Contents 

FDIC
 

Banking


Review
 

1997
 

Volume 10, No. 2
 

Chairman 

Andrew C. Hove, Jr. 

Division of Research 

and Statistics, 

Director 

Wm. Roger Watson 

Deputy Directors 

Barry Kolatch
 

Steven A. Seelig
 

Editor 

Steven A. Seelig 

Editorial Committee 

Jack T. Reidhill
 

Detta Voesar
 

Managing Editor 

Detta Voesar 

Editorial Secretary 

Cathy Wright 

Design and Production 

Geri Bonebrake 

The views expressed are 

those of the authors and do 

not necessarily reflect official positions of the Federal 

Deposit Insurance Corporation. Articles may be reprinted or abstracted if the 

FDIC Banking Review and 

author(s) are credited. 

Please provide the FDIC’s 

Division of Research and 

Statistics with a copy of any 

publications containing 

reprinted material. 

Single-copy subscriptions 

are available to the public 

free of charge. Requests for 

subscriptions, back issues 

or address changes should 

be mailed to: FDIC Banking 

Review, Office of Corporate 

Communications, Federal 

Deposit Insurance Corporation, 550 17th Street, N.W., 

Washington, DC, 20429. 

What Every Loan Officer Needs to Know about the Year 2000 

Computer Problem (But Doesn’t Know How to Ask) 

by Jay Golter and Paloma Hawry Page 1 

The purpose of this article is to explain the nature of the Year 2000 problem and 

the dangers it can create for different organizations. The authors discuss the types 

of risk that emanate from these system problems and propose a process by which 

a bank’s loan department may establish policies to assess and mitigate credit risk 

resulting from Year 2000 issues. 

Small Business Credit Markets: 

Why do we know so little about them? 

by Katherine Samolyk Page 14 

This study discusses the characteristics of firms, lenders, loans, and financial 

markets that can affect the availability, quantity, and price of credit to a small 

business. These are the characteristics on which researchers need data in order to 

test hypotheses about small business credit markets and, in particular, about the 

two central issues the author focuses on: To what extent do relationships with 

lenders affect the credit conditions faced by small businesses, and how will bank 

consolidation affect credit availability to smaller business borrowers. 

Recent Developments Affecting Depository Institutions 

by Jane Coburn Page 33 

This regular feature of the FDIC Banking Review contains information on regulatory 

agency actions, state legislation and regulation, and articles and studies pertinent 

to banking and deposit insurance issues. 
Year 2000 

What Every Loan Officer 

Needs to Know about the 

Year 2000 Computer Problem 

(But Doesn’t Know How to Ask) 

by Jay Golter and Paloma Hawry* 

On May 5, 1997, the Federal Financial Institutions Examination Council (FFIEC) issued 

an inter-agency statement about the Year 

2000 problem, giving guidance on what financial institutions need to do to assure that they do not suffer 

serious computer-system failures related to the 

change of century on New Year’s Day 2000.1 One 

section of the statement specifically addressed the 

potential credit risks that could arise from a borrower’s inability to manage its own Year 2000 compliance 

efforts successfully: 

“Financial institutions should develop processes to 

periodically assess large corporate customer Year 

2000 efforts and may consider writing Year 2000 

compliance into their loan documentation. Loan 

and credit review officers should consider in their 

credit analysis of large corporate customers whether 

the borrower’s Year 2000 conversion efforts are sufficient to avoid significant disruptions to operations.” 

(FFIEC (1997), 4.) 

Moreover, the FFIEC anticipates issuing further 

guidance on Year 2000 issues, including those related to 

credit risk. Analyzing the scope of any firm’s Year 2000 

challenges is difficult for professional systems consultants, let alone for the typical loan review officer, who 

has a limited understanding of computer programming 

and systems integration and might feel ill-equipped to 

conduct the type of analysis called for in the interagency statement. The purpose of this article is to explain the nature of the Year 2000 problem and the 

dangers it can create for different organizations. The 

article discusses the types of risk that emanate from 

these system problems and proposes a process by 

which a bank’s loan department may establish policies 

to assess and mitigate credit risk resulting from Year 

2000 issues. A list of reference materials is also included. 

ORIGIN AND NATURE OF THE 

PROBLEM 

In the Stanley Kubrick science fiction movie 2001: A 

Space Odyssey, the computerized system operating a 

manned spacecraft has to be disconnected when it 

turns against the crew. One year earlier than predicted 

by the movie’s title, many businesses may also find that 

their computers have turned against them, as many 

systems on which people depend cease to operate correctly. The problem lies in the inability of some computers to interpret correctly dates in which the year 

does not begin with 19—and failure to correct the 

problem before the immutable deadline could have 

dire results for any firm. In fact, many computer industry experts believe that unless firms have already 

made significant progress fixing the problem it is now 

too late for some of them to survive.2 

*Jay Golter is a financial analyst in the FDIC’s Division of Research and 

Statistics. Paloma Hawry is a manager at the Actoras Consulting Group 

in Shaumburg, IL. The views and opinions are those of the authors and 

not necessarily those of the FDIC. Nothing in this article constitutes 

FDIC policy. 

The authors wish to thank John McIsaac, Cory Hamasaki and James Jarrell for reviewing early drafts of this article and providing useful insights. Steven Seelig, Jack Reidhill, Jane Lewin and Detta Voesar also 

provided editorial assistance. 

1The authors’ opinions, interpretations and representations regarding 

the FFIEC and its statements and policies, including the May 5 statement, are not to be relied on as FFIEC policy. The sole source of 

FFIEC policy is the FFIEC. 

2For example, see Peter de Jager’s remarks in Levy and Hafner (1997). 

1 
FDIC Banking Review 

The origin of the problem is that early computer 

programmers had to work around the constraints imposed by limits on the size of computer memory and by 

the expense of storing data. One useful technique was 

to represent dates with an implied century. For example, a date field holding the value “01/01/56” meant 

“January 1, 1956” and not “1856” or “2056.” Use of 

this convention reduced the amount of storage required and improved the computer’s processing speed. 

Date fields were expanded only when necessary. For 

example, a mortgage system might have four-digit 

years for “maturity date” but two-digit years for “opening date,” “last payment date,” “next mailing date,” 

and so forth. The convention of representing years 

with two digits was also used when some components 

of systems with calendar functions (for example, the 

timer on a security system) were hard-coded. 

Computer systems often use dates to determine 

how long something has existed (for example, to see 

whether it is time to perform scheduled maintenance 

in a manufacturing plant) and this determination is 

made by subtracting the earlier date from the current 

one. A system that orders a replacement part every five 

years, might record that a part was last being installed 

on June 1, 1992; on June 1, 1997 the system would 

calculate that “97/06/01” – “92/06/01” represented five 

years and that the part needed replacing. However, in 

the Year 2000, the system might conclude that the 

part is -97 years old (“00/01/01” – “97/06/01” = -97 1/2 

years). How the computer would then proceed would 

depend on how the programming instructions had 

been written. Some systems might recognize the calculated age as being invalid and might generate a report listing such occurrences for further investigation. 

Other systems might leave the replacement parts unordered since they would never reach a calculated age 

of five years. 

To the extent that the eventual consequences of 

using date shortcuts were contemplated during the 

1960s and 1970s, it was believed that the underlying 

programs would be replaced well before the century 

changed and that if they were not, that there would be 

plenty of time to correct the problem. Even some programs written recently may contain some elements 

that will malfunction in date calculations after Year 

2000. Now that the century is drawing to a close, however, the time left in which to correct this problem is 

rapidly shrinking. 

The actual amount of time required to modify a system that has a century date problem can vary significantly depending on a number of factors. These 

include the age of the systems in operation; the number of systems in operation; the number of programs 

and lines of code in all systems; the number of computer languages in which programs are written (and the 

availability of programmers with skills in those languages); the quality of the system maintenance that has 

been performed (in particular, the extent to which documentation explains the purposes of each computer 

instruction); the extent to which electronic data are exchanged with other parties; and the degree to which 

the organization depends on equipment with embedded microchips that may not function properly in the 

next century. And what makes Year 2000 remediation 

programs particularly challenging is the need to (1) find 

all of the places where date problems might lead a program to miscalculate or terminate; (2) coordinate the 

repairs of all parts of the overall system so that no one 

repair interferes with the operations of other parts of 

the system; (3) test the repair by using data that accurately mimic the processing that will occur in the next 

decade; and (4) complete the project without any time 

extensions being granted. 

Six Concentric Circles of Risk 

To assess each bank’s credit-risk exposure to Year 

2000 problems, it is necessary to understand the operational risks that Year 2000 creates for a bank’s borrowers.3 These risks are like ripples in a pond, moving 

outward from the center of the firm’s operations. The 

central risk lies in the firm’s computer systems that 

handle core applications. These functions traditionally 

were housed on mainframe systems, but recent developments in data processing have moved much of this 

activity onto other platforms. The second circle of risk 

encompasses networks and PCs that may be important 

in the day-to-day operation of a firm. The third circle 

of risk involves exchanges of data with third parties. 

The fourth represents equipment built around microprocessors that operate with internal calendars. Extending outside the company, the fifth circle is 

composed of business partners—those organizations 

that provide essential services or are key customers of 

the firm. Finally, the sixth circle of risk is represented 

by the macroeconomy which may be adversely affected by the disruptions that result from efforts to adjust 

to the uncertainties posed by this unprecedented challenge and from the failures of some to prepare successfully for the date change. 

3 This section is abstracted from the authors’ unpublished manuscript, 

“Circles of Risk,” which provides much greater detail about the areas 

that organizations need to address in their Year 2000 remediation projects. Readers can obtain copies by sending an e-mail message to: 

jgolter@fdic.gov, or to PHawry@Compuserve.com, or by calling 

202-898-3924. 

2 
Year 2000 

First Circle: Core Application 


Systems
 

In most large organizations, computer systems perform critical functions, including payroll, inventory 

management, accounting, accounts payable and receivable processing, and scheduling (of staff, production, or 

deliveries). The software used to run each of these 

processes may have been developed by an in-house 

programming staff or purchased off the shelf from a 

software firm, or it may represent a combination of offthe-shelf products and custom-developed applications. 

If operations are to continue unaffected by the date 

change, many elements of a firm’s core system need to 

be scrutinized, and either modified and tested or replaced. This process must be conducted on all important components of the system in a coordinated fashion 

so that the replacement of one part with a centurycompliant version does not interfere with the functioning of another part with which it interfaces. 

The important components include the system’s 

hardware, its operating system software, and its application software (for example, the general ledger system). If any of these components is incapable of 

properly handling dates in the 21st century, it will probably have to be replaced with a newer, Year 2000-compatible version, but the upgrading of one component 

may require the upgrading of other components as 

well. 

Programs will have to be examined line by line to 

look for places in which dates are used. Date-sensitive 

functions must be analyzed to verify that they will perform properly when dates from the 21st century are 

used. Every modification must be tested to ensure that 

the change does not inadvertently affect either another 

part of the program or one or more other programs on 

the system. The difficulty and cost of converting inhouse applications will depend partly on how well 

those systems are documented.4 

Second Circle: Networks, 


Workstations, PCs
 

The search for an institution’s vulnerability to Year 

2000 problems moves outward from the mainframe 

system to other data processing systems. Although the 

core functions of larger organizations usually reside on 

a mainframe computer, many important tasks may be 

performed on a network system, on a workstation, or on 

a stand-alone PC. A firm might be able to function 

without these systems for an extended period of time, 

plan should include testing a network’s hardware, software, and central data. 

Third Circle: Third-Party Data 


Exchanges
 

The next circle of vulnerability involves exchanges 

of data with other entities. Even though an institution 

may have corrected all of its own data-processing systems, it may still be vulnerable if it is not prepared to 

read accurately the data it receives from other sources. 

One of the ways in which automation has developed 

over the years is by increasing the use of systems that 

exchange data between organizations. An example is 

Electronic Data Interchange (EDI) systems, in which a 

major customer and all of its suppliers exchange important data—from initiation of orders through invoicing and payment—without manual intervention. This 

development complicates the Year 2000 compliance 

process because all of the parties must agree on how 

the data will be modified. As each side of the data 

stream modifies and updates its data systems, it is important to coordinate and test the results with the 

counter-party. 

Fourth Circle: Plant and Equipment 

Although data-processing systems create the key areas of risk for many organizations, other places may also 

make an organization vulnerable to Year 2000 problems. Many important pieces of equipment, including 

telephone switchboards, security systems, HVAC, and 

elevators, may operate with embedded microprocessors that employ calendar functions and it is not always 

obvious that a particular piece of machinery has date 

functions incorporated in it. These must be tested to 

determine how they will behave when the century 

changes. 

The potential failure of embedded microprocessors 

could expose some organizations to risks even greater 

than the ones faced from a malfunctioning data-processing system. Some manufacturing processes may 

rely on control systems that receive time-stamped data 

from sensors, compare the changes over time between 

readings, and either signal an operator that some procedure should begin or automatically make some adjustments to the process. If such control units 

incorrectly determine the sequence in which readings 

have occurred or incorrectly calculate the time between readings, they may fail to perform properly. The 

failure could disrupt the manufacturing process and 

but doing so would cause a great deal of disruption and 4“Documentation” refers to the text descriptions in clear English of the 

inconvenience. Thus, part of a Year 2000 compliance purpose and logic behind each section of computer code. 

3 
FDIC Banking Review 

adversely affect a firm’s ability to generate revenue. To 

determine in advance which machinery will be impaired, it is necessary to know how it was designed, and 

what the capabilities of the embedded microprocessors 

are.5 

Fifth Circle: Business Partners 

The next circle of vulnerability is located outside of 

the firm itself. All business organizations depend on 

suppliers to provide essential goods and services. If 

any of these suppliers has difficulty providing service, 

the organization’s own operations could be adversely 

affected. Therefore, it is important for all firms to perform due diligence on their important suppliers to 

make sure that each has adequately addressed Year 

2000 issues. Similarly, when a firm makes business 

planning and trade credit decisions, it should look at 

the vulnerability of its customers. 

Sixth Circle: Macroeconomic Repercussions 

The final circle of risk to which an organization is exposed because of date-change problems involves the 

economy as a whole. This is important to banks because, in general, a poorly performing economy will 

lead to a deterioration in the quality of a bank’s loan 

portfolio and will therefore require an increase in loanloss reserves. 

The most immediate economic disruption from Year 

2000 problems is the large cost that many firms will incur in fixing their systems to prepare for the next 

decade. This cost includes the opportunity cost of not 

being able to undertake other investments during the 

remaining years of the 20th century because of the 

need to focus resources on Year 2000 conversions. 

As firms engage in “prudent” planning for the date 

change, their not being able to determine with any certainty which goods and services will be available uninterrupted after January 1, 2000, may lead them to build 

up inventories of raw materials and finished goods. 

This anticipatory stocking up is like the rush to buy 

batteries and various staples when a major storm is predicted. In these cases, simply the process of accumulating inventories and then reducing them back to 

normal, will cause some distortions in the overall level 

of economic activity. 

5A good source of additional information about Year 2000 risks within embedded technology is the Web site of the (British) Institute of Electrical 

Engineers (www.iee.org.uk/2000risk/). 

6 Jones (1996), 38. 

7Dr. Yardeni’s various articles on the subject are all available on his Web 

site at www.yardemi.com/cyber.html. 

8The Y2K Reporter #11, January 5, 1998. 

Finally, economic disruption will be caused by the 

actual failures of some systems or enterprises. Initially, 

failures will be caused by the inability of individual 

organizations to fix critical systems in time. Between 

now and the Year 2000 some marginal firms may choose 

not to incur the cost of converting a system and may 

subsequently go out of business. One analyst predicts 

that Year 2000 problems will create a 1 percent level of 

risk that any given Fortune 500 corporation fails, a 3 

percent risk of failure for any given small firm (less 

than 1,000 employees), and a 5 – 7 percent risk for any 

given mid-size firm (1,000 – 10,000 employees). The 

analyst notes: “Mid-sized corporations . . . have historically shown a distressing tendency to utilize quite a lot 

of software, but to be only marginally competent in 

how they build and maintain the software. . . . There 

are about 30,000 companies in the ‘mid-size’ range in 

the United States, and a 5% to 7% business failure rate 

would mean that from 1500 to about 2100 companies 

might close or file for bankruptcy as a result of the year 

2000 problem. This is a significant number and it is an 

open question as to whether the impact of the year 

2000 problem is severe enough to trigger a recession.”6 

Another analyst, Dr. Edward Yardeni, Chief Economist at Deutsche Morgan Grenfell, has written extensively about the Year 2000 and its potential effects on 

the world economy.7 Based on his analysis of the remediation efforts to date of the federal government, 

the electric utility industry, the transportation industry 

and other components of the economy, Dr. Yardeni has 

estimated that “there is a 40% chance of a global recession during 2000 as severe as the 1973-74 downturn.”8 

The magnitude of the economic effects of the Year 

2000 will be determined by how successfully each firm, 

each government entity, and each nonprofit organization addresses the problems it faces. As a whole, the 

banking industry has demonstrated a greater awareness 

of the problem than most other sectors of society, so 

bankers are in a good position to inform their customers and other members of the community about 

the nature and urgency of the problem. 

