEN CREDIT IS SCARCE
supply and demand. Monetary policy works on
The recent period of restrictive monetary policy
the
raised anew the question of whether such a policy
increase in loans to small business could be
pinches small business especially hard. When
because the supply of small business credit was
credit is being rationed, large firms supposedly
squeezed harder. Or it could be because the
supply
side.
The
comparatively
smaller
crowd small ones to the end of the line. So the
demand for loans from small business did not
survey attempts to get facts to answer the question.
increase as much.
The tight-money policy evidently set up cross
current effects on small business. In some ways
the policy bore adversely on small businesses—
There is evidence to indicate the latter was
true. All industries did not participate equally in
the recent boom. Those that expanded most
in other ways it seemed to favor them.
rapidly had the greatest reason to borrow.
Monetary
restraint caused some banks to
The boom seemed to be concentrated in indus
change their lending policies, to the detriment of
tries in which large firms are typical. Metals,
small borrowers. Credit standards were upgraded,
petroleum, chemicals, rubber, and public utilities
more stress was placed on the deposits that bor
— all large-scale industries— scored some of the
rowers must maintain, and longstanding custom
greatest gains in both sales and bank loans. Thus
ers were given greater preference than ever. These
the relatively greater increase in loans to larger
changes tended to favor the large concern over
borrowers may be due in part to relatively greater
the small.
expansion of large-firm industries rather than to
But not all banks revised their lending policies,
an uneven impact of tight money.
and not all to the same degree. Big banks appar
From 1955 to 1957, small banks experienced a
ently did most of the policy changing. Small
relatively smaller loan increase than large banks.
banks— specialists in small business lending—
This also suggests a less hearty demand for loans
often reported no revisions at all.
from small firms as compared to the big cor
Results of the Federal Reserve survey suggest,
on the face of it, that tight money bore harder
on small business than large business. The report
porations.
The prime sources of short-term credit to small
(Continued on Page 18)
15
THE ANATOMY OF THE STUDY
The Federal Reserve study of small business financing is divided into three main parts. Available now
is a report on Parts I and 2.
Part I
Background studies. Experts write on critical areas of interest. Existing information is reorganized
and re-examined to throw new light on the experiences and problems of small business.
Sixteen papers are presented, dealing with the following topics:
A utho r
Title
Observations Based on Background Studies
George Garvy
Who Finances Small Business?
V ic to r L. A nd rew s, Seym our
Friedland, Eli Shapiro
Risks and Returns in Small Business Financing
Geoffrey H . Moore, Thomas R.
Atkinson, Edward J. Kilberg
Adequacy of Small Business Financing: One View
A. D. H . Kaplan, Paul H . Banner
Adequacy of Small Business Financing: Another View
Irving Schweiger
What is Small Business?
Eleanor J. Stockwell
Small Business in the American Economy
James S. Duesenberry
"Adequacy" of Financing Facilities fo r Small Business — Some
Jack Guttentag
Conceptual Problems
Trends in the Relative Importance of Small Business
Jesse W . Markham
The Survival of Small Manufacturing Business
James McNulty
Effects of Long-Run Shifts in Demand for Final Product on the
John Sheahan
Position of Small Business
Government Loan Programs for Small Business
16
Carl A rlt
Security Financing of Small Business
Richard C. Pickering
Public Policies Affecting Small Business
Ramsay Wood
Management Problems of Small Manufacturing Enterprise
in Relation to Financing
J. Clark, Jr.
State Development Corporations
Paul S. Anderson
Part II
Surveys of Lenders. These surveys view the practices, policies, and techniques of small business
finance through the eyes of lenders. New information is developed from extensive use of question
naires and interviews. Included are:
1. A survey of member-bank lending. A large sample of banks was asked to report their out
standing business loans on October 16, 1957. The results are analyzed and compared with a similar
survey made two years earlier. Though loans of all sizes are covered, emphasis is placed on loans to
small firm s.
2. A report on inte rview s w ith commercial bankers. Bankers were asked to express their
opinions and describe their operations in small business lending.
3. A description of the activities of factors and commercial finance companies. Th is survey
was also based largely on personal interviews.
4. An in q u iry into the flo w of credit from large to small business. Interviews with experienced
credit men in large corporations develop important new information in this relatively unexplored area.
5. An analysis of small business lending by life insurance companies. Th is survey supple
ments a similar one made by the insurance industry itself.
6. An opinion survey taken among those w ho supply equity capital to small business. This
is the most pressing problem area in small-business financing.
Part III
A survey of borrow ers. Th is study is still in the exploratory stage, with completion set fo r 1959.
Interviews will be made with small businessmen to view the adequacy of financing from the borrower's
point of view.
N O T E : C o p ie s o f the re p o rt are a v a ila b le fro m the U . S . G o ve rnm e nt P rin tin g O ffic e , W a sh in g to n 25, D. C . @ $1.50 each. A sk fo r:
Fina n c ing S m a ll Bu sin e ss, a R e p o rt to the C o m m itte e s on Ba nking and C u rre n c y and the S e le c t C o m m itte e s on S m a ll B u sin e ss by the
Fe d e ra l Reserve Sy ste m .
17
business review
business were less affected by monetary restraint
increase. This narrowing spread in rates, how
than were many other lenders. From 1954 to
ever, may have discouraged some banks from
1957, small banks had a relatively greater deposit
lending to small business.
growth and were consistently in a better lending
position than large banks. Big corporations were
Conclusion
heavy borrowers from large banks and, in addi
Small business in general has been holding its
tion, tapped the security markets for greatly
own in the postwar period. It has access to great
increased sums. No doubt a significant portion of
quantities of short and intermediate credit. The
these proceeds was available to small firms in the
supply of long-term credit and loans, however,
form of trade credit. Factors and finance com
seems somewhat less than adequate. In the words
panies also were able to build up their funds for
of Federal Reserve Chairman Martin, this gap
small-business lending.
