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

Through much of 1993, overall business demands for credit remained quite weak. In the aggregate, nonfinancial businesses largely used internal funds to finance growing outlays for fixed capital and inventories and contained 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. Debt service burdens have fallen markedly. Equity cushions seem to have move to more comfortable levels. Indicators of finanial stress, including loan default rates and bankruptcy filings, have dropped well down from peaks of recent years. Banks also have charted marked improvements. Equity capital, buoyed by record earnings, climbed to nearly 8 percent of assets last year, and the share of trouble 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 progrssed--a trend that has continued in the new year. The 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 pickup 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.(1) Although the relationship between the size of the credict arrangement that a bank has with a business customer and the size of the customer's assets or sals is not precise, our surveys and examiner experience suggest that 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 Report 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 lending to small customers.