ASSESSING AND MITIGATING RISK 

IN COMMERCIAL LOAN 

PORTFOLIOS 

The earnings of a lending institution could be significantly reduced if the bank’s commercial customers 

were delinquent or had to default because of Year 2000 

problems within their own systems or within the system of their important customers and/or suppliers. 

4 
Year 2000 

Banks should therefore incorporate analyses of their 

customers’ Year 2000 risks into their loan review 

process. 

When a thorough assessment gives the lender confidence in the borrower’s ability to handle its Year 2000 

challenges, both parties can benefit. Firms that complete extensive Year 2000 remediation projects will 

probably find that after the date change, even though 

they may experience disruptions that impair their cash 

flows, these disruptions represent manageable, temporary events. Bank loan officers who have been monitoring those remediation projects will be better able to 

recognize when a firm’s problems are temporary and 

thus when the firm deserves credit extensions. 

Managing the risks in a commercial loan portfolio involves setting up a program to evaluate four aspects of 

each loan. First, if the borrower became delinquent or 

were to default how seriously would the bank be affected. Second, how seriously could Year 2000 problems affect the borrower. Third, how well is the 

borrower dealing with these risks. Finally, how can the 

bank best minimize its exposure to Year 2000 risks. In 

establishing a program to manage these risks in its 

commercial loan portfolio a bank may wish to use the 

following elements as a starting point: planning and 

strategy, assessment of portfolio risk, customer assessment, tools and procedures, and integration into the 

existing credit review process.9 

Initial Planning and Strategy 

Senior management at banks should consider developing an approach for addressing the Year 2000 risks 

within its loan portfolio. The first step in addressing 

these risks is to develop a strategy. Then plans will 

have to be developed for implementing the strategy. 

(Because time is the scarcest resource in all Year 2000 

activities, many of the necessary activities may have to 

be performed simultaneously.) The strategic questions 

that should be considered include the following: 

•	 Should the bank take a defensive posture at 

the risk of alienating some long-term customers? 

•	 How will the bank deal with customers who do 

not appear to be adequately addressing their 

Year 2000 challenges? 

9 This article does not attempt to provide an exhaustive list of all the programs a bank may undertake to manage the Year 2000 risks in its loan 

portfolio. Each bank will need to develop a program that is appropriate 

for the unique Year 2000 characteristics of its customers. 

•	 Should the bank view current and new customers’ needs to finance Year 2000 conversion 

projects as an opportunity to increase lending? 

•	 Under what circumstances will the bank provide additional working capital to a borrower 

whose cash flows have been disrupted by problems related to the Year 2000? 

•	 How will the bank evaluate the Year 2000 risks 

within its loan portfolio? How will individual 

loans be prioritized for Year 2000 assessments? 

•	 How will the bank monitor and track its exposure to Year 2000-related credit-quality risks? 

•	 How much assistance will the bank give to its 

customers in dealing with their Year 2000 projects? 

•	 Will the bank require that Year 2000 compliance be written into covenants for new and renewing credits? 

•	 What information about a commercial customer’s Year 2000 readiness will be communicated to third parties, such as partners in a loan 

participation, credit bureaus, or other potential 

lenders? 

•	 How will the commercial loan department’s 

Year 2000 project be integrated with the bank’s 

other Year 2000 projects? 

•	 How much detail will the bank provide to 

commercial customers and other business partners who, as part of their own due diligence efforts, inquire about the bank’s Year 2000 

readiness? 

Personnel from several areas of the bank will need to 

be involved in the early planning phases. The board of 

directors should approve the final action plan, oversee 

its implementation, and ensure that adequate resources are provided. Senior management needs to 

sponsor and develop the strategic plan and be responsible for ensuring its successful implementation. Commercial loan officers will communicate the bank’s 

policies to its customers. They will also obtain the information that will be used to assess the customers’ 

Year 2000 readiness. The loan assessments will be incorporated into the credit approval and loan review 

process. The Loan Review and Credit Departments 

will need to develop the procedures by which Year 

2000 Review Department will also want to help plan 

for the prioritizing of credits in the loan portfolio for 

risk analysis. The legal staff (or outside counsel) and 

the Risk Management Committee will need to review 

the loan agreements to determine whether additional 

5 
FDIC Banking Review 

language or covenants should be added to cover Year 

2000 concerns. 

The Data Processing Department may be asked to 

describe its Year 2000 project to the other parties mentioned above, to help them understand the scope and 

complexity of some of the issues borrowers will be facing and to give the loan officers a better understanding 

of the information the customers will provide. In some 

cases it may prove useful for data-processing personnel 

to accompany loan officers to meetings with customers 

about Year 2000 issues. Other internal parties that may 

also be involved in developing and implementing a risk 

management project include Cash Management, Corporate Trust, Audit and Marketing. 

At the end of the initial planning process, a written 

program that describes not only policies and procedures but also each division’s role in implementing the 

plan should be presented to the board of directors for 

approval. 

Assessment of Portfolio Risk 

After completing the initial planning, commercial 

banks will need to develop a process for evaluating the 

nature and scope of the Year 2000 risks in their loan 

portfolios. They will also need to establish priorities 

for mitigating those risks. Each loan portfolio is unique 

and contains a different mix of industries, loan structures, collateral, and loan sizes. Moreover, some commercial customers have sophisticated in-house systems 

and maintain direct control over the majority of Year 

2000-affected processes, whereas others are highly dependent on the technology of third parties, such as suppliers or distributors. Because lenders are unlikely to 

have the resources, time or training to audit the Year 

2000 compliance of every commercial customer, they 

must develop some means of identifying the greatest 

risks and addressing them efficiently while engaging 

their other customers in less-extensive forms of monitoring. 

Institutions may choose to analyze the riskiness of 

each lending relationship through a two-step 

process. The first step would involve classifying the 

portfolio according to the risks posed by different 

types of customers; increasingly-intensive levels of 

monitoring requirements could then be applied to 

the classes of loans that present the greatest risk to 

the institution. In the second step, the individual efforts of the customers in each stratum would be evaluated so that entities that have not taken adequate 

measures to deal with the Year 2000 challenges they 

face could be identified. 

Loans have four major characteristics that contribute 

to the degree and nature of the potential Year 2000 

risks they pose for the lender. These four risk categories are the type of business, the relative size of the 

credit, the structure of the loan, and the type of collateral. A particular customer may contribute risk in all 

four categories. Some banks may choose to distill this 

process of measuring risk into a scoring system to rank 

the risks presented by each borrower. Others may 

choose to develop a system in which borrowers with 

similar risk profiles are grouped together. The statistical analysis and sampling approaches for risk monitoring are discussed later in this article. 

Line of business risk. Because of the businesses 

some borrowers are in, they may not face much direct 

risk from Year 2000 problems. Other borrowers that 

rely on sophisticated automation for producing, delivering, or getting paid for their products and services, 

will face much greater risk. For example, it is difficult 

to imagine how a barber might be put out of business 

because of Year 2000 difficulties. On the other hand, a 

medical practice—even a small one—will have many 

more sources of vulnerability: a doctor’s practice could 

be severely threatened if his or her switchboard (or an 

answering service’s switchboard) failed for an extended 

period, or if access to on-line patient records was lost, or 

if sophisticated diagnostic or testing equipment malfunctioned and produced inaccurate readings, raising 

issues of liability, or if billing systems that are linked to 

medical insurance companies ceased to work. To some 

extent, determining the risks posed by certain types of 

businesses may become an iterative process. As more 

is learned about the problems uncovered and being addressed by one borrower, the risks facing other borrowers in the same industry may become clearer. 

Proportionality risk. The larger a credit facility is, 

the greater the bank’s potential exposure. Hence, special attention should be paid to the larger credits in the 

loan portfolio. Of course, the bank’s potential exposure 

from a customer would include unused lines of credit, 

outstanding letters of credit, guarantees made on other 

credits, any portions of a loan that were sold with recourse in a participation agreement, and any other exposures the bank might have from its dealings with the 

customer, including those that could arise from derivative contracts created on the customer’s behalf. 

Credit structure risk. The structure of a loan may 

affect its riskiness. Loans that mature before the Year 

2000 will impose risk only if the borrower anticipates 

rolling over the credit. Amortizing loans may represent 

less risk than unsecured lines of credit from which customers can draw funds at will. 

6 
Year 2000 

Collateral valuation risk. Collateralized loans may 

lose value if the collateral itself becomes impaired by 

Year 2000 problems. For example, some sophisticated 

production equipment may malfunction after the century changes because of embedded noncompliant microchips that operate or control the machinery. Should 

the equipment fail and be difficult or impossible to repair, the borrower could have difficulty maintaining 

production and making payments on any loans. In this 

case, having a lien on collateral—the broken equipment—would not bring the lender any relief, but defaulting loans that were collateralized with real estate 

or government securities would be less likely to impose 

large losses on the bank. 

The ultimate purpose of the portfolio risk analysis is 

to develop the bank’s program of reviewing and dealing with its individual customers’ Year 2000 projects. 

For example, a bank may define four regimes of increasingly intensive review. The minimal regime 

might involve corresponding with a borrower (or rely 

on a questionnaire) to determine if the borrower is 

aware of Year 2000 issues and has a plan in place. The 

tions of their Year 2000 project remediation plans. The 

bank can then assess the reasonableness of the plans 

and the progress being made towards completing the 

project. 

A customer’s overall viability at the turn of the millennium can be affected by many factors, and lenders 

cannot expect to become as knowledgeable as expert 

consultants on Year 2000 project management. In 

many cases, loan officers, therefore, will need access to 

expertise, whether from within the Year 2000 compliance team in the bank’s Data Processing Department 

or from outside consultants. Ultimately, however, 

lenders will need to become familiar enough with the 

issues involved in Year 2000 project management to 

understand the assessments being made by those experts. 

Lenders need to determine whether their customers 

have the commitment and skills to ensure that critical 

processes will function and contingency plans have 

been developed. Lenders need to be reasonably assured that Year 2000 risk is understood and is managed 

as a significant project within the client organization. Y2K
 most intensive regime might involve on-site interviews The characteristics of a well-executed Year 2000 combetween the borrower’s Year 2000 project manager and pliance project follow. 

the bank’s loan officer (accompanied by someone with Sponsorship: The Year 2000 project is sponsored by 

Year 2000 expertise, perhaps from the bank’s Year 2000 the CEO or the board of directors and a senior, experiproject team) and a request for regular progress reports. enced project manager is assigned to it and is accountA description of each regime would specify how the able. Scope: The project encompasses all potential 

initial customer contact would take place, what infor- areas of risk, not just the data-processing systems; the 

mation would be received from the customer, and how assessment extends to infrastructure, equipment and 

the responses might be evaluated. On the basis of the external relationships. Priorities: The organization has 

information reviewed, different follow-up programs 

could be defined for customers in each program. 

Risk management targets could be established. For 

example, a bank may decide that customers whose 

credits aggregate to at least 40 percent of total borrowings would receive the most intensive monitoring, and 

that no more than 15 percent of aggregate borrowings 

would be subject to the least-intensive regime. Similar 

goals could be established for the other risk categories. 

As customers are assigned to the appropriate monitoring program, the bank is then able to determine 

whether it is adequately covering its identifiable risks. 

Assessments of Customers 

A bank’s Year 2000 awareness effort should include 

all commercial customers. Thus, borrowers will be 

aware of the risks they face and will understand the activities they must engage in to reduce those risks. At a 

minimum, customers who were identified during the 

analysis of portfolio risk as contributing the greatest 

risks to the bank should be required to submit descripprioritized key areas of risk and remediation plans are 

scheduled to address all mission-critical areas. Areas 

that may begin to fail earlier than others are scheduled 

for prompt remediation. The first step in this process 

is to inventory all systems and equipment that may be 

at risk—and any large organization that has not yet begun to do this by the time the present article is published should be considered a high risk. Plan: The 

borrower has a written plan for addressing Year 2000 

problems, and it includes a reasonable timetable for 

completing important milestones; the timetable must 

leave sufficient time to test the programming changes 

that are implemented, and allow sufficient time to accommodate unexpected problems. Resources: The 

project has an adequate budget and sufficient numbers 

of dedicated employees are assigned to the effort; if appropriate, the company has engaged consulting services to assist with the project. The organization’s 

participation in Year 2000 user groups would be a good 

sign. Status: The borrower’s project has achieved a reasonable degree of completion, and in any case has not 

7 
FDIC Banking Review 

fallen behind schedule.10 Vendor compliance: The customer understands its reliance on externally controlled 

processes or equipment and is taking steps to confirm 

that the external organization will be compliant. For 

example, if the borrower is a manufacturer, vendors 

may be asked to test and warrant that the equipment 

that controls the production process will not fail with 

the date change. Whenever possible, a vendor’s representations should be confirmed by independent 

third parties. In the case of critical equipment where 

the possibility exists that it could malfunction by operating in a manner that appears normal while generating 

inaccurate readings, plans should be made to conduct 

tests after the date changes. Coordination with Business 

Partners: The firm has engaged in a dialogue with its 

customers and suppliers, has performed due diligence 

on key partners and developed contingency plans in 

case any of them suffers serious Year 2000 disruptions. 

In cases in which the organization exchanges electronic data with other entities, agreements have been 

reached concerning new standards and interfaces. 

Plans have been made for testing interfirm exchanges 

of data early enough in advance of the date change to 

allow time to correct any problems that emerge during 

testing. Contingency plans: The client has plans for minimizing the consequences of any date-related disruption. For example, what will a hospital do if it 

determines that certain pieces of equipment are malfunctioning? Do alternative solutions or products exist? Have they been contracted for or leased ahead of 

time? Does the hospital have an alternative communications plan in place if the telephone system fails to operate? 

For the customers representing the bank’s greatest 

exposure, loan officers will want to evaluate the organizations’ project plans and monitor their progress in 

achieving their goals. The May 5th FFIEC statement 

presents a useful framework for assessing an organiza10 The FFIEC (1997) strongly encourages financial institutions to have 

completed an assessment of their Year 2000 project by the end of third 

quarter 1997, and to have the programming changes for all critical systems made by December 31, 1998. The entire year of 1999 to then be 

devoted to testing. Similar time frames are appropriate for borrowers 

with large data-processing needs. 

11“According to survey findings released last week by Gartner Group 

Inc., 40 percent of the 2,300 companies and government organizations 

in 17 countries are still at the initial awareness and assessment phase.” 

(InformationWeek (1997). “Cap Gemini America, which offers Year 2000 

remediation services, found only 16 percent of Fortune 500 companies 

surveyed have begun to implement a full-fledged strategy to become 

Year 2000 compliant, and only 24 percent have a detailed plan in place. 

Some companies have not begun any work at all.” (Patrizio (1997).) 

“Very few of the 2,000 midsize retailers in the United States are ready 

for the Year 2000 according to a study released last week by the National Retail Federation.” (InformationWeek (1997).) 

tion’s Year 2000 project. The statement includes a description of the five phases that a bank needs to complete in order to address the Year 2000 challenge 

properly. These phases are Awareness, Assessment, 

Renovation, Validation and Implementation. In using 

this framework to track the progress of an organization, 

the bank can ask the client to provide target dates by 

which 25 percent, 50 percent, 75 percent, and 100 percent of the critical systems will be renovated, validated, 

and implemented. Plans must include deadlines that 

are reasonable, given the resources being used, but that 

at the same time provide enough slack to accommodate any unexpected problems that may emerge. 

Progress toward meeting deadlines can then be monitored at the appropriate times. Other aspects of the 

borrower’s Year 2000 plan should also be evaluated. 

The bank should determine if the borrower’s plan includes assessment and repair of internal infrastructure 

(such as HVAC and elevators); the extent to which the 

firm has performed due diligence on key suppliers and 

business partners; whether contingency plans exist and 

are reasonable, and whether Year 2000 planning has 

been integrated with the firm’s business strategies, including the development and introduction of new 

products, and mergers and acquisitions. 

Tools for Monitoring and Reducing Risk 

Loan officers may find different tools to be especially useful in managing the bank’s Year 2000 risks. 

These are customer awareness campaigns, customer 

questionnaires, and statistical analysis and sampling. 

Customer awareness and education campaigns. 

Unless a problem is understood and taken seriously 

customers will not adequately address it. Unfortunately, surveys in late 1997 indicate that senior management of many organizations have yet to understand the 

complexities and enterprise-wide effects the “millennium bug” can have on their organizations.11 Financial institutions should ensure that their customers 

understand the issues surrounding Year 2000, and the 

actions they might take to minimize their exposure. 

Year 2000 presents an opportunity for financial institutions to provide a service by bringing attention, focus, 

and external discipline to their customers’ remediation 

projects. 

Awareness campaigns can take many forms. Some 

institutions might write or reproduce articles on the 

topic and send these to their customers. Other institutions might mount vendor fairs and bring together a variety of experts, ranging from consulting companies to 

technology tools vendors to provide their customers 

with a range of sources of information. Still other insti8 
Year 2000 

tutions might mount seminars on Year 2000 assessment 

and remediation strategies and incorporate the financial institutions’ own expectations relative to their 

lending policies and monitoring practices. In some 

cities, Year 2000 users’ groups have been formed. Because the financial-services industry was one of the first 

to become aware of the problem, some banks have 

been early participants in these groups. However, 

many users’ groups have limited participation to dataprocessing personnel. Lending or credit officers who 

wish to join these meetings should ask if their participation would be welcome or if their presence might inhibit discussion. 

