undoubtedly represent extensions of credit to small business. There is also evidence that commercial banks are tailoring their loans to meet the borrower's needs. The number of term loans is increasing; their repayment is geared to earnings after taxes and reflects projected debt repayment ability from depreciation and amortization accruals. Although the commercial banking mechanism may be deficient in some respects and can be improved, perhaps the most convincing arguments in support of stimulating the greatest possible use of private credit as opposed to increased direct lending is available in a letter of the Board of Governors of the Federal Reserve System dated December 18, 1944, to the Honorable James E. Murray, chairman of the Special Committee of the Senate To Study Problems of American Small Business, from which I quote in part: "*** Although the liquid resources of business as a whole, including small business, have increased greatly during the war, there will be enterprises that must resort to credit in order to accomplish their individual reconversion and readjustment. The credit needs of a substantial number of these can be met by the banks in the form of regular bank loans. The Board believes, however, that in many cases the financial needs of worthy enterprises, particularly during the reconversion period, will represent degrees of credit risk that banks ordinarily should not be expected to assume. "The desired extension of the credit area to cover these situations may be brought about either by encouraging the private banking and credit system of the Nation to perform the task or by further expansion and innovations in direct lending by the Government. The Board emphatically favors the former course. "The Board recognizes that whenever private credit appears to be restricted or otherwise inadequate pressure for increased Government lending is inevitable. However, no expansions of Government activity in the field of credit should be permitted unless and until it is clearly demonstrated that the private financial system is either unable, or able but unwilling, to do the job. The supply of funds today in the hands of the private banking system is abundantly adequate for all demands of reconversion and readjustment of business. Bankers are actively seeking outlets for increased commercial and industrial lending. The Board believes that as long as private enterprise in finance can and will do the work, it should be encouraged and aided in doing so." "The foregoing are the general views of the Board as it sees the problem at this time and on the basis of information available to it. The discussion has been limited to the credit needs of small business, as specified by your letter. The Board wishes, however, to emphasize its view that the problem of small business cannot be met satisfactorily by pumping out more and more credit. Programs in other fields would have greater importance. Chief among them would be a modification of the corporation income tax giving substantial and preferential advantages to smaller corporations and to new ventures. This would encourage the flow of equity capital to such enterprises and correspondingly reduce the need for credit not obtainable from banks on the usual basis. Another aid to small business would be a provision for better access to industrial research and the use of patents. In the opinion of the Board, such measures would be much more effective in maintaining the competitive position of small business than any of the current proposals to provide more credit through some form of governmental assistance." It can be argued : First, that this point of view was of a previous Board whose philosophy was not akin to that in office today, and Second, that the Board's recommendations in 1945 were in anticipation of "the immediate and temporary problems of war contract termination * the renewal and resumption of civilian operations of every type including increased lending activities of the smaller banks * * * a need of every form of business and industrial financing by small war plants whose expanded borrowings have been guaranteed by war agencies but who must approach their banks for financing during a period of uncertain changes with wartime guaranties continued." In reply, I am confident that the Federal Reserve Board, the Federal Advisory Council, the boards of the individual Federal Reserve banks, and members of their industrial advisory committees, if polled, would not be in favor of encouraging the trend toward multiplication of Government credit agencies with its inherent threat to our private banking system, which passage of the Small Business Act of 1957 would involve. In further reply to those who would object to my flashback to the uncertain economic backdrop of 1945, are not many firms today facing cutbacks or cancellations of Government contracts? Are not the profit margins of many businesses very insecure? Are we not actually in a very uncertain period when business, large and small, is facing its private bankers, who are doing a magnificent job of helping industry carry staggering inventories and receivable requirements compounded by the inflation? Is not small and large business and its bankers continuing to face up to the terrific and perhaps impossible problem of financing new plants with old depreciation dollars, after 30-percent and 52-percent income taxes, which virtually eliminate the possibilities of expansion from retained earnings? I am certain that the Federal Reserve Board today does not forecast the future as less uncertain than in 1945 (or for that matter with any less degree of accuracy either) nor do I believe that the Board would say that the period ahead is one in which a Government credit agency might be expected to do a job for which private banking was incapable or for which Government was better fitted. It is in the light of this reasoning that I recommend against passage of the principal lending sections of the Small Business Act of 1957. II. Your committee is urgently requested to amend the Financial Institutions Act of 1957 if and when it reaches conference committee, as follows: In place of revoking existing authority of the Federal Reserve banks to make loans direct to industry under section 13 (b), the bill should be amended to authorize the Federal Reserve banks to guarantee financing institutions against loss on loans made to business enterprises or to make commitments to purchase such loans from commercial banks. The percentage of the loan to be guaranteed would vary with specific cases, but in no case would it exceed 80 or 90 percent. Arguments used in support of repealing section 13 (b) were: (a) From the testimony of C. Canby Balderston, vice chairman of the Federal Reserve Board, in 1955: 1 66 * section 13 (b) of the Federal Reserve Act