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For release on delivery

Statement by

Jeffrey M. Bucher

Member, Board of Governors of the

Federal Reserve System

before the

Subcommittee on Financial Institutions

of the

Committee on Banking, Housing and Urban Affairs

U.S. Senate

July 31, 1974

Mr. Chairman and members of the Subcommittee, 1 am
pleased to have the opportunity to present the view of the
Board of Governors on proposals to authorize national banks,
Iedera 1ly-insured banks and savings and loan associations to
charge their corporate borrowers interest rates that reflect
current market conditions.
The Board has been concerned for some Lime with the
impact which usury ceilings have on the availability of funds
in local credit markets.

1L goes without, saying that no one

wants to pay higher rates of interest for borrowed money than
is absolutely necessary.

But at the same time, it is


important to insure the availability of credit and the flow of
funds in all financial markets on an equitable basis.


inLerest rates in specific* markets are limited to artificially
low levels, the continued availability of credit in these markets
will be severely threatened.

Under such circumstances, lenders

are likely to impose much stricter non-price lending terms in
order to compensate t'cr the relatively low nominal rates which
can bo charged.

And borrowers, finding it increasingly difficult

to obtain financing in local markets, may be forced to seek funds
from out of State sources.
There is no question but that the potential for dis­
ruption of credit flows in States with relatively low usury
ceilings has increased greatly in recent months due to the general

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increase of interest rates in competitively-determined markets.
Large commercial banks have been paying rates of 12 per cent or
more on large certificates of deposits in recent weeks in order
to obtain loanable funds.

These rates exceed by as much as 2

percentage points the maximum rates that banks are allowed to
charge on loans to businesses in several States — including Tennessee,
Arkansas and Montana.

Since July, moreover, the prime rate charged

by large money market banks to their best corporate customers has
been at 12 per cent--also above the usury ceiling on business
loans in the aforementioned States.

It is reasonable to assume

that many of the lending institutions in these States are finding
it unattractive to lend at the relatively low usury rate, and
since they cannot afford to compete effectively for money market
funds, these institutions will find it increasingly difficult to
continue to accommodate local credit needs of these conditions persist.
Ou.r information— although limited--does indicate a noticeable
slowdown in business lending at some of the larger banks in Tennessee
and Arkansas in the last two months.

In late April, the national

prime rate rose above the 10 per cent usury ceiling that prevails
in these two States, and in May and June commercial and industrial
loans at 12 of the large Tennessee and Arkansas banks (the only
regional banks for which we have current data) declined by approximately
5-1/2 per cent.

This decline contrasts with experience in the comparable

months of previous years, when loans at these banks generally increased;

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and it contrasts especially with the continued substantial
expansion this past spring in business loans at other large
banks around the country.

1L might also be noted that in the

last few weeks Federal funds— which are overnight loans sold by
one bank to another— have traded at rates above 12 per cent.
Thus, there is some temptation for banks in States like
Tennessee, Arkansas, and Montana to sell Federal funds or to
direct their money into other more attractive investments,
rather than to lend to local borrowers at the 10 per cent
ceiling rate.
Because of distortions such as these that result from
artificially low rate limitations, the Board strongly encourages
efforts to reduce the restraints imposed on local credit markets
by usury ceilings.

We would prefer that remedial action to correct

these inequities be undertaken at the State level, and in this
regard we believe that States should promptly reevaluate
usury laws in light of recent experience.


We understand, however,

that in some States this is a constitutional problem which may
require considerable time to resolve.

In view of this, and given

the urgency of the problems developing in some markets currently,
the Board supports the emergency measure proposed by S.3817 as a
means of providing some relief to these markets.

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The Board has reservations about two specific items in
the pending bill.

First, we strongly urge that the maximum loan

rate which institutions will be allowed to charge not be tied to
the Federal Reserve discount rate.

As you are aware, the discount

rate is a policy rate, administered by the Federal Reserve for
monetary policy purposes.

It is not a market-determined rate, and

at times may not move in parallel with market rates.
Instead the Board would advise that the loan rate be
tied to a market-determined interest rate, one which more clearly
responds to changes in credit market conditions.

We suggest for

this purpose the rate paid on 90-day Treasury bills, and specifically
the average rate paid over the preceding month or quarter on such

The bill rate is published weekly and is a familiar rate to

lending institutions.

If the loan rate were tied to such a market

rate, then adjustments would be made automatically to changing market
conditions, whereas this might not necessarily be the case if the base
rate used were the discount rate.
The second concern which the Board has with the proposed
bill is that the legislation would apply only on loans to corporations
and would exclude all noncorporate borrowers.

For equity reasons the

Board believes that the bill should be expanded to cover all loans for
business purposes.

Indeed, if lending institutions are allowed to

charge higher rates on loans to corporations, we can foresee sharp

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diminution in the availability of credit for unincorporated

Available funds will be channeled into higher

yielding corporate loans, and credit which is already scarce for
other borrowers could become virtually unavailable.

And, as a

side effect, we would probably see many partnerships and pro­
prietorships incorporating in order to obtain financing.


has reportedly occurred in Missouri, a state with a relatively
low usury ceiling from which only corporate borrowers are exempted.
With the inclusion of the above two modifications--i.e .,
tying the loan ceiling to a market rate and not the discount rate,
and expanding the coverage to all business loans, not just corporate
loans— the Board favors the proposed legislation as a productive
and desirable emergency measure that should help to ease dispro­
portionate credit contraints in certain local markets.