If the institution has already determined that it will 

alter its lending and credit policies, conduct Year 2000 

audits, or require self-assessments from its borrowers, 

these new policies can be introduced in the awareness 

campaign. It is essential to make all customers clearly 

aware of the Year 2000 issues as soon as possible, so 

they can quickly plan and implement compliance programs. 

Customer questionnaires. Probably the single most 

effective tool that the financial institution might wish 

to use to determine the degree of risk within the loan 

portfolio is customer completion of a self-assessment of 

its Year 2000 readiness and planning. A fairly comprehensive and well-designed questionnaire will yield important information and clearly indicate the level of 

risk exposure and next steps that might be necessary to 

reduce risks. Many major corporations now require 

their key suppliers to answer such questionnaires to 

certify their compliance with Year 2000 before they will 

renew contracts.12 Some insurance companies are now 

developing specialty policies for business interruption 

from Year 2000 problems with primary underwriting 

data generated from customer self-assessment questionnaires.13 Lenders should determine when it would 

be appropriate to incorporate this type of assurance into 

the overall credit review of a customer. Many of the 

Year 2000 questionnaires that are currently in use can 

be modified to reflect the lender’s needs (see Appendix). Ideally, for the questionnaire to support the 

lender’s review process, it should allow quantitative 

analysis (that is, should provide scoring data that can be 

weighted and/or evaluated in a risk assessment). 

12Hoffman (1997). 

13For example, American International Companies’ Millennium Insurance Policy. 

There are different approaches a financial institution can take to using questionnaires. The institution 

can require customers to complete the questionnaire 

immediately or at the point of next loan renewal, or it 

can take a softer approach and promote the questionnaire as a tool that is to be used primarily for the benefit of the customer and is not tied directly to a lending 

policy. In either case, once the customer has produced 

a self-assessment of Year 2000 readiness, it will probably have a better understanding of the scope of the 

problem and the efforts needed to remedy any shortcomings. 

If the financial institution chooses to use questionnaires, it will have to determine which of the completed forms it wishes to review and how it will respond to 

the information contained in them. This decision 

would evolve from the program that was developed 

during the assessment of portfolio risk. 

Statistical analysis and sampling. Because the 

time and resources available for addressing Year 2000 

credit concerns are limited, banks may find it more efficient to use statistical analysis or sampling, or both. 

Statistical analysis of the overall portfolio will help with 

the portfolio assessment; sampling may help the bank 

estimate the initial state of readiness of different segments of the portfolio. 

The purpose of the statistical analysis is to segment 

the loan portfolio into potential risk categories as described in the section on assessing portfolio risk. The 

first step is to determine which characteristics may be 

relevant in contributing Year 2000 risk to the bank. 

The variables that would be appropriate are business 

category (such as SIC code) and specific product lines; 

type of collateral; credit structure; projected outstanding balances on 12/31/99; current outstanding balances 

and line commitments; the risk or credit scores already 

associated with that credit, and liquidity of the borrower; and if available, the results of the initial Year 2000 

questionnaires. 

The next step is to determine how the loan portfolio is distributed across each of these characteristics and 

then to plan accordingly. For example, if a large proportion of the loan portfolio is associated with a particular type of business (for example, retailing, 

manufacturing, technical services), specialized review 

procedures for that industry can be developed. 

Important cross-tabulations should also be analyzed. 

For example, what percentage of the estimated 

12/31/99 portfolio is composed of loans to businesses 

with poor liquidity secured by equipment that may be 

9 
FDIC Banking Review 

impaired by embedded technology that is not Year 

2000–ready? 

When a bank wants to get a sense of how well prepared various types of borrowers are while it is developing initial plans and strategies for addressing Year 

2000 credit risks, sampling may be useful. Surveying 

and compiling the responses of all borrowers could take 

considerable time and effort, so banks may choose first 

to survey a smaller sample of various categories of borrowers. (Banks that have not had much experience applying sampling techniques may wish to hire a 

consultant to help design the sample and interpret the 

results.) The results of the survey may help the bank 

determine how extensive its public awareness campaign needs to be and how much time and how many 

resources it should allocate to monitoring customers’ 

Year 2000 preparations.14 

Different banks will use statistical analysis and sampling in different ways. Some banks may choose to 

obtain information about each customer’s Year 2000 

project plans (from a written questionnaire, telephone 

contact, or on-site visits). Other banks may initially 

canvas a sample of borrowers to identify characteristics 

that may indicate risks. Still other banks may choose to 

build their models of portfolio-level risk before receiving any information from borrowers in order to save 

time in the early (analysis) stage and will then direct 

most of their attention to only the most critical borrowers. 

Integration into Loan Review System 

Banks will have to develop a system for incorporating the information they receive about each customer’s 

Year 2000 projects into the existing loan review system. 

In addition, some banks may choose to develop systems that track the overall level of Year 2000 risk in the 

loan portfolio. Decisions that have to be made involve, 

among other things, timing, verification, standards, 

measurement of success, and changes to the loan review process. 

Timing. Will the bank require that (some) borrowers report on Year 2000 progress more often than they 

are currently required to report financial data? Will the 

loan officer—on the basis of an assessment of the quality of the borrower’s plans and its progress to date in 

completing the plan—establish a separate review 

schedule for each customer? 

Verification. Will the bank require independent assessment of (some) borrowers’ Year 2000 readiness 

from an accounting firm or other independent analyst? 

Will the bank want to contact customers and/or suppliers of the borrower to verify that they have been coordinating on Year 2000 issues with the borrower? To the 

extent that the bank itself exchanges electronic data 

with a corporate customer, loan officers should help facilitate the interaction between the two organizations’ 

data-processing staffs and should stay informed about 

any difficulties that emerge during tests of the new formats. 

Standards. What will the institution consider minimal acceptable activity on the part of borrowers for the 

bank to retain confidence in the borrower? How will 

these standards be communicated to borrowers? Will 

new covenants be added to the loan documentation? 

Measuring the success of a borrower’s program. If 

a borrower experiences some disruption early in the 

Year 2000 caused either by the malfunctioning of internal systems or by such external factors as the inability 

of suppliers to deliver goods or services, how will the 

bank estimate the time required to recover and the obstacle the borrower faces in regaining normal cash 

flows? If such borrowers want to draw down or increase 

outstanding credit lines, how will the bank analyze 

these cases? 

Loan review. How will the bank incorporate information about a firm’s Year 2000 readiness into its credit and loan review decisions? How often will the 

borrower’s progress toward completing its Year 2000 

project plan be tracked and reevaluated? How quickly 

and firmly will the bank deal with customers that do 

not have adequate or realistic remediation plans or that 

have fallen far behind in implementing those plans? 

CONCLUSION 

The Year 2000 problem is unprecedented. Although 

simple in origin, it can have serious consequences. For 

many borrowers, managing a remediation plan is complex, and commercial customers who do not properly 

handle their Year 2000 projects can present banks with 

credit risks. To manage this type of risk effectively, a 

bank will have to devote time and resources to developing and implementing an action plan. This task is 

made more difficult by the need for loan officers to become more knowledgeable about the technical and operational aspects of their customers’ business than they 

normally have to be. However, if the bank successfully implements a plan, it will have not only avoided 

large credit losses but also strengthened its relationship 

with its best customers. 

14For more information on how to create and measure a sample, see 

Cowan (1997). 

10 
Year 2000 

REFERENCES
 

Alter, Allan E. 1997. Year 2000: Not a Pretty Picture. 

Available: http://www2.Computerworld.com/home/cwlaunch.nsf/launch?ReadForm&/ 

homeonline9697nsf/$defaultview/4648065F895E4716852coo6FBE5C. 

Basle Committee on Bank Supervision. 1997. The Year 2000: A Challenge for Financial Institutions and 

Bank Supervisors. Available: www.bis.org/publ/bcbs31.htm. 

Cowan, Charles D. 1997. Statistical Sampling as a Management Tool in Banking. FDIC Banking Review 10, no. 1: 17–23. 

Federal Financial Institutions Examination Council. 1997. Year 2000 Project Management Awareness. 

May 5. Available: www.bis.org/publ/bcbs31.htm. 

Gartner Group. 1996. Year 2000 Arithmetic. July 29. 

Gartner Group. 1997. EDI and Year 2000: Trouble Brewing. March 28. 

Hoffman, Thomas. 1997. Auto Group Forms Year 2000 Center to Aid Suppliers. Computerworld October 20: 1. 

InformationWeek. 1997. Midsize Retail’s in Trouble. October 13: 189. 

InformationWeek. 1997. Slow Going on Code Fixes. September 29. 

Jones, Capers. 1996. The Global Economic Impact of the Year 2000 Software Problem Version 4. Available: www.spr.com. 

Keane, Inc. 1997. Much of Software and Hardware Used by Many Retail Firms Not Year 2000 Compliant. PRNewswire October 8. 

Levy, Steven and Katie Hafner. 1997. The Day the World Shuts Down. Newsweek June 2: 53–59. 

Ludwig, Eugene A. 1997. Remarks before the Risk Management Planning Seminar, Washington, D.C. 

September 25. Available: www.occ.treas.gov/97Rellst.htm. 

Patrizio, Andy. 1997. Most Fortune 500s Not Working on Year 2000 Fix. Techwire October 10. 

U.S. General Accounting Office. 	1997. Year 2000 Computing Crisis: An Assessment Guide. 

Washington, D.C. Available: www.gao.gov/special.pubs/publist.htm. 

11 
FDIC Banking Review 

APPENDIX
 

Sources of Additional Information
 

WEB SITES 

The World Wide Web on the Internet includes many sites that maintain extensive information 

about Year 2000 issues. 

Government Entities: 

FDIC: The FDIC has plans to include Year 2000 information on its Web site. The material will 

be accessible from the FDIC homepage at: www.fdic.gov. 

FFIEC: The FFIEC Web site includes the Year 2000 guidances that the Council has issued, 

Congressional testimony of bank regulators, bank trade associations, and links to other Year 

2000 Web sites. One link of potential interest to commercial loan officers is the U.S. General 

Accounting Office’s Year 2000 Assessment Guide. This document outlines the steps that organizations should follow as they manage their Year 2000 remediation project. The efforts of 

commercial customers can be compared to the practices described in this document. 

www.ffiec.gov/y2k/default.htm. 

Federal Reserve Board: The FRB site includes copies of testimony and speeches of agency officials, information on testing PCs for Year 2000 problems. www.bog.frb.fed.us/ysk/. 

General Services Administration: The GSA maintains a comprehensive Year 2000 Information 

Directory with links to other government agencies, vendors, and news articles. 

www.itpolicy.gas.gov/mks/yr2000/y201toc. 

Trade Associations: 

Institute of Electrical Engineers: This British association has some detailed information about 

the problems associated with equipment built with microchips that may malfunction when the 

calendar changes. www.iee.org.uk/2000risk/. 

Information Technology Association of America: The ITAA has a program for certifying that 

organizations are following best practices in dealing with Year 2000 issues. The Web site has 

more information about this program, including a way to order the questionaire upon which 

certification decisions are based (at the time of this writing, there is an initial fee of $250 to receive the questionnaire and a very substantial fee for applying for certification). The Web site 

also contains an archive of past issues of the ITAA’s electronic newsletter on Year 2000 issues, 

a page from which to order books about the Year 2000, and additional useful information. 

www.itaa.org/year2000.htm. 

RMA: The Association of Lending and Credit Risk Professionals: The RMA site has a Year 2000 

area which includes a questionnaire that loan officers can use as part of their Year 2000 assessment of borrowers. www.rmahq.org. 

Society of Information Managers: SIM sponsors a Web site upon which the Year 2000 Best Practices Discussion Group takes place. The Web site also includes a page from which a large 

number of Year 2000-related books can be ordered. www.year2000.unt.edu. 

Private Firms: 

ASB Bank: This New Zealand institution has some Year 2000 information on its Web site, including the text of a letter that it has sent to all of its customers discussing Year 2000 concerns. 

www.year2000.co.nz/y2kabs01.htm. 

BankBoston: Among U.S. financial institutions, BankBoston has been one of the most public in 

its discussions of Year 2000 issues. www.bankboston.com/todya/about/y2k.html. 

Gartner Group: The Gartner Group provides consulting and advisory services on technology matters to its clients, which include the FDIC and many financial institutions. They have con12 
Year 2000 

ducted a great deal of research and analysis on the Year 2000 problem. Occasionally, specific 

Year 2000-related materials are made available to the general public on their Web site. 

www.gartner16.gartnerweb.com/public/static/home.html. 

Market Partners: Market Partners was established to assist banks in their Year 2000 projects. Their Web 

site is open to the public and includes breaking news stories related to Year 2000 and the banking 

community and an extensive list of links to related Web sites (including one called H. Elliot’s Mother 

of All Year 2000 Links Page). www.marketpartners.com. 

Edward Yardeni: Edward Yardeni, Chief Economist at Deutsche Morgan Grenfell, sponsors Dr. Edward 

Yardeni’s Economic Network, a Web site of general interest to the banking community. Within the 

Web site is the Center for Cyber Economics from which the public has access to an archive of Dr. 

Yardeni’s writings on Year 2000, and an extensive listing of related Web sites, including several that 

discuss legal issues. The site also contains a brief questionnaire that can be used for assessing the Year 

2000 readiness of other organizations. www.yardeni.com. 

Year 2000 Information Center: This site is the home of Peter de Jager, perhaps the Paul Revere of the 

Year 2000. The site includes links to various solution providers, local user groups, and to a daily listing of articles that have appeared in the press about Year 2000. www.year2000.com. 

Electronic Newsletters: 

Several organizations produce newsletters about Year 2000 issues that are delivered via e-mail. The ones 

listed here are free to the public. 

Cutter Consortium: The Cutter Consortium produces a weekly newsletter aimed at the CIO and CEO 

of corporations. www.cutter.com/consortium. 

ITAA: The ITAA’s weekly newsletter has an emphasis on issues relating to government policies. It includes a listing of upcoming Year 2000 conferences and seminars. www.itaa.org/year2000.htm. 

Year 2000 Information Center: This newsletter includes the URLs for several recent press reports on 

Year 2000 topics that are available online. www.year2000.com. 

BOOKS 

Year 2000 Problem: Strategies and Solutions from the Fortune 100 

Leon Kappelman, Contributing Editor 

International Thomson Computer Press. 

Leon Kappelman, a professor at the University of North Texas, is the Co-Chair of the Society of Information Managers’ Year 2000 Task Force. Information about the book can be found at 

www.year2000.unt.edu/book/main.htm. It can be ordered by calling (512) 321-9652 or 1-888-999-2665. 

This Web site also has links to a long list of additional books about the Year 2000 problem. 

13 
FDIC Banking Review 

Small Business Credit Markets:
 

Why do we know so little
 

about them? 


by Katherine Samolyk*
 

The vast majority of U.S. businesses are small 

and medium-sized. Internal Revenue Service 

(IRS) data for the 1992 tax year indicate that 

there were around 16 million firms in nonfarm, nonfinancial industries.1 Fewer than 5,000 of these were 

large firms, mostly corporations, having more than $50 

million in annual sales. Another 16,000 were what 

bankers would call middle-market firms, those with 

sales of $10 million to $50 million. The remaining 99.9 

percent of businesses were financially small. 

In this country, small business is seen as a means to 

economic opportunity, innovation, and growth.2 It is 

also commonly accepted that there is a role in the U.S. 

economy for independent enterprises that stay small. 

Historically these values have been reflected in the 

legislative and regulatory consideration given to small 

business, as well as in antitrust policies that aim to limit the concentration of economic power. 

In particular, smaller firms tend to receive special attention when policymakers focus on conditions in the 

banking sector. For example, during the contraction in 

bank credit in the early 1990s, when it was thought that 

smaller enterprises were most likely to feel the 

crunch,3 initiatives were taken to promote the availability of credit to small businesses, and bank regulatory reporting was expanded to include data on small 

loans to businesses.4 And now longer-term secular 

trends in the financial sector have raised concerns 

about the attractiveness of the small business borrower. 

Specifically, some analysts believe that financial innovation and changes in bank regulation may be causing 

the banking industry to find small commercial customers less attractive.5 

Survey data indicate that small businesses rely on financial intermediaries—especially commercial banks— 

as lenders. Thus, it is not surprising that the rapidly 

changing structure of the commercial banking industry 

has raised concerns about the future availability of 

credit for small businesses. Historically policies such as 

deposit insurance or branching restrictions may have 

encouraged small business lending (though that was 

not their purpose) by promoting the existence of smaller institutions that make smaller loans.6 By the same 

token, the ongoing consolidation of the banking industry has highlighted the question of whether, as banking 

organizations grow in size, the needs of smaller business customers will continue to be met. 

Supply and demand considerations can explain the 

logic behind this conjecture. Smaller businesses may 

* Katherine Samolyk is a financial economist in the FDIC’s Division of 

Research and Statistics. 

1 Although 1993 Statistics of Income (SOI) data on business tax filers 

from the IRS have been published, they do not report on nonfarm, nonfinancial unincorporated businesses by size class. The 1992 data reported in this paragraph are from unpublished special tabulations 

produced by SOI. 

2 In some discussions, “small” and “new” are used synonymously, as the 

vast majority of newer firms tend to be small. Of course, new firms also 

tend to be very risky, as evidenced by their failure rates (Bates (1991)); 

it is only in hindsight that one can say the winners seemed like such 

sure things. 