which authorizes the Federal Reserve banks to make loans for working capital purposes to establish businesses when credit is unavailable on a reasonable basis from usual sources * * * was put into our Federal Reserve Act during the depression of the 1930's and has now largely accomplished the purpose for which it was enacted. Therefore, the Federal Reserve would favor its repeal now. Such repeal would release to the Treasury some $27 million which has been tied up in connection with section 13 (b)." (b) Quoting from Senate Staff Report No. 121, 85th Congress, 1st section, Financial Institutions Act of 1957: The section 13 (b) "provisions * * * which were first enacted in 1934 authorized the Federal Reserve banks to make working capital loans and commitments to established industrial or commercial businesses. This authority has been utilized very little in recent years and in any event appears to be inconsistent with central banking functions." (c) Quoting from the statement of J. L. Robertson, member, Board of Governors, Federal Reserve Board, in hearings Study of Banking Laws, part II, page 854: "The bill would have the effect of repealing the present authority of the Reserve banks under section 13 (b) of the Federal Reserve Act to make working capital loans and commitments to business enterprises. The repeal of this authority which has been utilized very little in recent years would be in accord with the position heretofore taken by the Board in this matter." From the above, it is apparent that no case was made for retention or modification, improvement, and extension of section 13 (b) direct lending or loan-guarantee authorities. In support of preserving this vital function of the Federal Reserve banks, I submit that: Mr. Balderston's statement is not borne out by the facts set forth in exhibits A-1 and A-2. These offer conclusive proof that section 13 (b) lending authorities have served very important purposes, which may be ever-recurrent. Note the need for credit: In 1938, a short-lived but severe period of economic recession And in 1940 more of the same In 1941-43, the early war years 1 Before Subcommittee on Small Business of the Senate Committee on Banking and Currency, May 11, 1955, in connection with Senate bill S. 381 which proposed appropriating surpluses from Federal Reserve banks for the purpose of establishing loan insurance funds and organizing investment companies. And again in 1950-51, the Korean war period In 1952, when we again experienced a brief recession In my opinion, we may expect to experience again similar periods of demonstrated need for section 13 (b) credit. Whether or not such circumstances were or were not in keeping with congressional intent when these provisions were enacted is a matter of speculation. There can be no argument that these powers have and can continue to be used. The committee's and Mr. Robertson's justification for discarding the authority because "it was little used in recent years" overlooks: (a) An important and increased use during the recent years 1951 and 1952. (b) The presence of peak prosperity years as the obvious cause of little use in the more recent years 1954-56. With this must be coupled the obvious fact (which may be borne out by a questionnaire sent the 600 banks in the 10th Federal Reserve District) that the banking industry's lack of knowledge of these lending powers and the absence of pressing need contribute substantially to their lack of use at this time. References to section 13 (b) on the Senate floor contained in the Congressional Record of March 21, 1957, page 3644, state that section 13 (b) was passed prior to the passage of the RFC. The further implication was that direct lending by a Government agency supplanted the private lending functions of the commercial banks in conjunction with the Federal Reserve banks. The facts are that RFC commenced making loans in 1930 and its liquidation was commenced several years ago. It was not Congress' thought that the RFC was a substitute for section 13 (b). Senatorial comment when the bill was being debated included a statement that section 13 (b) was only used four times in 1956, which was correct. The state ment was also made that "in the course of 25 or 26 years, it has rarely been used." This was obviously in error. The bill was passed 23 years ago and over 3,700 commitments were made, comprising three-quarters of a billion dollars of loans. Such is hardly "rare use." From the floor discussion it was also suggested that a "disaster fund" in the Department of Agriculture and loans available by the present Small Business Administration would handle any lack of credit otherwise available to business through its local bank with a 13 (b) Federal Reserve bank participation. This thinking is deplorable and tends to confuse direct grants for disaster relief and subsidy payments by the Federal Government with the extension of sound loans by the private banking mechanism in the absence of the usual sources of credit to businesses whose continued operation is vital to the economic life of a community. The committee's attention is invited to several other most vital and significant "qualities" of Federal Reserve banks section 13 (b) credit. Please refer to exhibits B which sets forth loan data in the 10th district during the period 1946-56. 1.The nine loans made were to relatively small businesses, measured in terms of number of people employed by the borrower. 2. Measured in the terms of size of credit, only 2 of the 9 loans made were under $250,000 and thus classified in the so-called small business category. 3. Your committee's attention is again invited to both exhibits A-1 and B-1 as evidence of the fact that the commercial-bank participants in 13 (b) commitments were not ducking the risk. Further investigation will undoubtedly prove that losses sustained have been small. This is confirmation of the fact that each 13 (b) recipient of credit had to demonstrate that it was creditworthy and his proposition sound. 4. Measured in terms of potential economic hardship to which the employees, their families, and the communities would have been exposed had these loans not been made, the story is quite different; losses to society would have been substantial. If the reserve bank is required to submit to your committee the flesh and blood statistics on a national scale reflecting the number of employees and size of the town to which the borrower were located, I am confident that you gentlemen will approve this proposal to amend S. 1451 and provide for continuance and extension of loan-guaranty authorities of the Federal Reserve banks of this country. 5. Inflation has cut the lending limits of all individual banks in this country and thus increased the need for commercial bank loan participation outlets. 