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For Release on Delivery
10:0(3 a.m. EST
March 17, 1994
Testimony of
John P. LaWare
Member. Board of Governors of the Federal Reserve Syst
Before the
Committee on Small Business
of the
United States House of Representatives
March 17. 1994
Introductory Remarks
Mr. Chairman,
I am pleased to be here this morning
to discuss regulatory and other initiatives designed to
stimulate bank lending, especially to small businesses, and
to comment on recent trends in business lending activity.
A
review of these issues seems quite appropriate at this time.
In recent months, the economy has displayed increasing
evidence of underlying strength, accompanied by rising
demands for credit by households and businesses'.
As these
trends continue, we believe that initiatives taken in the
regulatory arena will help facilitate the lending process
for creditworthy small businesses.
I will begin my remarks this morning by reviewing
some of the key initiatives that have been taken in the past
year and their status, and follow with a look at recent
financing trends and the need for additional -initiatives.
You also asked for my views on the adequacy of bank
Call Report data on small business lending; I will comment
on the Call data at the end of my statement and also bring
to yoiir attention the survey of Small business finances that
the Federal Reserve currently has underway.
We believe the
survey, which is being co-sponsored by the Small Business
Administration, will provide important information fos.?
assessing credit availability for small businesses.
-2-
Recent
S u p e rv is o ry
P o lic y
In itia tive s
Last spring, the Administration,
the Federal
Reserve and the other federal banking agencies
("agencies")
announced a series of initiatives to reduce regulatory
impediments to the availability of credit to small- and
medium-sized businesses and farms, other businesses,
individuals.
and
These initiatives were a continuation of
ongoing interagency efforts to ensure that examiners
evaluate bank lending activities in a consistent,
prudent,
and balanced manner.
One of the most important initiatives involves a
proposal to revise the agencies’ requirements for real
estate appraisal by certified or licensed appraisers in ways
that would reduce costs to banks and their customers.
Such
appraisals, which relate to a requirement of Title XI of
FIRREA, would be required less often under these revised
rules.
To implement this initiative, rules were issued for
comment last year and approved by the Board on March 9th.
These rules do three things:
(1) they increase the threshold
amount for which such appraisals are required from $100,000
to $250,000;
(2) they expand the "abundance of caution"
exemption for business loans, so that an appraisal would not
be required when the value of real estate taken to
collateralize a loan is not material to the decision to make
the loan; and (3) they exempt from apipraisals business loans
of less than $1 million, where the principal source of
-3-
repayment is not the sale of or income from the real estate
held as collateral.
Loans secured by real estate are an important
source of credit for many small and mid-sized businesses.
Thus, eliminating the requirement to obtain an appraisal in
the cases just specified should work to their clear
advantage by reducing costs.
At the same time, such
exemptions will not erode the safety and soundness of the
lending institutions.
Other actions taken by the agencies to facilitate
small business lending include a new policy that permits
qualified banks to set aside a portion of their smallbusiness loan portfolios.
The selected loans will be
evaluated by examiners only on the basis of their
performance and not on the level of loan documentation.
This change is intended to encourage loans to smaller
businesses that banks believe to be creditworthy based, for
example, on the borrower’s past credit experience or the
b a n k ’s general knowledge of the customer, but where strict
adherence to traditional documentation standards and
procedures might make the loan too costly.
The agencies also have issued numerous statements
in the past year, the intent of which has been to clarify
supervisory policies and reporting requirements^
These
statements deal with a variety of issues related to the
treatment of troubled real estate loans, sales of foreclosed
-4properties, restoration of problem loans to performing
status, and the interagency framework for assessing loan
quality.
In designing each of these initiatives, the
agencies have sought to remove impediments to- bank lending
that might occur: owing to -unnecessary' costs and supervisory
burdens.
Thus, às the economy develops momentum and as
underlying demands for credit pick up, these actions will
help ensure that credit decisions of lenders and borrowers
are not unduly discouraged by costly appraisal and
documentation procedures or by a misunderstanding of
examination policies.
Trends
in
B u siness
Fin a n cin g
A c tivity
Ultimately, however, the major determinant of
business credit use and availability is not régulations or
supervisory policies, but underlying economic and financial
forces.
In this regard, we are beginning to see evidence
that business lending has picked up, including small
business lending.
Indeed, in recent quarters,
incoming data
on the economy and credit flows have revealed appreciable
underlying strength.
Let me briefly review some recent
trends that are setting the stage for bank credit growth
this year.
Through much of 1993, overall business demands for
credit remained quite weak.