3 See Samolyk and Humes (1993). 

4 Section 477 of the 1991 FDIC Improvement Act (FDICIA) requires 

that the Board of Governors of the Federal Reserve System report periodically to Congress on the availability of credit to small businesses. 

More recently, under the Community Reinvestment Act small business 

lending was included in the mandate for banks to serve local community needs. 

5 See Berger, Kashyap, and Scalise (1995). 

6 Indeed, it should be noted that although historical branching restrictions promoted the atomistic structure of the industry, it is less clear that 

they also promoted efficient provision of credit to borrowers (Berger, 

Kashyap, and Scalise (1995)). In unit-banking states, densely populated areas tended to have numerous banks competing for local customers, 

but small towns were more likely to have only single institutions to 

serve their needs. 

14 
1

0

0

Small Business 

face tighter credit conditions simply because the costs 

and risks associated with lending to them are greater. 

Although these costs and risks may depend upon the 

type of loan that is sought, they can also be affected by 

who the lender is. If larger banks face cost diseconomies in serving both small and large commercial 

customers, then industry-wide bank consolidation will 

adversely affect credit conditions for small businesses. 

Even if larger banks do not dramatically reduce the volume of their small business lending, differences in how 

these institutions make credit decisions can affect who 

gets credit. For example, to the extent that larger 

banks favor credit scoring models or standardized loan 

products, the ability of firms and firm owners to pledge 

collateral or guarantee loans may become more important relative to the value of establishing borrowerlender relationships.7 

A number of researchers have studied the extent to 

which relationships between borrower and lender benefit small business borrowers, and the findings they 

have produced are mixed. Similarly, there is a growing 

body of literature that examines whether bank consolidation will reduce the supply of smaller commercial 

credits funded by banks, and again, the results are 

mixed. 

These are important issues, and the success of attempts to address them empirically depends on the 

kinds and quality of data available, particularly data 

about supply and demand factors and market conditions. For ultimately the attractiveness of small businesses (individually and as a group), like that of any 

borrower or group of borrowers, is related to these customers’ characteristics, their credit needs, and the costs 

of meeting these needs relative to the costs of serving 

other customers. Yet surprisingly little is known about 

small firms as borrowers or about their credit markets.8 

Survey data do confirm that small businesses rely 

on financial intermediaries—especially commercial 

banks—as lenders,9 but the information available to us 

about the role of intermediaries as small business 

lenders, about the underlying costs and risks associated 

with small business loans, and about the factors that influence decisions to supply credit or to demand credit 

is meager at best. There is no single source of data that 

includes all of the types of information one would like 

to consider in assessing the availability of credit.10 

This lack of information reflects the complexities of 

the market relationships involved. Of course, problems identifying and analyzing the factors relevant to 

decision making affect financial market research generally; but the unique nature of small businesses makes 

the problem of gathering data about these credit markets particularly challenging. 

First, even defining the category is problematic because the term small business means different things to 

different people. A bank is likely to classify its small 

business customers by a financial criterion, such as 

sales or assets, but the criterion used by the Small Business Administration (SBA) is number of employees. 

To the SBA, a small business is any firm with fewer 

than 500 employees—a cutoff that some might consider fairly sizable. Second, however “small” is defined, 

this population comprises firms with very diverse characteristics (in contrast, households are a more homogeneous group, making choices about consumption, 

investment, and borrowing that can be characterized in 

terms of the household’s income, wealth, stage in the 

life cycle, and other demographic characteristics). 

Third, many small businesses keep few, if any, financial records besides those needed for filing tax returns 

(in contrast, large, publicly traded businesses have sophisticated, standardized accounting systems and publish periodic financial reports). Finally, the credit 

market options available to small businesses are not 

well defined. Whereas households and large corporations borrow in fairly standardized markets (households 

in mortgage and consumer credit markets, large corporations in publicly traded debt and paper markets as 

well as from banks and other lenders), the diverse small 

business population obtains loans from a wide range of 

sources, including loans not identified as commercial. 

In particular, smaller firms are more likely to finance 

themselves by tapping the personal credit available to 

the firm’s owners and the owners’ friends or family. 

The next section of this study discusses the characteristics of firms, lenders, loans, and financial markets 

that can affect the availability, quantity, and price of 

credit to a small business. These are the characteristics 

on which researchers need data in order to test hypotheses about small business credit markets and, in 

particular, about the two central issues this paper 

7 Avery, Bostic, and Samolyk (1998) present evidence that these sorts of 

commitment do appear to have become more prominent features of 

small business loans during the past decade. 

8 This statement does not apply to bankers, who have information about 

their small business customers that other specialists, such as economists and policymakers, do not have. 

9 In contrast, large businesses (mostly corporations) can raise funds in 

direct credit markets, that is, in markets where debt and equity issues 

are placed directly with investors. 

10 Oh (1991) discusses a number of other sources of data on small firms 

and comments on the deficiencies that limit their usefulness for studying small business finance. 

15 
FDIC Banking Review 

focuses on: To what extent do relationships with 

lenders affect the credit conditions faced by small businesses, and how will bank consolidation affect credit 

availability to smaller business borrowers. The two 

subsequent sections describe the data that have been 

collected from small businesses and from commercial 

banks. These descriptions of the available data are followed by a section summarizing the studies done to 

date on relationship lending and on bank consolidation. Underscored throughout are the ways in which 

both data and methodology limit the studies’ usefulness to those addressing important policy questions in 

the area of small business finance. Ultimately, it is hard 

to avoid concluding that better data are essential for a 

better understanding of what small business’ credit 

needs are and whether these needs will continue to be 

met by existing and evolving financial markets. 

FACTORS INFLUENCING SMALL BUSINESS
 

CREDIT ARRANGEMENTS
 

Small business lending, like consumer credit, is increasingly characterized as a separate product line or 

market by lending institutions. Thus, it would be 

plausible for economists to construct a model of a small 

business credit market, including all of the factors believed to affect the costs and returns to lending and to 

borrowing. These factors would determine small business credit conditions—defined in terms of the quantity, price, and other terms of credit agreements as well 

as the ability of certain borrowers to obtain a loan at all. 

Generally, credit demand by firms is considered to 

reflect the profitability of a firm’s prospects relative to 

the availability of internal resources to fund these 

prospects.11 If a business has profitable prospects that 

it cannot fund internally or chooses not to, then it 

should borrow if the prospects remain profitable given 

the costs of obtaining the credit.12 For small businesses, these costs may include owners’ guarantees, 

pledges of collateral, and covenants restricting the 

firm’s behavior. 

In choosing to extend credit, lenders should weigh 

the expected risks and return of a given loan relative to 

the lender’s current portfolio and other available lending opportunities. A loan’s credit risk is related to the 

borrowing firm’s prospects and the condition of its balance sheet as well as to provisos of the loan contract, including collateral, guarantees, and term to maturity. 

The profitability of a given loan, however, is also affected by the costs associated with assessing and monitoring these risks as well as by the costs of originating, 

funding, and servicing the loan. When intermediaries 

develop an expertise in screening, contracting, and 

monitoring loans to small businesses, they reduce the 

marginal costs of gathering credit information. 

11 For a textbook discussion, see Mishkin (1992), chaps. 5 and 6. 

12 Frazzari, Hubbard, and Peterson (1988) discuss why, for smaller firms, 

external financing is likely to be more expensive than internal financing. 

Academic conjectures about how small business 

credit arrangements should differ from those of other 

borrowers tend to focus on the greater difficulty and 

cost, for a lender, of obtaining information and assessing risks, and on the lender’s use of credit arrangements that mitigate these costs. (The reason both the 

inherent risks and the costs involved in assessing them 

are believed to be greater for smaller businesses is partly that smaller firms are often newer and therefore less 

established.) Although these academic conjectures often take the form of informal discussions rather than 

mathematical models, the discussions do build on a 

growing literature of formal models. 

At the same time, testing these “cost-based” theories of small business credit availability is particularly 

challenging for researchers. The available data usually 

do not include direct measures of borrower risk; hence, 

researchers use certain characteristics of the borrower 

or of the loan as indirect indicators of risk. Similarly, direct measures of the information and transaction costs 

of funding various borrowers are not available, and researchers must use indirect measures—again, certain 

characteristics of the borrower or of the loan—as “proxies” for these factors. A wide range of observable factors that researchers have related to the underlying 

credit characteristics of certain borrowers or certain 

types of loans is discussed in the rest of this section. 

They include characteristics not only of the borrower 

and of the loan but also of the borrower-lender relationship, of the lender itself, and of the financial markets. 

Characteristics of the Borrower 

Certain small business customers may involve higher information costs for lenders because of the types of 

businesses they are in, the inadequacy of their financial 

accounting, and/or their failure to separate business 

and personal finances. And some smaller business borrowers may represent greater credit risks than others, 

16 
Small Business 

such as newer firms with less-proven track records, 

firms with numerous other credit commitments, or, of 

course, firms with bad credit histories. Greater costs or 

risks will translate into either more monitoring or more 

true uncertainty for lenders to small businesses, but 

there are no direct measures of the costs and risks of 

funding a given firm. Thus, proxies for these factors 

should be defined and related to observed credit conditions as lenders seek to be duly compensated. 

Researchers have conjectured that costs and risks 

are correlated with a range of firms’ characteristics, 

including industry, size, age, and the legal organization of the business (incorporated versus unincorporated). For example, researchers have used firm age 

as a proxy for business risk as well as an indirect measure of the information that is publicly available 

about a firm (a firm’s age is posited to be inversely related to a lender’s information costs).13 A firm’s characteristics may also be related to its demand for 

credit. 

Loan Characteristics 

The costs and risks of funding a small business are 

also conjectured to depend on the size and type of loan 

the firm is seeking. Since any fixed costs associated 

with making a loan translate into higher per-dollar financing costs for smaller credits, credit terms should be 

related to loan size. In addition, certain types of loans 

may involve lower costs and risks for lenders. For example, vehicle loans tend to be fairly uniform in contracting features, criteria for approval, and loan-to-value 

ratios and can therefore be evaluated on their own merits rather than on the firm’s merits. To the extent that 

lenders can reduce their costs by standardizing loans, 

smaller firms can obtain better credit terms by taking 

advantage of these credits. 

In contrast, the costs and risks associated with 

more idiosyncratic types of lending, such as business 

credit lines, should be greater than those incurred on 

standardized credits or on loans linked to the acquisition of particular assets. Therefore, the variations 

in the costs and risks across small business borrowers 

may be reflected in the types of loans that firms obtain as well as in the interest-rate differentials they 

pay on a given loan product.14 The differences in 

loan products imply that researchers studying credit 

relationships should segment small business credit 

markets along product lines. For example, when one 

is measuring how interest-rate differentials are related to firms’ characteristics, it is important to look at 

patterns for a given type of loan. 

Other Loan Terms 

Besides a loan’s size and type, contractual loan features are related to the costs and risks incurred by both 

borrowers and lenders. For example, an increased term 

to maturity allows the borrower’s payments to be distributed over a longer period of time. Although this reduces the size of the payment and the costs of 

renewing the loan, it also extends the time horizon over 

which a borrower’s fortunes may change. All other 

things equal, lengthening the term of a loan transfers 

risk from the borrower to the lender; hence it tends to 

be associated with an increase in the loan’s rate. 

In contrast, credit enhancements—including collateral pledges, loan guarantees, and loan covenants—are nonprice features of loan contracts that 

tend to shift risks from lenders to borrowers. A loan 

secured with a collateral pledge gives a lender an explicit claim to assets; hence, a collateral pledge can 

increase the return a lender expects to get if default 

should occur.15 Moreover, the pledge of personal collateral or a loan guarantee can represent the commitment 

of assets otherwise more difficult, if not impossible, 

for lenders to reach in the event of default.16 Of 

course, in the case of a guarantee, the claim is on the 

general net worth of the guarantor rather than on specific assets. For corporations or limited partnerships, 

the guarantee creates an explicit claim where otherwise liability is limited to the owners’ equity. Finally, 

loan covenants limiting actions of the firm that could 

potentially reduce loan creditworthiness are another 

means of mitigating problems associated with imperfect information and lender costs. Because the value 

of a firm’s credit enhancement to a lender partly depends on what has been promised to others, the willingness of borrowers to limit the promises made to 

other lenders can also enhance their creditworthiness, 

albeit at some cost to the borrower. 

13 Leeth and Scott (1989) use age as a proxy for business risk, conjecturing that younger firms are more risky. Petersen and Rajan (1994) 

and Berger and Udell (1995) use age as a proxy for the information 

available about a firm. 

14 Of course, a firm’s ability to take advantage of lower-cost types of 

loans depends on the firm’s planned use of the funds, such as its need 

to finance the purchase of a building, vehicle, or capital equipment. 

15 Mann (1997) presents an extensive discussion of the role of secured 

lending in small business finance. 

16 Bester (1985) presents a theoretical framework in which collateralization reduces what is called the adverse selection problem, that is, the 

ability of borrowers to misrepresent their riskiness. Chan and Kanatas 

(1985) advance the argument that the pledge of personal assets signals 

the willingness of a firm’s owner to risk wealth besides the equity that 

has already been invested in the firm. See Avery, Bostic, and Samolyk 

(1998) for an extensive discussion of personal commitments in small 

business financing arrangements and of results as to their importance. 

17 
FDIC Banking Review 

Characteristics of the Relationship 

between the Borrower and the Lender 

Economists also conjecture that the nature of the relationship between a small firm and its lender should 

affect the credit conditions the firm faces. Lenders 

should have better information about borrowers they 

have dealt with previously. Thus, small firms should 

be able to obtain better credit terms from lenders with 

whom they have developed a relationship, whether 

through a previous credit arrangement or through the 

purchase of other business services.17 Lenders also 

should have better information about borrowers in the 

markets where they have maintained a more active 

presence. Hence, screening and monitoring costs have 

a geographic dimension that is particularly important 

for smaller firms. 

These relationship dimensions of information costs 

suggest that markets for smaller business credits will 

tend to be characterized by more-localized and longerterm relationships.18 All other things being equal, 

smaller business borrowers should be at a greater informational disadvantage if they seek credit from nonlocal 

lenders who are not familiar with their geographic market or line of business. Not only will smaller firms face 

higher costs when shopping for new lenders, but they 

may also lose the benefits of dealing with lenders with 

whom they have already formed relationships. The 

value of these relationships, however, is likely to depend on the type of loan being sought. As discussed 

below, it may also depend on the characteristics of the 

lender as well as of the local credit market. 

Type of Lender 

Banks, and to a lesser extent finance companies, are 

the dominant sources of small business loans.19 However, whereas finance companies tend to focus on standardized types of lending, commercial banks fund a 

greater share of information-intensive small business 

loans. Researchers contend that banks’ greater share of 

such loans reflects a cost advantage that banks have as 

small business lenders.20 Historically they have pro17 Several theoretical papers have demonstrated that loan rates and/or 

collateral requirements should decline as relationships between borrowers and lenders mature (Diamond (1991), Boot and Thakor (1994)). 

18 Indeed, for antitrust purposes the geographic markets serving smaller 

commercial customers are defined as local markets. Antitrust laws are 

designed to protect all bank customers, but special emphasis is placed 

on small firms and consumers who face high costs in finding alternatives to their local banks. Both the Department of Justice and the Federal Reserve Board of Governors scrutinize proposed bank mergers for 

potential anticompetitive effects. Defining the relevant product and 

geographic markets as well as alternative suppliers of small business 

credit are key features of these analyses. 

vided a wider range of business services than nonbank 

intermediaries, and this may reduce information costs, 

as banks obtain additional information through the other financial products (such as depository or cash management) that they sell to smaller firms.21 Banks have 

also tended to offer a wider range of loan types, which 

can reduce the cost of finding the most efficient credit 

product for a business. Finally, the decentralized structure of the U.S. banking industry may enable small 

business customers to develop local relationships. 

To some extent, differences between banks and finance companies also reflect regulatory policies as well 

as market factors.22 The very different regulatory environments may be manifest in differences in lending 

strategy and in the contractual features that characterize particular types of loans. For example, one might 

expect that fairly low-cost credit enhancements, such 

as signatory personal guarantees, would be used more 

frequently by regulated banking institutions, if only to 

satisfy government examiners seeking to limit loan 

risk. 

Other Lender Characteristics 

Credit terms received by smaller enterprises should 

also reflect the characteristics of the particular lending 

institution. Within the commercial banking industry, 

for example, smaller banks are increasingly viewed as 

different commercial lenders from larger regional or 

money-center banks. If the costs and profitability of 

19 By focusing on this type of lending, these intermediaries can develop 

a comparative expertise in evaluating and monitoring credit risks and 

in settling the defaulted claims of small borrowers. Fama (1985) and 

Bernanke and Gertler (1987) argue that the nature of their lending is 

what makes these institutions “special.” Because of wide variations in 

business characteristics and credit needs, intermediaries may tend to 

specialize in screening and monitoring particular types of borrowers— 

such as firms in certain industries or certain regions. By focusing on 

certain types of firms, a lender can reduce the average costs of producing information about the prospects for these firms, as any fixed 

costs can be spread over numerous borrowers. 