6. National and member banks are at a further disadvantage in Kansas and in other States in that their cash reserves by law are lodged with Federal Reserve banks and therefore unavailable as a source of profit to correspondent banks. Consequently, these banks have a limited leverage when it comes to placing with a correspondent the excess portion of a somewhat risky or problem loan to a company whose continued existence is dependent upon bank credit and whose continuance in business in your hometown may be vital to your bank and to your community. Thus the need for access to credit participations with the Federal Reserve banks. The third reference above held that section 13 (b) "appears to be inconsistent with central banking functions" Frankly, gentlemen, I do not know what these are. But may I again quote from the Federal Reserve Board's letter of December 18, 1944, which was in respect to the Wagner-Spence bill. This bill embodies principles which the Board considers sound. It abolishes the direct lending features of section 13 (b) of the Federal Reserve Act and, without additional congressional appropriation, extends and makes more workable a loan-guaranty mechanism by which the private banking system could meet more fully the credit needs of business and industry. The "Arguments in behalf of this bill have already been presented by Chairman Eccles to the Senate and House Committees on Banking and Currency. arguments in favor of the bill, as changed by three limiting amendments suggested by the chairman in the hearings, may be summarized as follows: "The bill would encourage a greater flow of funds from the private banking and credit system into those marginal credit risks which banks would not assume without a guaranty. "All loans would originate with banks or other private financing institutions. Amounts, terms, collateral, and other details of proposed loans would be worked out between the borrower and the financing institution to which he applies. Thus the operation of the plan would be decentralized throughout the United States. "Credit extensions in the marginal area of risk would be encouraged by guaranties up to 90 percent of those loans on which banks may desire guaranties. The lender would share in the risk to the extent of 10 percent or more, which would be a sufficient exposure to prevent lending institutions from involving the guaranty fund in careless or excessive credit hazards. "No new appropriation would be required. An appropriation made by Congress in 1934, amounting to $139 million would be adequate to guarantee a total of more than $500 million of loans outstanding at any one time. "The benefits of the guaranty would go primarily to the smaller units of business and industry. For the small businesses that are regarded by bankers as marginal or debatable credit risks, the guaranty would be the deciding factor in establishing their credit. Term lending, in which the risk factor is generally higher, would be especially encouraged. "The plan would be administered by experienced personnel in the Federal Reserve banks who are administering the V-loan and T-loan programs, a similar credit mechanism. Financing institutions are already familiar with services of the Federal Reserve banks in this field. Thus no new personnel, controls over banking, or untried activities or principles, are involved. "Finally, no competition between direct Government lending and the private credit system would be involved. On the contrary, the guaranty plan would encourage the existing private system to extend credit which otherwise might be furnished by the Government or not at all. The trend toward multiplication of Government credit agencies, if continued, may threaten the destruction of the private banking system." Other recommended amendments to Financial Institutions Act of 1957, S. 1451 and H. R. 7026, which will aid commercial banks in the extension of credit to small business are: (a) Increase the lending limit of national and Federal Reserve member banks from 10 percent of capital and surplus to 15 percent of capital and surplus by amending section 34 (a) of title I. (b) Eliminate the provision of section 42 (f) of title II, which requires that member banks maintain reserves against public funds. The State bank law in Kansas and a number of other States imposes no such requirement on State banks and consequently places them in a better position profitwise or permits these banks to maintain larger deposits with correspondent banks. (c) Eliminate the prohibition contained in section 45 (c) of national banks in cities over 5,000 from receiving premium income from the sale of insurance on the lives of borrowers or policies protecting loan collateral. This provision places these banks at a competitive disadvantage with local finance companies and savings and loan associations. The public now demands insurance protection of its loans. The loss of future profits from this business will prove to be very harmful to many banks. III. As a final suggestion to your committee, let me urge that it undertake as a separate project a study of the problems of small business-commercial banks. A continuance of the prevailing corporate tax structure and other banking laws is slowly but surely destroying their earning power and competitive position. A serious problem of continuity of ownership and management exists. The shift of population from rural areas to cities and from large urban centers to suburbs has disturbing overtones. The consequences of either more inflation or deflation will have serious effect on the banks, their small business customers, and on the economy. The regulatory agencies are in sorry shape in a number of respects. An audit of their mission and performance is a must. The availability of detailed facts and figures concerning banks and banking will permit conclusive research. The conduct of regional hearings will permit Congress to come to closer grips with the need for further constructive legislation. EXHIBIT A-1 Industrial loans and commitments by Federal Reserve banks under seo. 13b of the Federal Reserve Act, June 19, 1934, to Dec. 31, 1956 In case of a revolving line of credit the "number" includes only the original application but the "amount" includes all disbursements made under the loan. * Includes applications approved conditionally by the Federal Reserve banks and under consideration by applicant. 3 Includes industrial loans past due 3 months or more, which are not included in industrial loans outstanding in weekly statement of condition of Federal Reserve banks. Not covered by Federal Reserve bank commitment to purchase or discount. NOTE. The difference between amount of applications approved and the sum of the following 4 columns represents repayments of advances, and applications for loans and commitments withdrawn or expired. |