Statement by John P. LaWare, Member, Board of Governors of the Federal Reserve System, before the Committee on Small Business of the U.S. House of Representatives, March 17, 1994 - Statements to Congress - Transcript

Federal Reserve Bulletin, May, 1994

I am pleased to be here this morning to discuss regultory 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 businessses. 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, then followed 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 Report data at the end of my statement and also bring to your attention the survey of small business finances that the Federal Reserve currently has under way. We believe the survey, which is being cosponsored by the Small Business Administration, will provide important information for assessing credit availability for small businesses.

RECENT SUPERVISORY POLICY INITIATIVES

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, and individuals. 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 could reduce costs to banks and their customers. Such appraisals, which relate to a requirement of Title XI of the Financial Institution Reform, Recovery and Enforcement Act of 1989, 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 9. These rules do three things: (1) They increase the threshold amount for which such appraisals are required for $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 appraisals business loans of less than $1 million when the principal source of 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 midsize 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 small business 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 exprience or the bank's general knowledge of the customer but for which 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 with the intent of clarifying 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 properties, 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, as the economy develops momentum and as underying demands for credit pick up, these actions will help ensure that credit decisions of lenders and borrowers are not unduly discouraged by costly apparaisal and documentation procedures or by a misunderstanding of examination policies.

TRENDS IN BUSINESS FINANCING ACTIVITY

Ultimately, however, the major determinant of business credit use and availability is not regulations or supervisory policies but underlying economic and financial forces. In this regard, we are beginning to see evidence that business lending, including small business lending, has picked up. Indeed, in recent quarters, incoming date 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.