Why it's too hard to start a new business - small business capital

Washington Monthly, March, 1994 by Jon Meacham

Overall, the cost of compliance with bank regulations is $17 billion a year; small banks now spend one out of every four operating dollars on compliance. Leland Stenehjem, chairman of First International Bank and Trust, a small bank in North Dakota, has 39 employees, 13 of whom work nearly full-time on meeting regulations. "We used to have the philosophy that it was up to us to run the bank, to make the decisions, because we know the people in our town," says Stenehjem. "But more and more the decision is the examiner's, and all he's got is what's on paper."

Examiners who stick tightly to collateral rules even on the smallest deals are keeping bankers like Stenehjem from making loans based, in pan, on the borrower's character--James Stewart, small town, It's a Wonderful Life kind of banking. Consider Herman Simpson, a Helena, Arkansas, man who, in 1992, came up with a great business idea: open a day care center for the elderly. Simpson got together with a friend and figured that they could get started for $40,000. ($40,000 may not sound like much, but Helena, Arkansas, is pan of the Mississippi Delta, which Simpson rightly describes as "the most poorest area of the country.") The plan? Simpson and his partner would mm a building the partner already owned into a day care center, "plus a chore service which would help them with heavy cleaning and yard work and stuff, and also some homemaker stuff that the elderly need." They wrote a business plan and went down to Phillips County' s First National Bank.

But the bank couldn't grant a loan because even though Simpson and his partner had good credit histories, their collateral did not quite meet the minimum standard. The bankers later told Congress in hearings on the small business credit crunch that what stopped First National was the fact that bank regulators would have "classified" the loan. (An adverse classification is a regulator's prediction that a given loan is bad and won't be repaid.)

Clinton understands this problem and has issued some deregulation orders, but five years of tight oversight has turned bankers never the jazziest, boldest guys around anyway--into terrified automations. "Banks are scared to death that their loans will be classified," says Ronald B. Cohen, a senior partner in a Cleveland accounting firm that specializes in company financing. "And when they train their loan officers, that reticence becomes embedded in the culture. Now, they have to make loans that look like cream-puff loans. The situation is if you make a loan that's classified--if you take a risk that you wouldn't have thought of as a risk five or six years ago--your job is in trouble. These are 24-year-old trainees assigned to small business loans. Or you get safe MBA-types dealing with entrepreneurs, which is a clash."

So where are banks putting their money? Government securities and bonds, not in enterprises like Simpson's. Beginning in the 1970s, the world's industrialized nations began meeting to regulate bank capital standards--that is, to decide how much money banks had to keep in the vault, no matter what the loan demand or the economic climate. This is a One World Government conspiracy 1over's dream: Called the "Basel Committee" (after the Bank for International Settlements in Basel, Switzerland), regulators decided banks would have to keep 7.25 percent of the value of business and most consumer loans on hand. (It went up to 8 percent at the end of 1992.) That means, for example, that for a banker to lend $100,000 to an entrepreneur opening a store, the bank would have to have at least $8,000 in capital.