In the aggregate, nonfinancial
businesses largely used internal funds to finance growing
-5outlays for fixed capital and inventories and continued to
focus efforts heavily on balance sheet restructuring. When
external financing was needed, it was concentrated in
capital markets, spurred by continuing declines in bond
rates and a strong stock market.
Many firms used proceeds
from new security offerings to pay down bank loans. Such
paydowns were an important factor contributing to the
continued weakness in total business loans at banks last
year.
The favorable interest rate environment and the
restructuring activity of firms have produced a much
healthier business sector.
markedly.
Debt service burdens have fallen
Equity cushions seem to have moved to more
comfortable levels.
Indicators of financial stress,
including loan default rates and bankruptcy filings, have
dropped well down from peaks of recent years.
have charted marked improvements.
Banks also
Equity capital climbed to
nearly 8 percent of assets last year, buoyed by record
earnings, and the share of troubled assets on the books of
banks dropped to its lowest level since 1986.
As banks have become more assured of their own
financial health and that of their customers, their
willingness to lend has grown.
We observed on Federal
Reserve surveys last year a consistent easing of terms and
standards on business and consumer loans as the year
progressed--a trend that has continued in the new year.
The
-6-
easing appears to have been more substantial for large
firms, but respondents also have eased standards for small
firms.
The reporting banks attributed this easing to the
improved economic outlook and their own strong capital
positions.
Moreover, although growth of total business loans
was held down last year by restructuring activity of big
firms, we began to see signs of a pick-up in lending to
small firms.
The new Call Report data on small business
loans provide some evidence of this.
I have included in my
testimony a set of tables derived from the new Call Reports.
These tables show the breakdown of outstanding loans by size
of loan and by size of bank, for different categories of
business and farm loans.
Although the relationship between
the size of the credit arrangement that a bank has with a
business customer and the size of the customer’s assets or
sales is not precise, our surveys and examiner experience
suggest
there is a strong positive correlation.
Thus, we
feel comfortable in assuming that most of the small loans
reported by banks are to small businesses.
More than 6,000 banks indicated on the June Call
that "virtually all" of their loans to businesses were less
than $100,000 in size.
We singled out these banks to see
what had happened to their lending last year.
We found
that, while aggregate business loans were running off last
year, this subset of banks maintained and increased their
-7-
lending to small customers.
[These figures are shown in
Table 3.]
More generally, in the first two months of this
year, growth of business loans at all domestic banks has
strengthened.
Total commercial and industrial loans
increased at an average annual rate of 7.5 percent in
January and February.
officers,
In the latest survey of bank lending
respondents indicated that the demand for loans by
businesses has firmed, largely reflecting increased needs to
finance inventories and investment in plant and equipment.
These signs of a greater willingness to borrow and
spend on the part of businesses are quite encouraging.
Moreover, banks, which are better capitalized and more
liquid than they have been in a long while, appear to be
able and willing to meet the rising credit demands.
In this
environment, I believe that the recent initiatives taken in
the supervisory area will help to facilitate new lending,
particularly to smaller borrowers.
Need for Additional Initiatives?
You asked my opinion about the need for additional
initiatives.
In this regard, I view the steps that have
recently been taken as an ongoing part of the supervisory
process.
This process is never complete.
Regulators always
have to remain vigilant to possibilities for reducing
burdens and making the supervisory process more efficient.
We must guard against implementing new policies that might
-8unnecessarily impede the lending process.
We also must be
aware of special situations, such as those resulting from
the California earthquake, when there may be a need to ease
standards temporarily.
And, while supervision alone can play only a
limited role in spurring aggregate lending, there is scope
for the Congress and the agencies to work together to foster
an environment for banks that will allow them to make sound
loans and to compete efficiently in financial markets.
Important in this regard are the initiatives now before
Congress related to interstate banking and broader powers
for banks.
Adequacy of Call Report Data on Small Businesses and Farms
Let me conclude by commenting on the adequacy of
data for assessing credit availability to small businesses.
In particular, you have asked about the new data we now
collect on the Call Reports.
The new Call Report data are a
good, albeit not perfect, measure of bank lending to small
businesses.
We believe that their usefulness as an
indicator of trends in bank credit flows to small borrowers
will increase each year as we collect more observations, and
the data will be a valuable supplement to information we
gather from other sources.
Our experience with the data reported for the first
time in June revealed, as might be expected, a number of
reporting problems that needed to be resolved. Consequently,
-9the staffs of the relevant agencies have made a number of
changes to the reporting instructions designed to clarify
definitions and improve the quality of the reported
statistics.
