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June 2, 1978

Commercial Paper,
Commercial Banks
Business-loan demand at large moneycenter banks has been unusually weak
in the current economic expansion at least until the last several months.
Why such sluggishness in loan
growth? The answer may lie with the
large national and multinational firms
which do business with the moneycenter banks. To some extent, they
have not had to borrow because of
the strong liquidity positions they built
up during the earlier stages of the recovery. In addition, they have relied
increasingly on alternative sources of
short-term credit - including the commercial-paper market.
This market has become a primary
source of short-term credit to large
corporate borrowers in recent years,
so that it has taken over part of the role
traditionally played by large commercial banks. Of course, it remains a
somewhat limited market. Only highly
rated and widely known corporations
can issue commercial paper, because
of the unsecured nature of these shortterm promissory notes. Still, the market for nonfinancial paper has only recently begun to reach its potential,
because most eligible firms have begun
to use the market as an important
source of funds just within the past
decade.
For these firms, commercial paper became a viable alternative to shortterm bank borrowing during the two
credit
of the late-1960's,
when disintermediation limited banks'
ability to obtain loanable funds. During these episodes, banks actually encouraged their strongest customers to

borrow in the commercial-paper market. This type of borrowing historically
had been less costly than short-term
bank borrowing, yet many corporations had hesitated to use the paper
market for fear of straining bank relationships. Thus, they quickly overcame
their hesitation after their own bankers encouraged them to turn to this alternative form of borrowing.
Borrowers had also been pushed in this
direction by the upward trend in credit-market yields over the postwar peri,,od. This trend had led major
corporations to pursue more sophisticated strategies in managing their
portfolios of financial assets, but it also
made them more conscious of interest-cost differentials in managing their
liabilities. Thus, many eligible firms
came to place emphasis on changes In
relative borrowing costs in deciding
between commercial-paper market or
bank borrowing in the post-credit
crunch" period - see chart.

Cost advantage
While decreases in the relative cost of
paper-market borrowing led to
heavier paper utilization in 1973-75,
business firms have continued to rely
more heavily on the commercial-paper
market despite a somewhat more
competitive prime-rate stance by bank
lenders in 1976-77. A clue to this paradoxical behavior is the fact that the
spread between the prime bank-lending rate and the commercial-paper
rate, while narrowing, is still well
above historical levels. For the highestrated paper issuers, the spread is currently around 11h percentage
(continued on page 2)

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Opinions expressed in this newsletter do not
necessarily reflect the vievvs of the ma.nagement of the
Federal Reserve Ba.nk of Sa.n Francisco, nor of the Board
of Governcv5 01: the Federal Reserve System.

4
points - below the 1 3 -percentagepoint spread of the 1975-76 period,
but far above the 1/3
-percentagepoint average of the 1966-74 period.
Spreads in
years may well have
been well above the threshold which
had attracted heavy reliance on paper
by most companies already in the market. Once spreads rise significantly
above those levels where the shortterm bank balances of these firms
have been reduced to zero or very
low levels, further changes in the
spread will have only a small impact on
short-term financing decisions. Thus, a
decline· 0f,·say, '1h,percentage point- when the spread is above the threshold level will have little impact on the
relative growth in paper and loans,
compared to a 14percentage point
decline when spreads are below the
threshold.

Entryinto the
Nonetheless, the size of the spread in
recent years has stimulated some
growth in commercial paper, as more

and more firms that were eligible to issue paper responded to the strong financial incentive to do so. In 1976, the
number of firms rated by Moody's, the
largest commercial-paper rating service, increased more than -17percent,
compared to very small or negative
growth throughout the 1972-75 period. Actually, the faster entry lagged
about a year behind the widening of
.the bank-paper rate spread, reflecting .
the time required to be rated, as well
as uncertainty over whether spreads
would remain high enough to make
the paper market a worthwhile longrun proposition.
However, further growth of the commercial-paper market through entry
may be somewhat limited because of
the relatively small number of companies qualified to obtain access to the
market. Indeed, 1976 may represent
the peak year for new entrants into
the market. In 1'977,the number of
firms rated by Moody's increased only
about 4 percent, despite the continued
cost incentives created by the wide
rate spread.
An important new factor in recent
years has been the emergence of borrowing by certain foreign firms (especially
utilities) in the commercialpaper market. Foreign issuers, who
apparently borrow very little from
large
commercial banks, have ac-

u.s.