In one way, monetary restraint has had less
“ may be inhibiting the prosperity and growth of
the nation.”
effect on small than large firms. Interest rates rose
There is strong new support for action to nar
more— both in percentages and absolute amounts
row the gap. Congress is considering some sort
— on loans to large borrowers than on loans to
of “ capital bank” for small business. The details
small borrowers. A survey-to-survey comparison
aren’t worked out yet but most of the proposals
shows an increase of 0.7 percentage points in
provide for Government funds to make long-term
the smallest borrower category versus an increase
loans to small firms. Another possibility
of 1.2 points in the largest. The reason was that
Government action to stimulate the flow of private
usury laws and banking tradition set an effective
ceiling. The typical rates charged small business
— higher at the start of the tight-money period—
soon bumped the ceiling and stayed there while
lower rates charged big business continued to
18
is
investment— perhaps through participation agree
ments,
guarantees,
and
development
credit
corporations.*
* N e x t m o n th 's Bu sin e ss Review w ill contain an a n a ly sis o f Pe n n syl
va n ia 's experience in fina nc ing in d u s t ria l d ev e lo p m e nt.
F O R THE R E C O R D . . .
INDEX
BUSIN ESS
FACTORY PAYRO LLS, D IST.
0949 - 100)
FAC TO RY EM PLOYM ENT, D IST.
(1949 100)
J
•v/—•-
~ V
V
D EPARTM ENT j TORC aALEo, DIoT.
(1947-49-100, SEASONALLY ADI)
A
'"w—~
^ y V \ A
C O NSUM ER PRICES, PHILA.
(1947-49 «100)
♦
2 YE A R S
AGO
_____________________ \
/
YE AR
AC3 0
.
APR.
1958
T h ird Fe d e ra l
Reserve D is t ric t
U n ite d S ta te s
Per cent ch ange
Per cent change
SUM M A RY
A p r il 1958
fro m
4
m os.
1958
A p r il 1958
fro m
year
ago
year
ago
mo.
ago
mo.
ago
year
ago
Fa c to ry *
4
m os.
1958
fro m
year
ago
LO C A L
C H A N G ES
D ep a rtm ent S to re
Check
Paym ents
E m p lo y
m ent
P a y ro lls
Per cent
change
A p r. 1958
fro m
Per cent
change
A p r. 1958
fro m
mo.
ago
year
ago
mo.
ago
Sa es
year
ago
S to c ks
Per cent
change
A p r. 1958
fro m
mo.
ago
Per cent
change
A p r. 958
fro m
year
ago
mo.
ago
Per cent
change
A p r. 1958
fro m
year
ago
mo.
ago
year
ago
O UTPUT
M a n u fa c tu rin g p ro d u c tio n
C o n stru c tio n c o ntra c ts . ..
C o al m in in g ...........................
0
+ 12
— 3
— 14
+27
-3 0
-1 3
-
8
— 27
— 2
+
6
— 11
-1 2
+
4
-2 9
— n
7
-2 2
EM PLO YM EN T AND
IN C O M E
0
0
—
7
— 12
—
7
— 2
-1 0
-
8
+
+
7
1
+
+
4
1
-
3
0
+
1
0
—
+
+
+
+
3
0
+
+
5
7
1
5t
+
+
+
+
4
2
8
5
16
4f
La nc a ster
-
-
1
-1 3
8
... — 1 — 5
— 2
— 17
+
5 +
-
-2 3
+
7
+
9
2
+
+
+
2
2
4
+ 12
+ 2f
— 2
— 7
+
4
P h ila d e lp h ia
0
-
7
-
1
— 9
+
5
Read ing
...
0
— 7
+
4
-1 0
+ 13
Sc ra nton
...
+
7
-1 1 +
1
— 16
+
....
-
4
- II
-1 0
+ 17 -
— 8
— 6
— 15
+
2
-
-
9
+ 14 — 4
+
8
— 1 +
3
+ 11
0
+ 18
+
3
— 2
4
+
+
8
+
7
+
7
+
9
-
2
+
3
+
6
+
+
+
+
0
5
6
2
0
+ 2
+ 12
+ H
+ 16
+ 6
+
+
+
+
+
4
3
7
5
13
4
Tre n to n
-
6
W ilk e s -B a rre . + 16 — 6
+
9
W ilm in g to n
. -
2
— 6
— 2
0
-
+
-
0
+
4
+
3 +
4
+
2
6
+ 10 -
2
3
+
1
+
4
0 +
1
1 — 7
3
................................
................................
6* + 3* +
’ A d ju ste d fo r seasonal v a ria tio n .
3*
f2 0 C itie s
0
0
+
2
4
+
+
{P h ila d e lp h ia
2
3
Y o rk
................
6
2
-
+
1 + 12
PRIC ES
W h o le sa le
C o n su m e r
1
— 4
6
BA N K IN G
+
.
0
— II
TRA D E*
( A ll m e m b er banks)
D e p o sits ....................................
Loans ...........................................
In ve stm e n ts
...........................
U .S . G o v t, se c u ritie s . . . .
O th e r
......................................
Check paym ents ..................
V a lley
F la rris b u rg
Fa c to ry e m p lo ym e n t
( T o ta l)
....................................
Fa c to ry wage incom e . . . .
D e p a rtm e nt sto re sa le s . .
D ep a rtm ent sto re sto c ks .
Le hig h
3
+
0
+ 14
5
-
+
+40
1 +
5
4
* N o t re stric te d to c o rp o ra te lim it s o f c itie s but covers areas of
one o r m ore c o u ntie s.
@FedFRASER