20 See Petersen and Rajan (1994) and Berger and Udell (1995). 

21 To some extent, however, the range of business services provided by 

finance companies reflects the regulatory definition of a finance company. The Federal Reserve classifies all institutions that fund shortand intermediate-term credit but are not depository institutions as finance companies. Although the historical roots of finance companies 

are very different from those of commercial banks, the industry has 

evolved into one that funds a broad range of credit for the business 

and household sectors. It has also evolved into an industry that is 

dominated by the largest firms, most of which are captive financial affiliates of major U.S. corporations (D’Arista and Schlesinger (1992)). 

22 Finance companies have never been subject to minimum capital 

standards, regulated lending limits, or restrictions on geographic 

branching or on affiliations with nonfinancial corporations; however, 

they are prohibited from issuing federally insured deposit liabilities. 

Large finance companies must raise funds in capital markets and are 

subject to the scrutiny of sophisticated investors; smaller finance companies borrow from other intermediaries, including banks. 

18 
Small Business 

small business lending are related to the scale and 

scope of a bank’s activities, then the credit terms obtained by a small business will be related to the size of 

its lender. Obviously, larger business customers require larger banks to meet their credit needs. Small 

banks are constrained by their size to make smaller 

loans, given the need for portfolio diversification and 

regulatory limits on loans to individual borrowers. 

However, some researchers have argued that 

smaller banks can make small commercial loans more 

profitably than other lenders because they develop 

better information about the local community.23 

Larger and organizationally complex banking companies may find it less profitable to focus on both relationship-oriented small business borrowers and 

either large commercial customers or more-standardized loan product lines, such as credit-card lending. 

If large organizations do find relationship-oriented 

small business loans to be less profitable, they will either charge more for them or be less willing to extend 

them than will smaller banks.24 

In addition to a lending institution’s structural 

characteristics, its current condition can affect the 

credit terms obtained by its small business borrowers. 

The financial condition of a lender is, of course, related to the condition of its current loans, hence its 

current borrowers. Although bank asset-quality 

problems may be due to a number of factors, lenders 

experiencing these problems may tighten origination 

standards for prospective borrowers, including small 

firms.25 

Financial Market Structure and 

Economic Conditions 

Researchers posit that financing options should be 

affected by the structural characteristics and cyclical 

conditions in loan markets. Clearly the competitive 

structure of business loan markets reflects the availability of credit alternatives. As stated above, small 

firms seeking credit in geographic or product markets 

that are highly competitive should obtain better credit 

terms.26 However, if the market is dominated by large 

banks, the terms that small business borrowers obtain 

may not be as favorable. 

Credit availability for small business should also be 

considered in the context of broader financial and 

economic conditions. Despite public policies that 

promote small business lending, smaller enterprises 

are considered most vulnerable to changing conditions over the business cycle. Economic downturns 

have the potential to magnify the problems associated 

with lending to information-intensive small commercial borrowers. As property values and income 

prospects become less certain, the ability to use personal guarantees or collateral to mitigate a lender’s 

risks and costs is likely to decline. 

INFORMATION ON LOANS TO 


SMALL BUSINESSES
 

Although there are several surveys of small business 

finance, the only comprehensive, publicly available 

data on the credit arrangements of small firms are from 

the National Survey of Small Business Finances (NSSBF), cosponsored by the Board of Governors of the 

Federal Reserve System and the Small Business Administration. Surveys were conducted for 1987 and 

1993 to gather detailed financial data on the types and 

23 Nakamura (1994) discusses this view. It is important to note, however, that banks choose whether to devote resources to processing information about local borrowers. Because small banks serve limited 

localities, focusing on an information-intensive small business credit 

niche may be a more efficient business strategy for them than it would 

be for the branch of a large organization that focused on meeting the 

needs of corporate customers. 

24 See Berger and Udell (1996) and Berger, Saunders, Scalise, and Udell 

(1997). 

25 An institution may be having problems because it effectively underprices the risks or costs of lending to certain borrowers, hence giving 

these borrowers credit terms that are too good. Alternatively, an institution may be in poor condition because, although it priced risks correctly, it has effectively gotten a bad draw in terms of the performance 

of its loan portfolio. Thus, asset-quality problems are not a clear indisources of credit used by small businesses. The data 

for each survey year are based on a sample of firms that 

was statistically designed to be representative of all 

non-agricultural, nonfinancial enterprises having fewer 

than 500 full-time-equivalent employees.27 This latter point is particularly important for researchers because, although some private analysts also collect data 

on firm-level finances (as discussed below), these data 

cator of past underwriting standards. 

26 At the same time, however, Petersen and Rajan (1995) conjecture that 

because borrowers and lenders in these markets have more alternatives, relationships tend to have less value. 

27 The survey for both years is restricted to include only for-profit, nonagricultural, nonfinancial firms with fewer than 500 full-time-equivalent employees (as reported by Dun and Bradstreet) that were in business at the end of the survey year. The NSSBF reports data for 3,224 

firms in 1987 and 4,637 firms in 1993. The two surveys differ somewhat in the focus of the information sought. Population estimates are 

also not directly comparable for the two years, because of differences 

in the underlying small business populations that the surveys represent. (See Cole, Wolken, and Woodburn (1996) for details.) For additional information about the 1987 and 1993 NSSBF, see Elliehausen 

and Wolken (1990) and Cole and Wolken (1995). 

19 
FDIC Banking Review 

are hard to use as small business estimates, for they are 

not based on scientifically designed samples. In contrast, the NSSBF is designed to provide a comprehensive picture of small business credit conditions for a 

well-defined population.28 

NSSBF: Overview 

The NSSBF asks sampled firms to report information on their outstanding loans, including the balance 

due, the type of loan (such as line of credit, mortgage, 

or vehicle loan), any collateral and guarantee arrangements, and the source of the loan (that is, the type of 

lender). Respondents also report detailed information 

about the terms of their most recent loan applications. 

Finally, each firm is asked to report income-statement 

and balance-sheet data as well as demographic characteristics about the firm and its owners. Table 1 lists the 

types of information included in the 1993 NSSBF. 

Lacunae in NSSBF Data 

Careful collection of survey data is expensive and 

difficult. Thus, although the NSSBF is unparalleled in 

its ability to link the characteristics of a small business 

to the firm’s use of credit, its capacity to record the role 

of lenders in the credit-allocation process is more limited. The only information reported by respondents 

about each supplier of credit is type (such as commercial bank or finance company), geographic distance 

from the firm, and the duration of the relationship with 

the firm. To a large extent, the reason for the lack of 

information about suppliers of credit is that small firms 

are not likely to have much information about their 

lenders. For example, small businesses are not likely 

to be able to report much about their lenders’ balance 

sheets, including how these lenders book the various 

types of loans they make to the firms. Thus, although 

it is generally believed that loans booked as mortgage 

or consumer loans by lenders are often used to finance 

28 The population characterized by the NSSBF does not really represent 

the population of very small business entities, in particular the millions 

of individuals filing tax returns to report small amounts of income from 

part-time business activities. 

29 Gathering this sort of information for each outstanding small business 

loan would be virtually impossible. 

30 Cole and Wolken (1995) and Elliehausen and Wolken (1995) report extensive univariate statistics on firms’ credit use, by source and by type. 

For statistics on the distribution of outstanding small business credit 

dollars across types of loans and types of lenders, see also Elliehausen 

and Wolken (1995) and Cole, Wolken, and Woodburn (1996). The articles reporting on the 1993 NSSBF use preliminary data that differ 

from the final-use database now available on the Internet. 

31 See Avery, Bostic, and Samolyk (1998). 

32 This measure of loans and leases does not include credit-card debt, 

trade credit, or loans from owners. 

small business activities, the survey data cannot be 

used to quantify the extent to which this is the case. 

In addition, the information provided by the NSSBF about a firm’s outstanding loans is missing some 

factors that researchers need if they are to fully evaluate small business credit arrangements. Survey respondents report the source, type, balance due, and 

whether certain credit enhancements are pledged on 

each outstanding loan. However, they do not report 

the original loan amount, loan origination date, maturity date, or contractual interest rate. Although the 

reason for these omissions may be that many firms 

would not be able to recall the information, the omissions do make it difficult for researchers to study the 

capital budgeting decisions of small firms. 

Finally, although the NSSBF reports a lot of information about the terms of a firm’s most recent credit 

application, it does not include data about a number 

of important factors that normally affect credit decisions. In particular, it reports very little information 

about a prospective borrower’s options at the time of 

the loan application. More problematic is the fact 

that the NSSBF reports employment, income-statement, balance-sheet, and financial-service-usage data 

for the survey year but nothing about a firm’s financial condition when it last applied for credit—unless 

that happened to be in the survey year.29 These 

omissions limit the extent to which researchers can 

relate the financial condition and options of a borrower at the time of a credit decision with the reported outcome of the application process. 

The Usefulness of NSSBF Data 

Despite these shortcomings, the NSSBF data are 

useful in several respects. First, they allow researchers 

to quantify the relationship between small business 

borrowing and a wide range of firms’ characteristics. 

Economists at the Board of Governors of the Federal 

Reserve System and other researchers have published 

studies describing the features of the small business 

population and of small business credit markets represented by the NSSBF.

30 According to these studies, in 

1993 the small business population was composed of 

roughly five million firms that, by and large, were quite 

small, generally not that young, and concentrated in 

the services, trade, and construction industries.31 

Roughly 60 percent of these firms had an outstanding 

line of credit, loan, or lease; however, among the other 

firms some may have used trade credit or credit cards 

for very short-term financing needs.32 The 1993 data 

also suggest that the proportion of firms that borrow 

20 
Small Business 

Table 1
 

The 1993 National Survey of Small Business Finance
 

Overview of Survey Content
 

Firm Characteristics as of 1993 

Includes
 

Standard Industrial Classification (SIC) code
 

Legal organization type
 

Year business was acquired
 

Number of FTE employees
 

Selected owner characteristics
 

Use of Deposit Services in 1993 

Includes 

Checking accounts 

Savings accounts (any nonchecking deposits) 

Up to three possible sources 

Up to three possible typical monthly balances 

Outstanding Credit and Financing in 1993 

Includes 

Lines of credit 

Capital leases 

Mortgages 

Motor vehicle loans 

Equipment loans 

Any other loans 

Up to three possible sources 

Principal owed to each source 

Types of collateral pledged on loans from each 

source 

Whether guarantees have been pledged to each 

source 

Loans from partners/stockholders 

How many? 

Total principal owed 

Are they subordinated to other loans? 

Use of Other Financial Services during 1993 

Includes
 

Transaction services
 

Cash management services
 

Credit-related services
 

Pension/trust services
 

Brokerage services
 

Yes or no reported for each financial institution 

used by firm 

Relationships with Financial Institutions/ 

Credit Sources in 1993 

Up to six institutions identified as most important 

financial service suppliers
 

Type of supplier
 

How many years has used supplier?
 

Distance between firm and supplier location
 

Most frequent method of conducting business
 

Most Recent Credit Application1 

Includes
 

Month and year applied (last three years)
 

Amount applied for
 

Primary use of loan or line proceeds
 

Secured by real estate?
 

Appraisal required?
 

Cost of appraisal
 

Environmental survey required?
 

Cost of environmental survey
 

Was application approved or denied?
 

Information about lender applied to
 

Type 

Length of relationship (as of 1993) 

Distance between lender and firm 

Why firm applied to this particular lender 

Loan application accepted or denied? 

1Does not include applications either pending or withdrawn by firm. 

tends to increase with firm size, and very old firms borrowed less frequently than others. 

Second, the NSSBF is the only source—public or 

private—of data that can be useful for constructing a 

representative picture of who funds small businesses. 

Hence, it can be used to assess quantitatively the validity of a number of credit-market issues, such as the 

concern that banks will no longer be the preeminent 

small business lenders.33 As shown in table 2, the 

1993 survey indicates that more than two-thirds of 

borrowing firms obtained at least one of their loans, 

credit lines, or leases from a commercial bank. Just 

over one-fifth of borrowing firms reported obtaining 

some credit from a finance company, the second most 

important source of loans. But in addition to market 

shares based on number of borrowers, shares of dollar value of borrowings are also important, since very 

small firms dominate the sample but account for a 

small share of total small business credit outstanding. 

In terms of loan dollars, commercial banks were the 

dominant source of small business credit, accounting 

for almost 60 percent of the dollar amount of outstanding credit lines, loans, and leases.34 Finance 

companies remain a somewhat distant second, funding roughly one-seventh of outstanding small business credit in 1993. 

33 Small business loans and loan dollars as measured here do not include 

credit-card debt, trade credit, or loans from owners. 

34 As reported in Cole, Wolken, and Woodburn (1996), this share has 

changed little since 1987. 

21 
FDIC Banking Review 

Table 2
 

The 1993 National Survey of Small Business Finances
 

Panel A. Percentage of Firms Having Any Loans,
 

by Loan Type and by Lender Type 

All Sources1 Commercial Banks Finance Companies 

All Borrowing All Borrowing All Borrowing 

Firms Firms Firms Firms Firms Firms 

All loans, lines, leases 59.1 100.0 40.7 68.9 12.6 21.3 

Credit lines 25.7 43.5 22.0 37.2 1.4 2.4 

Vehicle loans 25.3 42.8 13.9 23.5 8.0 13.5 

Equipment loans 14.8 25.0 8.0 13.5 2.2 3.7 

Mortgages 7.8 13.2 5.3 9.0 0.3 0.5 

Leases 10.3 17.4 2.0 3.4 2.3 3.9 

Other loans 12.7 21.5 5.1 8.6 0.3 0.5 

Panel B. Percentage of Outstanding Small Business Credit,1 

by Loan Type and by Lender Type 

All External 

Sources Commercial Banks Finance Companies 

All external sources 100.0 58.6 13.6 

Credit lines 42.0 32.8 6.4 

Vehicle loans 4.3 2.0 1.8 

Equipment loans 8.2 4.9 1.9 

Mortgages 24.9 11.3 2.1 

Leases 4.5 1.4 0.9 

Other loans 16.2 6.3 0.6 

1Percentage of the total value of outstanding credit lines, loans, and leases, excluding loans from owners. 

Third, the 1993 NSSBF is also the only source of 

data that can be used to construct a comprehensive 

picture of small business loan markets defined by the 

different types of loan products that small businesses 

use. As table 2 shows, small business borrowers most 

commonly reported having at least one loan in the 

form of a credit line or a vehicle loan (43.6 percent 

and 42.8 percent, respectively). However, as credit 

lines tend to be larger, they account for a much 

greater share of outstanding small business credit 

dollars than vehicle loans (42.8 percent and 4.3 percent, respectively).35 

Fourth, the information in the NSSBF can be used 

to describe many other features of small business 

credit arrangements. For example, researchers have 

documented the importance of collateral pledges and 

owners’ guarantees for particular types of business 

borrowers that use particular types of loans or sources 

of credit.36 They find that the personal commitments of owners’ wealth play an important role in the 

allocation of credit, especially to firms with limitedliability ownership structures, such as small corporations. Other researchers use data on the distance 

between firms and their lenders to characterize the 

geographic dimensions of small business credit markets. Their findings indicate that for most kinds of 

loans, (at least as of 1993) the vast majority of small 

businesses deal with fairly local lenders.37 

35 Lines of credit accounted for roughly 25 percent of small business 

loans but roughly 40 percent of the outstanding volume of small business credit. Roughly 80 percent of credit line facilities are small (less 

than $100,000); however, takedowns from larger facilities account for 

90 percent of outstanding balances owed on credit lines. Roughly 98 

percent of vehicle-loan balances were less than $100,000; of course, this 

understates the average size of the loans at origination. The data also 

indicate that commercial banks remain the dominant source of small 

business credit lines in terms of loan dollars, funding 78 percent of outstanding credit line balances. The outstanding vehicle-loan balances 

owed to banks and to finance companies were roughly equal (46.5 percent and 45 percent, respectively). 

36 Avery, Bostic, and Samolyk (1998) study the incidence of usage of personal collateral and personal guarantees by small firms, as well as the 

dollar amounts of credit backed by these enhancements. 

37 Kwast, McCluer, and Wolken (1997) use the 1993 NSSBF to examine 

the extent to which the small businesses obtain their financial services 

locally. Their results are consistent with the existence of fixed transaction and information costs for both lenders and borrowers that make it 

cost effective for small borrowers to borrow locally, but their results also 

show that within local markets, smaller firms shop around. It should be 

noted, however, that their findings reflect the predominance of very 

small firms in the NSSBF population and cannot be used to quantify the 

share of small business credit market dollars that is extended locally. 

22 
Small Business 

Other Data from Small Businesses 

Private-sector analysts also collect data on firmlevel finances. Although these samples are generally 

not statistically designed to be representative of any 

particular segment of the small business population, 

they have been used to generate conclusions about 

small business credit conditions. The National Federation of Independent Business (NFIB) has conducted surveys of small-firm finances that—although 

not publicly available—have been used in research 

on small business.38 For example, in late 1987 a mail 

survey was sent to a random sample of member firms, 

asking about their experiences with commercial 

banks as lenders and about the terms of their recent 

loans. The 1,921 usable responses are not statistically weighted to represent any specific small business 

population, but the survey’s administrators argue that 

the characteristics of the sample of responding firms 

are fairly comparable to those of what the administrators call “an estimated small business universe.”39 

Findings based on other private sources of data on 

small business finance have been cited as well in the 

popular press (see sidebar). Like the NFIB, these 

sources gather information from their constituencies 

or clients but generally do not scientifically link the 

data to a broader population of small firms. Thus 

small business data from private sources can lead researchers to very different conclusions because the 

small businesses represented by the samples may be 

different. Unfortunately, without information about 

the underlying populations, it is difficult to reconcile 

conflicting findings. 