The agencies, however, did not see the need to
add items to the report or to collect information by size of
borrower instead of size of loan for several reasons.
It would be extremely costly for most banks to
provide loan data by size of "business" because their
records--especially automated records--do not group loans in
this way.
We recognized that any particular definition of
small business that we selected might not be easily
available to all reporting institutions nor would it be
appropriate for all analytical purposes.
Moreover, Call
Report data, whether by size of loan or borrower, will not
yield a comprehensive enough view to evaluate the adequacy
and risks of small business financing.
For example, we
would need information on items such as: price and nonprice
terms of business loans; personal or credit card loans that
are used for business purposes; risk characteristics of the
borrower and the firm’s access to capital; and the cost and
availability of credit from nonbank sources.
The Federal Reserve knows that banks play an
important role in supplying credit and other financial
services to small businesses, and we have a strong
commitment to better understanding how the financing needs
of these businesses are being met.
It is for this reason
-10-
that we are now undertaking an extensive survey of 6,000
small businesses,
businesses.
including 1,200 minority-owned small
The survey will gather information on
characteristics of the business firms and their owners, on
their income flows and balance sheets, on their use of
financial services and credit sources, and on their recent
borrowing experiences.
I have with me the questionnaire
developed for that survey.
I think it is apparent from the
size of this document that the information we hope to gain
from this survey would be impossible to collect on the Call
Report.
Summary Remarks
Finally, let me summarize my remarks this morning
by saying that the Federal Reserve recognizes the highly
important role that small business firms play in the economy
and the need to promote the flow of credit to these firms.
We intend to continue to seek ways, consistent with safety
and soundness standards, to achieve this objective.
Table 1
BUSINESS LOANS AT U.S. COMMERCIAL BANKS
Amount Outstanding as of June 30,1993
Asset size of bank
(Millions of dollars)
Original amount
of loan or line
of credit or
commitment
(Thousands of dollars)
<$100
$100
to
$300
$300
to
$1,000
$1,000
to
$5,000
>$5,000
All banks
Commercial and industrial loans
(Billions of dollars)
21.8
17.7
10.7
9.6
17.6
77.4
Greater than $100 thru $250
3.2
4.5
4.3
5.5
8.6
26.1
Greater than $250 thru $1,000
3.7
7.6
9.0
12.9
22.2
55.4
Greater than $1,000
£L2
M
12.2
45.0
213.1
275,6
29.6
34.2
36.2
73.0
261.5
434.5
$100 or less
Total C&I loans
Loans secured by nonfarm, nonresidential properties
( Billions of dollars )
15.7
14.4
6.8
4.4
5.0
46.2
Greater than $100 thru $250
3.8
5.3
4.4
5.1
7.2
25.8
Greater than $250 thru $1,000
6.4
11.8
11.7
14.2
21.6
65.7
Greater than $1,000
12
5A
12.7
28.8
74.8
123.2
27.2
37.0
35.6
52.5
108.6
260.9
$100 or less
Total nonfarm, nonres. loans
Source: Call Reports
Table 2
BUSINESS LOANS AT U.S. COMMERCIAL BANKS
Percent Distribution as of June 30,1993
Original amount
of loan or line
of credit or
commitment
(Thousands of dollars)
Asset size of bank
(Millions of dollars)
<$100
$100
to
$300
$300
to
$1,000
$1,000
to
$5,000
>$5,000
All banks
Commercial and industrial loans
(Percent)
$100 or less
73.7
51.8
29.5
13.2
6.7
17.8
Greater than $100 thru $250
10.8
13.2
11.9
7.5
3.3
6.0
Greater than $250 thru $1,000
12.5
22.2
24.9
17.7
8.5
12.8
XÛ
12.8
33.7
61.6
81.5
63.4
100
100
100
100
100
100
Greater than $1,000
Total C&I loans
Loans secured by nonfarm, nonresidential properties
(Percent)
$100 or less
57.7
38.9
19.1
8.4
4.6
17.7
Greater than $100 thru $250
14.0
14.3
12.4
9.7
6.6
9.9
Greater than $250 thru $1,000
23.5
31.9
32.9
27.0
19.9
25.2
M
14.9
35.6
54.9
68.9
47.2
100
100
100
100
100
100
Greater than $1,000
Total nonfarm, nonres. loans
Source: Call Reports
Table 3
GROWTH OF BUSINESS LOANS A T U.S. COMMERCIAL BANKS
W ITH MOSTLY SMALL LOANS
Type of Loan
Year
Total
business
Commercial
and
industrial
Nonfarm,
nonrcsidcntial
real estate
Coastruction
and land
development
Amount outstanding, year—end
(Billions of dollars)
1989
59.5
32.2
21.1
6.2
1990
62.6
33.4
23.1
6.1
1991
63.1
32.0
25.3
5.8
1992
64.9
31.7
27.4
5.8
1993
71.3
33.7
30.7
6.9
Percent change, December to December
1989
6.6
3.6
13.3
1.7
1990
5.2
3.7
9.5
-1.3
1991
1.0
-4.1
9.8
-4 .7
1992
2.7
-.9
8.1
- .6
1993
9.9
6.2
12.0
20.4
7.4
4.8
14.8
9.8
13.6
9.8
29.4
1993 III lauiual utle)
112 (annualrate)
12.0
1. Banks arc those that reported on the June 30, 1993, Call Report that virtually all their business loans were in amounts of, or under
lines of credit or commitment of, less than $ 100,(KX). The number of such banks totaled 6,389. About 3(X) of these banks are excluded
from the above calculations because they were not in operation four years prior to 1993.