2

Percent

Percent

*Ratio of nonfinancial paper to paper plus (large bank) short-term loans.
**Bank prime rate minus 30-59 day dealer placed commercial-paper rate.

counted for roughly one-third of
nonfinancial paper growth since the
early-1 974 removal of U.s. ontrols on
c
caphal outflows and foreign controls
on capital inflows. Starting from a base
of almost zero, their outstandings reroughly 10 percent of
nonfinancial paper at the end of 1977.
These foreign borrowers have apparently acted in response to the sizable
spread between European bank-loan
rates and U.s. ommercial-paper
c
rates. Thus, their business mainly represents a subtraction from European
rather than u.s.bank loan totals.

Secular shift?
It is difficult to see how the large money-center banks could reduce their
prime rates enough to regain their traditionally dominant role in the shortterm financing of prime-rated
nonfinancial corporations. These firms
are now paying primary attention to
cost considerations instead of bank relationships in their short-term borrowing decisions, as a result of the upward
trend in interest rates in the post-war
period, the bank encouragement of
commercial-paper borrowing in the
earlier credit "'crunches," and the large
rate spread of the past several years.
Banks of course offer intangible services which are not available in the
more impersonal commercial-paper
market. Banks will usually support a

3

good customer when general credit
availability is limited, and they can develop knowledge of customers'
creditworthiness which would be difficult for smaller or regional firms to
generate in the open market. But since
commercial-paper issuers are usually
among the financially strongest and
best-known firms, they generally need
such bank services less than other
firms. And in any case, bank relationships can often be maintained through
longer-term loans, deposit balances
and infrequent use of credit lines.
Today, the bank cost of funds for an
additional loan· is roughly equal to the'
prime commercial-paper yield. To
make profitable loans, banks must add
mark-ups for variable operating costs
and reserve requirements - perhaps
more than 1 percentage point for
J2
the latter factor alone. In view of these
and other considerations, the mid1970's may have witnessed a secular
(rather than cyclical) shift in the shortterm financing patterns of prime-rated
nonfinancial corporations.

JohnP. Judd

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BANKING OATA- TWELFTHFEDERAL
RESERVE
DISTR.ICT
(Dollar amounts in millions)
Selected Assets and liabilities
Large Commercial Banks

Amount
Outstanding

Change
from

Change from
year ago
Dollar
Percent

5/17178

5/10178

Loans(gross, adjusted) and investments*
Loans(gross, adjusted)- total
Security loans
Commercial and industrial
Realestate
Consumer instalment
U.s. reasury securities
T
Other securities
Deposits (lesscash items)- total*
Demand deposits (adjusted)
U.s. overnment deposits
G
Time deposits- total*
States and political subdivisions
Savingsdeposits
Other time depositst
Large negotiable CD's

111,067
88,870
2,098
27,150
29,753
15,581
8,107
14,090
107,546
28,938
327
76,489
7,132
31,541
34,885
16,688

+ 246
+ 747
+ 220

Weekly Averages
of Daily Figures

Week ended

Week ended

5/17/67

5/10178

Member Bank Reserve Position
ExcessReserves( )/Deficiency (-)
+
Borrowings
Net free(+ )lNet borrowed (-)
Federal Funds-Seven Large Banks
Interbank Federal fund transactions
Net purchases(+)/Net sales(
-)
Transactionswith u.s.security dealers
Net loans (+)lNet borrowings (-)

-

+
+

-

-

-

+

-

+
+
+

7
199
50
119
382
156
555
97
474
151
52
460
486

+
+
+
+
+
+
+
+
+

+ 15.31
+ 19.42
+ 6.93
+ 14.14

14,746
14,455
136
3,363
6,398
2,940
423
714
13,185
2,641
98
+ 10,640
+ 1,268
- 423
+ 8,667
+' 7,351

+

27.39

-

23.06

+ 23.26
- 4.96
+ 5.34
+ 13.97
+ 10.04
+ 16.16
+ 21.62

-

1.32

+ 33.06
+ 78.73

Comparable
year-ago period

8
50
-58

+

54 .
148
94

+

367

+

903

-

271

+

120

+

427

+

42

6
4
10

*Includes items not shown separately. tlndividuals, partnerships and corporations.
Editorial
may be addressed to the editor (William Burke) or to the author ••••
Information on this and other publications can be obtained by calling or writing the Public Information
Section, federal Reserve Bank of San Francisco, P. O. Box 7702, San Francisco 94120. Phone (415) 544-2184.