DATA ON SMALL COMMERCIAL LOANS TO BUSINESS 

“Sharp Drop in ‘We’ll Just Put It on the 

Card’”— American Banker, August 25, 1997 

“Credit Card Use to Finance Business Is 

Soaring, Says Survey of Small Firms”— 

The Wall Street Journal, September 25, 1997 

On August 25, 1997, an article in the American Banker asserted that “recent surveys show 

that the use of personal credit cards for business financing, . . . has fallen in recent years.” 

One month later, an article in The Wall Street 

Journal announced that the use of credit cards 

by small firms was soaring. These two recent 

pieces illustrate the inconclusiveness of evidence yielded by different populations of small 

firms, especially when they are not well defined. 

The American Banker article reports the results of two 1996 studies (by the National Federation for Women Business Owners [NFWBO] 

and by Dun & Bradstreet [D&B]), but makes no 

attempt to define the small business populations 

on which the evidence is based. 

The Wall Street Journal story discusses an annual survey by Arthur Andersen and the trade 

group National Small Business United 

(NSBU), and does mention that the results are 

for businesses with fewer than 20 employees.1 

However, it does not state whether these businesses were drawn from the NSBU membership 

file or from some other groups of small businesses. 

1The Wall Street Journal article also acknowledges that the 

reported increase in credit-card use conflicts with the 

1996 Dun & Bradstreet (D&B) survey results. In doing 

so, it notes that “small firms,” as represented by the D&B 

study, refers to businesses with fewer than one hundred 

employees. 

The other main type of data used to study credit 

availability for small business is banking data on 

commercial loans (from Call Reports and from the 

Federal Reserve Board’s Survey of the Terms of 

Bank Lending). When linked to other information 

about the lending institutions or their markets, these 

data have been used to answer questions about how 

banks’ small-commercial-loan portfolios are related 

to the structure and condition of the banking industry. 

Call Report Data 

The only publicly available source of commercial 

banking data on outstanding small commercial loans is 

the midyear Report of Income and Condition (Call Report). Since 1993, each commercial and mutual savings 

bank has reported its outstanding balance and number 

of business loans of $1 million or less on its June Call 

Report. These data identify the number and dollar 

volume of outstanding Commercial and Industrial 

(C&I) loans, commercial real-estate loans, and agricultural loans for several loan-size classes.40 

38 The NFIB also publishes quarterly indices that summarize changes in 

credit market conditions as experienced by its members. 

39 See Dennis, Dunkelberg, and Van Hulle (1988) for a description of 

their 1987 survey. An academic study by Leeth and Scott (1989) describes earlier surveys. 

40 The Call Report small-loan numbers for the early years (especially 

1993) are known to reflect some confusion as to what was supposed to 

be reported; hence evidence from these years should be intepreted 

cautiously. 

23 
FDIC Banking Review 

Call Report data have an advantage over many 

other sources of information in that they cover the 

entire population of banks, and they are particularly 

valuable inasmuch as they can be used to examine 

how the volume of small commercial and agricultural 

loans held by a bank is related to a wide range of 

bank financial data also reported on Call Reports. 

Researchers can aggregate these data to examine 

how small commercial lending by the industry (by 

particular segments of the industry) is related to the 

industry’s structure and performance. 

Call Report small-commercial-loan data can also 

be linked with information about banks that is not 

published on Call Reports but is collected by bank 

regulatory agencies. For example, bank-level databases produced by the Federal Reserve Board of 

Governors and the FDIC track changes in the structural characteristics of the banking industry, including those due to the resolutions of bank failures as 

well as to unassisted bank mergers, acquisitions, and 

changes in charter.41 The FDIC also collects annual 

data on the geographic distribution of each bank’s deposits which can be used to construct a picture of the 

bank’s market in terms of this funding source. Call 

Report data are also frequently matched with other 

geographic data to characterize the economic or market conditions in which a bank is operating. For example, some researchers use state economic data, 

such as income growth and unemployment rates, as 

proxies for the local economic conditions affecting 

banks. 

The format of the Call Report itself, however, 

limits the usefulness of the small-commercial-loan 

data for studying small business finance. Characteristics of the loan rather than of the borrower make 

up these balance-sheet items. In particular, banks 

report data that are based on the size of the commercial loan—not the size of the business borrower. 

Some “small” businesses may obtain significant 

credit in amounts of more than $1 million, yet these 

loans are excluded. Moreover, it is believed that 

many smaller businesses finance their activities 

through bank loans not reported as commercial 

credits—for example, consumer installment loans 

and home equity lines of credit—and are thus excluded from the data. 

In addition, Call Report data report the consolidated commercial loan outstandings for all offices of 

a bank, whether the bank is a small community 

lender or one with branches in a number of states. 

Thus, although Call Reports identify the state, city, 

MSA, and county of what is usually the bank’s headquarters, they do not report the geographic location 

of the office where the small commercial loans were 

originated. Finally, balance-sheet data indicate only 

the quantity of small loans held by banks but reveal 

nothing about the terms associated with the loans. 

STBL Data on Small 

Commercial Loans 

Another source of commercial bank loan data that 

has been used for studying small business credit availability is the Federal Reserve Board of Governors Survey of the Terms of Bank Lending (STBL), 

administered since the late 1970s. This quarterly survey of roughly 300 banks reports data on the individual 

C&I loans made during the previous week. Although 

these data are not available publicly, they have been 

used in studies by Federal Reserve researchers because they include characteristics of individual loans, 

such as the dollar amount, interest rate, maturity, and 

whether collateral was required. 

The STBL data are particularly valuable because 

they can be used to study the terms of individual 

commercial loans. By linking the STBL loan data 

reported by each bank to Call Report and other 

data, researchers can examine the relationships between bank characteristics and loan originations. As 

with Call Report data, however, the scope of the 

survey information limits its usefulness for studies 

of small business finance, since it includes nothing 

about the characteristics of the borrower. Thus, the 

STBL does not indicate the size, type, or geographic location of the commercial borrower. The STBL 

also does not include any data on commercial loans 

collateralized by real estate, which are an important 

type of small business loan. Finally, the STBL samples do not necessarily characterize the entire population of banks adequately, because they tend to 

include high proportions of larger institutions (that 

is, the STBL oversamples large banks relative to 

their incidence in the industry) and are correspondingly less likely to adequately represent loans originated by small banks. 

41 The Federal Reserve Board (FRB) and the FDIC each produce a 

database that tracks the evolving structure of the banking industry. 

The FRB’s is called the FRB National Information Center (NIC) 

database and the FDIC’s is called the Structure database. 

24 
Small Business 

STUDIES OF RELATIONSHIP LENDING AND
 

BANK CONSOLIDATION VIS-À-VIS SMALL BUSINESS CREDIT
 

Despite limitations of data, public-policy concerns 

about how changes in the financial sector may affect 

the availability of small business credit have underscored the importance of gathering evidence about 

small business financing arrangements. These concerns center on two issues: the importance of firmlender relationships in the allocation of credits to 

small businesses and the effects of bank consolidation on the availability of smaller commercial loans. 

Evidence about Relationships between 

Borrowers and Lenders 

Three studies have used the NSSBF to explore the 

idea that borrower-lender relationships reduce the 

costs of lending and allow small business borrowers to 

obtain better credit terms.42 All three examine some 

aspects of the credit conditions respondents faced during their most recent applications for loans; one also examines collateral requirements on the outstanding 

credit lines reported by respondents. As noted above, 

although researchers conjecture that information gathering on small borrowers is a significant cost in originating loans, no data set includes direct measures of 

these costs. Thus, researchers examine the relationship between credit terms and several variables reported on the NSSBF that they use as a proxy for the 

information available to a lender about a firm. These 

variables include the firm’s age, the length of time the 

firm has dealt with this lender, and the types of financial services the firm reports having obtained from this 

lender. The studies use multivariate regression models to examine how some measure of credit availability 

is related to a firm’s characteristics (such as size, financial condition, or broad industrial class) and variables 

that measure the firm’s relationship with its prospective lender. 

Petersen and Rajan (1994) use the 1987 NSSBF to 

analyze the interest rate that firms reported obtaining 

on their most recent loans from institutional lenders. 

The authors’ tests focus on the correlation between 

this loan interest rate and the relationship variables, 

as well as on the total number of lenders that a firm 

borrows from. The authors conclude that larger 

firms, incorporated firms, and older firms obtained 

lower interest rates than smaller, unincorporated, or 

younger firms, but they cannot conclude that firms 

having longer relationships with their lenders obtained lower interest rates (all other things being 

equal). They also find no evidence that firms that 

purchase other services from their lenders obtained 

better credit terms, but they do report that firms 

dealing with numerous lenders paid systematically 

higher rates. 

The inability to find a systematic correlation between the length or breadth of the firm-creditor relationship and loan rates may reflect a number of 

factors. First, the statistical tests are applied to a 

sample that includes loan types ranging from lines of 

credit to vehicle loans. As discussed above, certain 

types of loans, such as vehicle loans, may not be very 

relationship oriented. Second, although the NSSBF 

reports data on when each firm obtained its most recent loan, the authors do not seem to have looked 

only at loans obtained during the survey year. This is 

particularly important, as the NSSBF reports firms’ 

financial data as of the survey year, that is, 1987.43 

Thus, for loans obtained a number of years earlier, a 

firm’s financial data may not be representative of 

what the firm looked like when the loan rate was contractually agreed upon. Finally, the tests presented 

by Petersen and Rajan do not examine credit extensions from a given type of lender, such as commercial 

banks, although relationships may matter more for 

banks than for nonbank lenders. Oddly enough, this 

study is frequently cited as evidence that firm-creditor relationships do matter.44 

In a related paper, Berger and Udell (1995) control 

for the type of loan and the type of lender in testing 

whether borrower-lender relationships improve credit terms received by small businesses. They, too, use 

the 1987 NSSBF but focus their analysis on a specific type of loan—lines of credit—obtained from commercial banks. They, too, analyze the relationship 

between proxies for the lender-borrower relationship 

and two different measures of credit terms on these 

lines of credit: loan rates and collateral requirements. 

Berger and Udell distinguish between public information about the reputation of a firm (which they say 

42 Petersen and Rajan (1994), Berger and Udell (1995), and Cole (1998). 

43For the exact questions asked of each firm, see Research Triangle Institute (1989). 

44 The reason may be that the authors also report findings that a firm’s 

late-payment rate on its trade debt is negatively related to its age, its 

longest lender relationship, and the share of its debt from a financial 

supplier. The authors interpret these results as indicating that lender 

relationships increase the availability of credit. 

25 
FDIC Banking Review 

is associated with the firm’s age) and the private information that a bank gathers through its relationships with small business borrowers. 

Like Petersen and Rajan, Bergen and Udell find 

that older businesses and incorporated firms tended 

to pay lower interest rates. However, Berger and 

Udell also find that, given a business’s age, firms having had longer banking relationships also paid modestly lower premiums over prime on their most 

recently obtained credit lines. In assessing collateral 

pledges on outstanding credit lines, the authors report that a firm’s age and the age of its banking relationship also affects the likelihood that collateral is 

required. This result is consistent with the notion 

that problems of getting information are more acute 

when banks lend to newer firms or to firms that are 

newer customers.45 At the same time, the quantitative evidence about the benefits of borrower-lender 

relationships is quite modest. Roughly speaking, 

Berger and Udell find that each year of the relationship reduces the premium paid over prime by two to 

three basis points.46 

A third study, this one by Cole (1998), uses the 

1993 NSSBF to examine the relationship between 

the length and breadth of the borrower-lender relationship and the probability that a firm’s most recent 

loan application is accepted. As with the Petersen 

and Rajan study, however, most of the results reported by Cole are based on relationships evident for a 

sample that includes all types of loans.47 The multivariate tests also include only subsets of the array of 

borrower characteristics that are conjectured to affect 

a lender’s acceptance/denial decision. Thus, the 

measured effects of the borrower-lender relationship 

may be due to their link to borrower characteristics 

that are not included in the analysis. The very last 

results presented by Cole report findings about how 

a broad set of characteristics of the firm and of the 

firm-lender relationship is related to credit extensions identified as “working capital” loans. These 

findings suggest that the major factor explaining 

higher denial rates between 1991 and 1994 was that 

firms were applying to lenders with whom they had 

had no previous financial dealings. For firms having 

some relationship with the lender, the author finds 

no systematic link between the age of the relationship (as of 1993) and the probability that a working 

capital loan was granted. However, there is some evidence that types of other services obtained from a 

prospective lender do affect loan acceptance/denial 

rates. Specifically, having an outstanding loan from a 

prospective lender appears to be associated with 

modestly higher denial rates, whereas having a savings account or purchasing other nonchecking financial services tends to be associated with lower 

loan-denial rates.48 Not surprisingly, the timing of 

the loan application was a major factor explaining acceptance/denial rates. Businesses applying for their 

most recent working capital loans from commercial 

banks during 1991 or 1992 were substantially more 

likely to be denied credit. Finally, older and larger 

firms tended to have lower denial rates. 

Findings about Bank Consolidation 

During the 1990s, restrictions on the geographic 

scope of banking organizations have been significantly 

liberalized. The Riegle-Neal Interstate Banking and 

Branching Efficiency Act of 1994, which authorizes interstate bank branching, increases the prospect of further industry consolidation, as some banks may choose 

to branch across state lines. As noted above, concerns 

about how bank consolidation will affect the availability of small business credit reflect the belief that smaller and larger institutions behave very differently as 

small business lenders. Larger banks may tend to focus more on credit scoring models or standardized loan 

products than on relationship-based evaluations tailored to a wide range of small business clients. 

Changes in the structural composition of the banking 

industry as well as in the broader financial-services industry may affect which small businesses get credit and 

the terms that they receive. 

Unfortunately, the publicly available NSSBF does 

not allow one to explore whether the importance of 

relationships depends on the scale and scope of a 

lender’s financial operations. Thus, to look for evidence about how bank consolidation has affected 

small business credit availability, researchers have 

45 Of course, the age of a firm may also reflect the firm’s inherent risk, 

that is, its underlying creditworthiness. Firms that have survived tend 

to be more-proven risks and therefore more creditworthy customers. 

Indeed, several other researchers have used a firm’s age as a proxy for 

the firm’s default risk. 

46 To some extent, the Berger-Udell tests are subject to some of the 

same data problems as the Petersen and Rajan study. For example, in 

conducting their analysis of the negotiated interest rate, they, too, do 

not appear to control for how long before 1987 the most recent loan 

was made. In addition, when assessing how the current age of the borrower-lender relationship is related to collateral requirements on each 

of a firm’s outstanding credit lines, they cannot control for how long 

before 1987 a credit line was obtained. Survey respondents are not 

asked to report the date on which they obtained each of their outstanding loans. 

47 Most of Cole’s results are based on the data for the 2,007 firms in the 

1993 NSSBF that applied for any credit between 1991 and 1994. 

48 The number of sources from which a firm buys financial services and 

the number of a firm’s business delinquencies are positively, but modestly, related to a higher rate of loan denial. 

26 
Small Business 

turned to the available data on bank commercial 

loans. The bulk of this research has been aimed at 

documenting the evident patterns between bank size 

and small-commercial-loan ratios. Early studies tend 

to interpret their findings as suggesting that bank 

consolidation reduces at least the asset share, if not 

the level, of smaller commercial loans, and more recent papers have argued that consolidation patterns 

may even increase “small business lending.”49 

The Call Report data indicate that at smaller 

banks, smaller loans constitute a much higher share 

of the commercial lending. An important issue, however, is the extent to which this reflects profitable 

loan opportunities rather than constraints imposed by 

the bank’s smaller size. There are very few studies 

that focus on how business credit terms vary with the 

size and scale of banking organizations, no doubt because there are few publicly available banking data 

other than bank Call Reports. Berger and Udell 

(1996) match Call Report data with information from 

the STBL (from 1986 through 1994) to examine how 

the rates and collateralization requirements on C&I 

loans are related to bank characteristics as reported 

on Call Reports and to loan characteristics as reported on the STBL. In particular, they study whether 

credit terms from larger and smaller banks systematically differ.50 Their results indicate that for loans in 

all size classes, larger banks on average charged lower interest rates and were less likely to secure their 

C&I lending. Thus, although larger banks make proportionately fewer small loans, the loans they do 

make are priced more cheaply than those from small 

banks. The authors interpret their findings as being 

consistent with the conjecture that larger, more-complex institutions engage in less information-intensive 

relationship lending than their smaller counterparts.51 Unfortunately, without additional data on the 

types of C&I loans extended or the characteristics of 

the borrowing firms, one cannot verify whether this is 

indeed the case or whether larger banks simply make 

relationship loans more efficiently.52 

A second important issue is the extent to which 

merger and acquisition alter the lending patterns of 

the banking entities involved. Most of the bank-consolidation studies using Call Report data can be characterized as event studies, which test for systematic 

differences in small-loan ratios between firms experiencing the event—here, a merger or an acquisition— 

and firms not experiencing the event. In other 

words, this type of research basically compares the 

behavior of banks involved in merger and acquisition 

(M&A) activity with the behavior of a “control 

group” of banks that have not undergone these structural changes. Researchers classify banks in terms of 

their M&A activity by using the structural merger 

and acquisition data collected by bank regulatory 

agencies. In some papers, banks involved in M&A 

activity are also classified by other characteristics of 

the changes in banking structure—for example, large 

banks that have absorbed small institutions, or banks 

within a given state that have been acquired by outof-state organizations. Breaking up M&A activity 

into a range of events allows a researcher to examine 

whether small business lending patterns can be related to specific types of M&A activity. 