Source: Call Reports
Table 4
FARM LOANS AT US. COMMERCIAL BANKS
Amount Outstanding as of June 30,1993
Asset size of bank
(Millions of dollars)
Original amount
of loan or line
of credit or
commitment
(Thousands of dollars)
<$100
$100
to
$499
$500
to
$4,999
>$5,000
AH banks
Loans secured by farm real estate
(Billions of dollars)
$100 or less
8.56
3.58
0.79
0.30
13.23
Greater than $100 thru $250
1.27
1.00
0.41
0.25
2,93
Greater than $250 thru $500
0.59
0.63
0.33
0.26
1.82
Greater than $500
0-21
0.49
0.64
1.27
2.61
10.64
5.70
2.17
2.08
20.59
Total
Farm production loans
( Billions of dollars )
15.89
5.25
1.54
0.70
23.38
Greater than $100 thru $250
1.51
0.92
0.54
0.44
3.41
Greater than $250 thru $500
0.77
0.61
0.41
0.45
2.25
Greater than $500
0.41
0.60
1.60
3.73
6.34
18.58
7.38
4.09
5.32
35.38
$100 or less
Total
Source: Call Reports
Table5
FARM LOANS AT U.S. COMMERCIAL BANKS
Percent Distribution as of June 30,1993
Asset size of bank
(Millions of dollars)
Original amount
of loan or line
of credit or
commitment
(Thousands of dollars)
<$100
$100
to
$499
$500
to
$4,999
>$5,000
All bant
Loans secured by farm real estate
(Percent)
$100 or less
80.5
62.8
36.4
14.4
64.3
Greater than $100 thru $250
11.9
17.5
18.9
12.0
14.2
Greater than $250 thru $500
5.6
11.1
15.2
12.5
8.8
Greater than $500
2J1
M
29.5
61.1
12.7
100
100
100
100
100
Total
Farm production loans
(Percent)
85.6
71.1
37.7
13.2
66.1
Greater than $100 thru $250
8.1
12.5
13.2
8.3
9.6
Greater than $250 thru $500
4.1
8.3
10.0
8.4
6.4
Greater than $500
22
M
39.1
70.1
17.9
100
100
100
100
100-
$100 or less
Total^
Source: Call Reports
Table 6
GROWTH OF FARM LOANS AT U.S. COMMERCIAL BANKS
W ITH MOSTLY SMALL FARM LOANS 1
Type of Lo;m
Year
Total
larrn
Farm
production
Secured by
farm
real estate
Amount outstanding, year—end
(Billions of dollars)
1989
20.5
13.0
7.5
1990
22.2
14.1
8.1
1991
23.8
15.1
8.7
1992
25.1
15.6
9.5
1993
27.4
16.9
10.5
Percent change, December to December
1989
7.0
6.3
8.3
1990
8.1
8.2
7.9
1991
7.5
7.5
7.6
1992
5.2
2.8
9.2
1993
9.1
8.4
10.3
1993 HI (annualram)
112 (annual rale)
9.6
8.4
8.0
8.6
12.2
8.0
1. Banks arc those that reported on the June >0. 1993. C all Report that virtually all their farm loans were in amounts of, or under lino«
of credit or commitment of, less than SUM),(MX). The number of such banks totaled 7.90.S. About 575 of these banks are excluded ftom the
above calculations because they were not in operation four years prior to 1993.
Source: Call Reports