There is a growing number of bank-consolidation 

studies that use the small-commercial-loan balances 

reported on the June Call Reports. Two of the most 

recent of these studies are by Peek and Rosengren 

(1998) and Strahan and Weston (1998). Peek and 

Rosengren test whether annual changes in ratios of 

small C&I loans to assets between 1993 and 1996 differ between banks that were not involved in mergers 

and banks that were. They classify each merger by 

how it affects the acquiring institution’s ratio of small 

loans to assets. For example, if bank A acquired bank 

B in early 1995, then bank A’s pre-merger loan ratio 

(from June of 1994) is compared with the ratio obtained by combining the June 1994 balance sheets of 

bank A and bank B. The authors then measure the 

relationship between post-merger commercial lending patterns and the pro forma changes in acquirers’ 

balance sheets. Moreover, they examine whether 

this relationship varies depending on whether the acquirers are relatively active or inactive as small commercial lenders.53 

49 There are far more studies of bank consolidation than of relationship 

lending. This paper discusses only a few of the most recent ones, including Peek and Rosengren (1998), Strahan and Weston (1998), and 

Berger et al. (1997). 

50 They test separate models for a number of loan-size classes to see if 

the determinant of credit terms differs with loan size. Berger and 

Udell also report interesting evidence about the relationship of loan 

characteristics to credit terms. Their findings, consistent with those in 

other small business research, are that larger loans generally have lower interest rates, whereas collateralized loans tend to have higher rates. 

Thus, collateral appears to be associated with riskier credits across all 

loan-size classes. 

51 Keeton (1996) and Whalen (1995) also present evidence about the relationship between organizationally complex institutions (such as banks 

owned by out-of-state holding companies) and small commercial loans. 

52 The authors do argue that to the extent that small credits are standardized loans, the attendant borrowers may be adequately served by 

larger institutions. However, they cannot estimate the mix of information-intensive versus standardized C&I loans in the STBL data. 

53 Banks whose ratios of small loans to assets are under 10 percent are 

defined as inactive small business lenders, while banks whose portfolio shares of small business commercial loans exceed 10 percent are 

defined as active. 

27 
FDIC Banking Review 

The authors report that acquiring banks tend to 

readjust toward their pre-acquisition ratios of small 

loans to assets during the year the acquisition took 

place. Moreover, the magnitude of the readjustment 

is related to the acquirer’s pre-merger presence as a 

small commercial lender. Acquirers with a heavier 

concentration of small commercial loans tend to offset decreases in their portfolio share of small loans, 

and banks with a low pre-merger share of small commercial loans tend to respond by offsetting mergerrelated increases in this share. The authors also 

report that small institutions (less than $100 million 

in assets) significantly offset merger-related decreases in small-commercial-loan ratios; however, all 

banks appear to eliminate merger-related increases. 

On the basis of the merger patterns during the period under scrutiny (mid-1993 through mid-1996), 

Peek and Rosengren conclude that bank consolidation may actually increase the availability of small 

loans. In particular, a surprising number of acquiring 

banks were relatively small institutions with significant small-loan portfolios. 

In a similar type of study, Strahan and Weston 

(1998) use Call Report data for 1993–96 to explore 

the hypothesis that bank consolidation may reduce 

small commercial lending by banking firms. They 

examine how small-C&I-lending ratios are related to 

the size and organizational complexity of banking organizations. Unlike Peek and Rosengren, however, 

they analyze banking data for consolidated holding 

companies because, as they argue, intra-holding company transactions among affiliates could bias the statistical results. The authors present two sets of 

multivariate tests. 

The first examines how the level of a banking organization’s C&I loans-to-assets ratio is correlated 

with various measures of its size and complexity. 

The “complexity” of a banking organization is defined by the number of its bank subsidiaries, the average size of these subsidiaries, and the number of 

states in which these banks operate. The results indicate that for organizations with less than $300 million in assets, there is a positive link between the 

average size of the bank subsidiary and the ratio of 

small commercial loans to assets. In other words, for 

companies below this size threshold, larger subsidiaries have higher ratios of small C&I loans to assets. In contrast, for companies with assets of more 

than $300 million, there is a negative link between 

subsidiary size and ratios of small C&I loans to assets. 

Generally the tests do not reveal significant links between the other complexity variables and the loan ratios. 

The second set of multivariate tests measures how 

the changes in ratios of small C&I loans to assets (June 

1996 compared with June 1993) are related to mergers among banking organizations and to the respective sizes of acquirers and their targets. Unlike Peek 

and Rosengren, these authors examine changes not 

only in shares of bank assets but also in small C&I 

loans relative to total C&I lending.54 Strahan and 

Weston analyze banks that were in existence in June 

1993 and were still in existence in June 1996, separating these institutions into organizations that were 

not involved in any acquisitions and organizations 

that were. They also sort acquirers into classes that 

reflect their size (small, medium, and large) and the 

size of their target (small, medium, and large). They 

then test how changes in the C&I loan ratios are related to the sizes of the organizations involved in 

bank mergers. 

The results indicate that organizations involved in 

mergers, on average, had greater increases in the 

shares of assets allocated to both small C&I and total 

C&I loans than banks not involved in mergers. However, they are unable to reject the hypothesis that 

there was no difference in the growth of small loans 

as a share of total C&I loans for these groups. The results also suggest that mergers occurring between 

smaller institutions (small acquirer and small target) 

were associated with modest increases in the portfolio shares of both small C&I loans and total C&I 

loans. Again, however, there is no significant change 

in small C&I lending as a share of total C&I loans for 

this group. In none of the other size pairings, the authors find statistically significant patterns between 

changes in C&I loan ratios and mergers. Consistent 

with the Peek and Rosengren results, these multivariate tests also reveal that for all banks in the sample, bank size was negatively related to changes in 

small C&I lending, both as a share of assets and as a 

share of total C&I loans.55 Despite the negative effects attributable to bank size, Strahan and Weston 

interpret their findings as suggesting that a further 

decline in the percents of independently owned 

54 They examine changes between 1993 and 1996 in the following ratios: 

small C&I loans to assets, total C&I loans to assets, and small C&I 

loans to total C&I loans. 

55 Not surprisingly, growth in personal income (in the state where a 

banking organization is headquartered) is positively correlated with 

both small C&I and total C&I loan ratios during this period. 

28 
Small Business 

banks need not adversely affect the availability of 

small business credit. They base this conclusion on 

the finding that, all other things being equal, small 

banks that acquired other small banks on average had 

modestly larger changes in C&I loans-to-assets ratios 

than other banks in the sample. 

Although the studies by Peek and Rosengren and 

Strahan and Weston contribute much to our understanding of bank commercial lending patterns, the 

implications of their findings for the availability of 

small commercial credits should be interpreted cautiously. Both studies base their sanguine view of 

M&A activity on balance-sheet ratios for merging 

banks, however the patterns evident in bank loansto-assets ratios do not tell us much directly about the 

aggregate supply of small commercial loans. For example, if active small business lenders account for a 

very small share of bank assets, then banks’ merger 

activity may have little effect on the allocation of 

credit dollars in the industry. In particular, the authors do not quantify the dollar changes in small commercial credits that are attributable to mergers.56 

Moreover, both studies verify that bank size is a 

major factor explaining the share of assets devoted to 

commercial loans of less than $1 million. Thus, as 

banks merge they get larger and are therefore likely 

(given legal lending limits) to make larger loans. 

Another important consideration in assessing how 

bank consolidation may affect the supply of small 

commercial loans is the behavior of other lenders in 

the commercial loan market. Even if a structural 

change—such as a merger—reduces one bank’s lending focus, other lenders may be willing to make profitable small loans. 

A recent study by Berger, Scalise, Saunders, and 

Udell (1997) uses STBL, Call Report, and bank 

structure data to examine how mergers and acquisitions have been related to a number of longer-term 

trends affecting the availability of smaller commercial credits, including the response of other banks to 

M&A activity. The authors use the STBL data on 

originations of C&I loans to estimate patterns in 

small commercial lending for the banking industry 

between 1980 and 1995.57 However, to derive these 

estimates, the authors must make several important 

assumptions. First, they must assume that data on 

loan originations can be used to generate an accurate 

picture of a bank’s outstanding C&I loan portfolio. 

Second, they must assume that the commercial lending patterns they estimate for banks in the STBL 

sample can also be used as estimates for banks with 

similar characteristics that are not in the sample. 

To analyze how lending patterns have been related to mergers and acquisitions, the authors decompose changes in bank small commercial loan ratios 

into a number of “effects.” First, for each institution 

involved in a merger, they estimate a “static effect” 

that measures the pure cross-sectional difference in 

lending that would be attributable to the merged institution’s larger size alone. They also estimate a 

number of dynamic “effects” that they interpret as 

reflecting longer-run factors that affect small commercial lending over time. These include the characteristics of the merger itself, the secular lending 

trends that are affecting all banks during this period, 

and the response of other banks in markets where 

mergers are occurring. Using the patterns measured 

at the bank level, the authors then derive aggregate 

estimates of how M&A activity has affected the dollar volume of small commercial credit in the banking 

industry during the period under scrutiny.58 

Their results yield a picture of small commercial 

lending patterns that is consistent with the results 

from other studies. They find that mergers of smaller banks are associated with increases in small commercial credits, whereas mergers of large banks are 

correlated with decreases. The aggregate static effect—that is, the pure size-based effect—of mergers 

on the volume of small commercial loans is negative 

and considerable. However, the estimated reaction 

of other banks in local markets offsets much, if not 

all, of the contraction.�� The authors note that this 

external effect is probably the least-accurate quantitative estimate presented. Still, they argue that the 

evidence suggests that despite continuing reductions 

in small commercial lending by merging banks, the 

total supply of these credits may not decline. 

56 To compute the net effect of mergers on the share of banking assets 

that is allocated to smaller commercial credits, one would have to consider the volume of assets as well as the number of banks. 

57 They use the STBL loan origination data to estimate the outstanding 

small C&I loans held by all banks between 1980 and 1995. 

58 An institution is counted more than once if it is involved in multiple 

mergers during the period. 

59 The conclusions of Berger et al. (1997) contrast sharply with those of 

an earlier study (Berger, Kashyap and Scalise (1995)). 

29 
FDIC Banking Review 

CONCLUSION
 While researchers have attempted to understand 

the dynamics of the credit markets facing small 

business, the weaknesses in the available data limit 

the conclusions that can be drawn. Most of the issues of small business credit availability are linked 

to the costs of lending to small business relative to 

larger firms. The relative costs of funding small 

firms reflect the basic characteristics of small borrowers, the ability to gather efficiently financial information on these firms, and the government 

policies that affect credit market participants. Since 

there is no data set that includes all of the factors affecting supply and demand in small business credit 

markets, the results derived from the available data 

should be interpreted as being consistent with certain conjectures rather than constituting quantitative estimates of market conditions. 

Data from surveys of small businesses are useful 

for measuring how small firms are financed and for 

relating a firm’s characteristics to credit market experiences. However, these data alone do not allow 

researchers to assess the supply conditions facing 

small firms. They include little information about 

lenders and limited information about a firm’s financial condition when it obtained loans. Similarly, 

there is no publicly available source of information 

about loans extended to small firms by individual 

commercial banks (or by any other type of lender). 

Thus, to assess the relationship between the availability of these loans and conditions in the banking 

industry, researchers are forced to use balance-sheet 

data on small commercial loan outstandings as a 

proxy for loans. 

The available data can tell us a great deal about 

the patterns in who the borrowers and lenders are, 

but they do not allow researchers to adequately address a number of important policy issues. For example, it would be useful to know more about how 

characteristics of banks and the structure of the 

banking industry are related to the allocation of 

credit to small firms. Nor can concerns about bank 

consolidation be adequately addressed without information about nonbank lenders, especially finance companies. We also know very little about 

how the availability of small business credit is related to economic conditions over the business cycle. 

To better understand demand and supply relationships in small business credit markets, researchers will always need consistent data from both 

small businesses and lenders. The breadth of the 

information needed suggests that periodic surveys 

are generally a more cost-effective source of data 

than quarterly reporting requirements. Moreover, 

since small businesses and nonbank lenders are not 

subject to reporting requirements, voluntary surveys represent the only means by which policymakers can obtain information about issues involving 

small business credit. 

Small business will continue to be an important 

social and economic force in our society. Thus, public policy that supports small business as an engine 

of economic growth and the bulwark of competitive 

markets must be concerned with the availability of 

credit to these entrepreneurs. If policy decisions regarding small business credit are to be informed, 

good data must be available. 

30 
Small Business 

REFERENCES
 

Avery, Robert B., Raphael Bostic, and Katherine Samolyk. 1998. The Role of Personal Wealth 

in Small Business Finance. Journal of Banking and Finance (forthcoming). 

Bates, Timothy. 1991. Financial Capital Structure and Small Business Viability. In Advances in 

Small Business Finance, edited by R. Yadzipour. Kluwer Academic Publishing. 

Berger, Allen N., Anil K Kashyap, and Joseph M. Scalise. 1995. The Transformation of the U.S. 

Banking Industry: What A Long, Strange Trip It’s Been. Brookings Papers on Economic Activity 2: 55–218. 

Berger, Allen N., Anthony Saunders, Joseph M. Scalise, and Gregory F. Udell. 1997. The Effects of Bank Mergers and Acquisitions on Small Business Lending. Federal Reserve 

Board Finance and Economics Discussion Series, working paper 1997–36. 

Berger, Allen N., and Gregory F. Udell. 1995. Relationship Lending and Lines of Credit in 

Small Firm Finance. Journal of Business 68: 351–82. 

————. 1996. Universal Banking and the Future of Small Business Lending. In Financial 

System Design: The Case for Universal Banking, edited by A. Saunders and I. Walter. Irwin 

Publishing. 

Bernanke, Ben S., and Mark Gertler. 1987. Banking and Macroeconomic Equilibrium. In New 

Approaches to Monetary Economics, edited by W. Barnett and K. Singleton. Cambridge University Press. 

Bester, Helmut. 1985. Screening vs. Rationing in Credit Markets with Imperfect Information. 

American Economic Review 75: 850–55. 

Boot, Arnoud W., and Anjan V. Thakor. 1994. Moral Hazard and Secured Lending in an Infinitely Repeated Credit Market Game. International Economic Review 35: 899–920. 

Chan, Y. S., and G. Kanatas. 1985. Asymmetric Valuations and the Role of Collateral in Loan 

Agreements. Journal of Money, Credit and Banking 17: 84–95. 

Cole, Rebel A. 1998. The Importance of Relationships to the Availability of Credit. Journal of 

Banking and Finance (forthcoming). 

Cole, Rebel A., and John D. Wolken. 1995. Financial Services Used by Small Businesses: Evidence from the 1993 National Survey of Small Business Finances. Federal Reserve Bulletin 81: 

629–67. 

Cole, Rebel A., John D. Wolken, and Louise R. Woodburn. 1996. Bank and Nonbank Competition for Small Business Credit: Evidence from the 1987 and 1993 National Survey of Small 

Business Finances. Federal Reserve Bulletin 82: 983–95. 

D’Arista, Jane, and Tom Schlesinger. 1992. The Parallel Banking System. Economic Policy Institute briefing paper. 

Dennis, William J., William C. Dunkelberg, and Jeffrey Van Hulle. 1988. Small Business and Banks: 

The United States. The National Federation of Independent Business. 

Diamond, Douglas. 1991. Monitoring and Reputation: The Choice between Bank Loans and Directly Placed Debt. Journal of Political Economy 99: 688–721. 

Elliehausen, Gregory E., and John D. Wolken. 1990. Banking Markets and the Use of Financial 

Services by Small and Medium-Sized Businesses. Board of Governors of the Federal Reserve 

System, Staff Studies No. 160. 

———. 1995. Descriptive Statistics from the 1987 National Survey of Small Business Finances. Board 

of Governors of the Federal Reserve System. 

Fama, Eugene. 1985. What’s Different about Banks? Journal of Monetary Economics 15: 29–40. 

31 
FDIC Banking Review 

Frazzari, Steven, Glenn Hubbard, and Bruce Peterson. 1988. Financing Constraints and Corporate Investment. Brookings Papers on Economic Activity 1: 141–95. 

Keeton, William R. 1996. Do Bank Mergers Reduce Lending to Businesses and Farmers? New 

Evidence from Tenth District States. Federal Reserve Bank of Kansas City Economic Review 

81: 63–75. 

Kwast, Myron, Martha Starr McCluer, and John Wolken. 1997. Market Definition and the Analysis of Antitrust in Banking. Antitrust Bulletin 42. 

Leeth, John, and Jonathan Scott. 1989. The Incidence of Secured Debt: Evidence from the Small 

Business Community. Journal of Financial and Quantitative Analysis 24: 379–94. 

Mann, Ronald J. 1997. The Role of Secured Debt in Small Business Lending. Mimeographed 

paper. 

Mishkin, Frederic S. 1992. The Economics of Money, Banking, and Financial Markets. 3rd ed. HarperCollins Publishers. 

Nakamura, Leornard I. 1994. Small Borrowers and the Survival of the Small Bank: Is Mouse Bank 

Mighty or Mickey? Federal Reserve Bank of Philadelphia Business Review November/ December 3–15. 

Oh, Charles. 1991. Available Data Bases for Research on Small Business Finance. In Advances in 

Small Business Finance, edited by R. Yazdipour. Kluwer Academic Publishing. 

Peek, Joe, and Eric S. Rosengren. 1998. Bank Consolidation and Small Business Lending: It’s 

Not Just Bank Size That Matters? Journal of Banking and Finance (forthcoming). 

Petersen, Mitchell A., and Raghuram G. Rajan. 1994. The Benefits of Firm-Creditor Relationships: Evidence from Small Business Data. Journal of Finance 49: 3–37. 

———. 1995. The Effect of Credit Market Competition on Lending Relationships. Quarterly 

Journal of Economics 110: 407–43. 

Research Triangle Institute. 1989. The National Survey of Small Business Finances: Main Study Questionnaire. 

Samolyk, Katherine, and Rebecca W. Humes. 1993. Does Small Business Need a Financial Fix? 

Economic Commentary. May 15. Federal Reserve Bank of Cleveland. 

Strahan, Philip E., and James Weston. 1998. Small Business Lending and the Changing Structure 

of the Banking Industry. Journal of Banking and Finance (forthcoming). 

Whalen, Gary. 1995. Out-of-State Holding Company Affiliation and Small Business Lending. 

Comptroller of the Currency Economic and Policy Analysis, working paper 95–4. 

32 
Recent Developments 

Recent Developments
 

Affecting Depository
 

Institutions
 

by Jane Coburn*
 

REGULATORY AGENCY ACTIONS
 

Federal Deposit Insurance Corporation 

Chairman Helfer Announces Resignation 

On March 14, 1997, Ricki R. Helfer announced 

her resignation as Chairman of the FDIC, effective 

June 1. Chairman Helfer’s resignation letter to President Clinton stated she achieved the goals she set 

when taking office on October 7, 1994. Several of 

these goals included the formation of the Division of 

Insurance to identify emerging areas of risk and to 

provide economic data to field examiners; a systematic analysis into the causes of the banking crisis of 

the 1980s and early 1990s; and the use of a diagnostic 

approach to bank examinations that focuses on risk. 

The direction of the agency changed under Chairman Helfer to an agency that stresses the need to 

help banks stay healthy and serve their communities. 

The passage of the Deposit Insurance Funds Act of 

1996 on October 1, 1996, which resulted in the full 

capitalization of the Savings Association Insurance 

Fund, was a notable achievement. Chairman Helfer 

was the first woman to head a federal bank regulatory agency. PR-19-97, FDIC, 3/14/97. 

Vice Chairman Hove Named 


Acting Chairman
 

Vice Chairman Andrew C. Hove, Jr. became 

FDIC’s Acting Chairman on June 1, 1997. This is 

Mr. Hove’s third term as Acting Chairman, including 

a two-year period following the death of Chairman 

William Taylor. Prior to serving as an FDIC Board 

member, Mr. Hove was Chairman and CEO of Minden Exchange Bank and Trust of Nebraska. PR-39-97, 

FDIC, 6/2/97. 

FDIC Adopts ADR Policy 

The FDIC on January 10, 1997, adopted a policy 

statement to further its commitment to the use of 

alternative dispute resolution (ADR) as an attempt to 

limit litigation or to provide a means of settling disputes. The policy statement was modified because 

of the re-enactment of the Administrative Dispute 

Resolution Act. 

Real-Estate Survey—January 1997 

The outlook for the nation’s residential and commercial real-estate markets continued to be favorable 

during the fourth quarter of 1996, according to the 

FDIC’s January 1997 issue of Survey of Real Estate 

Trends. This is a survey of senior examiners and other 

experts at the federal bank and thrift regulatory 

agencies about developments in their real-estate 

markets. The national composite index that summarizes responses reached 68 in January, up from 67 in 

October. The commercial index equaled 71 and the 

residential index was 65. Residential real-estate markets continue to show strength. Commercial markets 

are improving, with additional reports of rising sale 

prices and a larger volume of sales of commercial 

properties. Survey of Real Estate Trends, January 1997. 

*Jane Coburn is a financial analyst in the FDIC’s Division of Research 

and Statistics. 

Reference sources: American Banker (AB); Wall Street Journal (WSJ); 

BNA’s Banking Report (BBR); and Federal Register (FR). 

33 
FDIC Banking Review 

Real-Estate Survey—April 1997 

The April 1997 issue of the Survey of Real Estate 

Trends reported improvements in real-estate markets 

across the country. The survey of senior examiners 

and asset managers at the federal bank and thrift regulatory agencies indicated that during the previous 

three months overall results were positive, with 

widespread gains occurring in residential and commercial markets. Residential real-estate markets 

improved in the Northeast and Midwest regions. 

The composite index used by the FDIC to summarize results for both residential and commercial 

real-estate markets nationwide reached 71 in April, 

up from 68 in January. The commercial index 

reached 74, up from 71 in January; the residential 

index rose to 69 from 65 in January. Values above 50 

reflect improving conditions, values below 50 indicate declining conditions. Reports of excess supply 

in commercial real-estate markets continued to 

decline because of reports of higher demand for new 

office space. The housing markets outlook continued to improve in April, with reports of tight supply 

in every region. Survey of Real Estate Trends, April 1997. 

Real-Estate Survey—July 1997 

The July 1997 issue of the Survey of Real Estate 

Trends reported that conditions in residential and 

commercial markets improved during the prior three 

months. The composite index that summarizes the 

residential and commercial markets moved to 74 in 

July, up from 71 in April. The regional composite 

indexes moved upward in July except for the Midwest region, which was unchanged. The West 

region’s composite index and component index had 

the strongest showing of the four regions. Three 

hundred federal banking and thrift agency examiners 

and asset managers responded to the survey. Survey of 

Real Estate Trends, July 1997. 

Electronic Banking Safety-and-Soundness 

Exam Procedures 

On January 29, 1997, the FDIC issued safety-andsoundness examination procedures to its examiners 

that pertain to electronic banking. The procedures 

focus on planning, administration, internal controls, 

and policies. These procedures are just one component of a four-part approach to evaluating the risks 

inherent in emerging electronic banking activities. 

FIL-14-97, FDIC, 2/26/97. 

Part 344 Regulations Revised 

The FDIC has approved a rule that updates the 

regulations on securities record keeping and confirmation requirements for insured branches of foreign 

banks and nonmember banks. The rule revised Regulation 344 with an effective date of April 1, 1997. 

BBR, 3/3/97, pp. 400-401. 

1996 Financial Results 

The Bank Insurance Fund (BIF) earned $1.4 billion in 1996, ending the year with a balance of $26.9 

billion. Assessment revenue equaled $73 million, 

with interest earned on investments in U.S. Treasury 

obligations reaching $1.3 billion. The BIF reserve 

ratio reached 1.34 percent at year-end 1996. Five 

banks failed during the year with $182 million in total 

assets and $43 million in estimated losses to the BIF. 

The Savings Association Insurance Fund (SAIF) 

grew to a balance of $8.9 billion at year-end 1996. 

The SAIF reserve ratio at year-end 1996 equaled 1.30 

percent. Net income equaled $5.5 billion, which 

included a $4.5 billion one-time special assessment 

that capitalized the fund. One SAIF-insured institution failed in 1996 with total assets of $35 million and 

at an estimated cost to the SAIF of $14 million. PR21-97, FDIC, 3/25/97. 

1997 Midyear Financial Results 

The Bank Insurance Fund earned $535 million in 

the first half of 1997, ending the second quarter with 

a balance of $27.4 billion. The Savings Association 

Insurance Fund reached $9.1 billion with earnings of 

$246 million. PR-58-97, FDIC, 8/26/97. 

Assessment Rates 

The FDIC Board voted on May 6, 1997, to leave 

deposit insurance premium rates unchanged for the 

remainder of 1997. The assessment rate schedule for 

the remainder of 1997 ranges from zero basis points 

to 27 basis points for BIF-insured and SAIF-insured 

institutions. The FDIC reported that 95 percent of 

BIF-member institutions and 90 percent of SAIFmember institutions are rated well-capitalized and 

will continue to pay nothing for their deposit insurance coverage. The FICO rate on BIF-assessable 

deposits was set at 1.26 basis points; the rate for 

SAIF-assessable deposits was set at 6.30 basis points. 

FIL-59-97, FDIC, 6/6/97; PR-30-97, FDIC, 5/6/97. 

Semiannual Agenda of Regulations 

The FDIC published its most recent semiannual 

regulatory agenda in the Federal Register on April 

25, 1997. The agenda provides information about 

the FDIC’s current and projected rule makings, as 

well as information on existing regulations under 

review, and completed rule makings. Many of the 

pending regulations have resulted from the FDIC 

Board’s continued efforts to reduce the regulatory 

burden on banks, simplify rules, improve efficiency, 

and to comply with the Riegle Community Development and Regulatory Improvement Act of 1994. Of 

the 30 final or proposed rule changes, 8 were completed, 6 were published as proposals, 14 were 

expected to be proposed for public comment, and 2 

34 
Recent Developments 

may be issued for public comment. PR-33-97, FDIC, 

5/14/97. 

Proposed Changes to Simplify Deposit 


Insurance Rules
 

On April 29, 1997, the FDIC Board proposed 

changes to clarify and simplify the deposit insurance 

rules. The changes will make insurance rules less 

burdensome, more efficient, and easier to understand. The rules will include commonplace illustrations explaining how particular provisions affect basic 

types of consumer accounts. Also revisions to the following insurance rules are proposed: added flexibility for third-party deposits made by businesses on 

behalf of their customers, an extended grace period 

for beneficiaries, and clarification of insurance coverage of living trust accounts. PR-27-97, FDIC, 4/29/97. 

Foreign Banking Activities 

The FDIC Board proposed a rule that would allow 

well-managed state nonmember banks with international operations to engage in new activities without 

filing a formal application. The proposed rule consolidates and updates existing regulations with the 

goal of allowing state nonmember banks to compete 

effectively internationally. The FDIC’s international rules have not been revised since 1979 and will be 

consolidated into one regulation and reflect interagency standards. PR-45-97, FDIC, 6-24-97. 

Report on Underwriting Practices 

The semiannual Report on Underwriting Practices 

found that bank underwriting standards are sound 

but that some institutions engage in potentially dangerous lending practices. The purpose of the survey 

is to provide an early-warning mechanism for identifying potential lending problems and to report on the 

riskiness of current underwriting practices at FDICsupervised, state-chartered nonmember banks. The 

focus of the survey is threefold: material changes in 

underwriting standards for new loans, degree of risk 

in current practices, and specific aspects of the underwriting standards for new loans. The April issue 

of the Report on Underwriting Practices indicated that 

91 percent of the examined banks showed no material change in underwriting practices since their last 

examination. Report on Underwriting Practices, FDIC, April 1997. 

Federal Reserve Board 

Regulatory Relief 

The Federal Reserve Board on February 19, 1997, 

eliminated numerous rules and application requirements, with the intent to improve the competitive 

environment for banks. Tying restrictions have been 

eliminated and several activities (securities, data processing, consulting, and investment advisory) have 

been added to the list of activities permissible for 

bank holding companies. The changes in the rules 

should also shorten the application processing time 

related to the Community Reinvestment Act. AB, 

2/20/97. 

Federal Funds Rate Increase 

The Federal Reserve Board raised the federal 

funds rate 0.25 percent on March 25, 1997, to 5.5 percent. The federal funds rate, the rate that banks 

charge each other for the use of overnight funds, had 

remained unchanged since January 1996. WSJ, 3/26/97. 

Regulation CC 

The Federal Reserve Board on March 18, 1997, 

issued a final rule clarifying Regulation CC which 

governs the availability of funds and the collection of 

checks. The effective date for the rule is April 28, 

1997. The clarification related to the Federal 

Reserve’s check collection and return process. BBR, 

3/24/97, pp. 548-49. 

Regulation M 

The Federal Reserve Board has finalized its consumer leasing rules relating to Regulation M. The 

rules are effective immediately, with compliance 

optional until October 1, 1997. Regulation M applies 

to leases of personal property valued at less than 

$25,000 and when the lease term exceeds four 

months. BBR, 4/7/97, p. 638. 

Regulation Z 

The Federal Reserve Board has revised Regulation Z, the Truth in Lending Regulation. The 

revised ruling provides guidance on the treatment of 

fees associated with mortgage loans and error tolerances because of the disclosure of finance charges 

and other costs. The rule became effective February 

28, 1997, with compliance optional until October 1, 

1997. BBR, 3/10/97, pp. 444-45. 

Examination Frequency 

On January 24, 1997, the Federal Reserve Board, 

the Office of the Comptroller of the Currency, the 

Federal Deposit Insurance Corporation, and the 

Office of Thrift Supervision issued an interim rule 

and request for comment on a proposal to expand the 

examination frequency cycle for particular institutions. Examination frequency will be expanded to an 

18-month cycle for 2-rated, well-managed banks 

from the current asset size limit of $100 million to a 

new limit of $250 million. Federal Reserve Bulletin, March 1997. 

35 
FDIC Banking Review 

Office of the Comptroller

of the Currency 

Derivatives Handbook Published 

The OCC issued guidelines to national bank 

examiners relating to derivatives trading. The 

lengthy handbook includes guidelines on bank 

employee compensation, validation of national 

banks’ risk measurement models, and early termination agreements. AB, 1/27/97. 

National Access Committee Formed 

The Comptroller has formed a National Access 

Committee to support research, policy development, 

and outreach efforts to meet the OCC objective of 

improving access to financial services for the public 

and to support national banks’ new product and geographic markets. The committee, which plans to 

meet quarterly, includes 12 OCC employees and is 

chaired by the Assistant Deputy Comptroller for 

Compliance Management. NR-97-28, OCC, 3/14/97. 

Revenue Report 

The Comptroller issued a working paper titled, 

“Profit Persistence in Large U.S. Banking Companies.” The working paper concluded that banks earn 

higher profits by focusing on revenue-enhancing 

businesses rather than by focusing on cost-cutting 

measures. The study reviewed 237 large bank holding companies during 1986-92. AB, 2/28/97. 

Rules Changed for Bank Fiduciaries 

On December 27, 1996, the OCC released final 

changes to the regulations that govern the fiduciary 

activities of national banks. These rules, which have 

not been reviewed since the mid-1960s, became 

effective January 29, 1997. The rules include standards for how national banks hold and invest assets 

for their beneficiaries. BBR, 1/6/97, p. 6. 

Director’s Handbook 

The Comptroller has published a handbook 

describing the responsibilities of national bank directors. The handbook, “The Director’s Book: The 

Role of a National Bank Director,” was last revised in 

1987. The handbook explains bank directors’ 

responsibilities in overseeing the operations of a 

bank. AB, 4/9/97. 

International Comparison 

The Comptroller released a study titled, “Commercial Banking Structure, Regulation, and Performance: An International Comparison,” on March 24, 

1997. The research found no adverse effects for 

banks that are allowed to conduct a range of securities, insurance, and real-estate activities directly or 

through subsidiaries. The OCC reviewed the banking environments of 19 countries. BBR, 3/31/97, p. 594. 

Housing Video 

The OCC has produced a videotape and workbook that demonstrates to national banks how to participate in the federal low-income housing tax-credit 

program. The discussion includes how national 

banks can participate in providing affordable rental 

housing using the federal program under the investment authority provided national banks by the 

OCC’s community development and other public 

welfare investment regulations. BBR, 6/2/97, p. 1,045. 

Virtual National Bank 

The OCC has chartered the first virtual national 

bank, although the bank will not operate on the 

Internet. The bank intends to operate using telephone connections or customers’ personal computers 

and offer deposit products and electronic bill payment. The Houston-based Compubank was chartered late this summer and will begin operations on 

February 1, 1998. AB, 8/29/97. 

Federal Financial Institutions 

Examination Council 

Call Report Changes 

Beginning with the June 30th Call Report, filers 

will report residential mortgage assets separately 

from other assets and mortgage derivatives separately from other securities. Additional details on the 

maturities of residential loans and mortgage derivatives will also be required. AB, 3/4/97. 

CAMELS Guide 

The FFIEC has published a question-and-answer 

guide explaining the new S-component in the 

CAMELS supervisory rating system. The guide clarifies the revised CAMELS rating system that the 

financial institution regulatory agencies adopted in 

December 1996. The guide addresses questions 

such as how the S-component, which is a measure of 

sensitivity to market risk, will be determined and its 

importance relative to the composite rating. The 

sixth component of the CAMELS rating system 

reflects the degree to which changes in interest rates, 

foreign-exchange rates, commodity prices, or equity 

prices can influence an institution’s earnings or capital. The S-component represents the institution’s 

management ability to identify, measure, monitor, 

and control market risk. Also considered as part of 

the grading of the S-component is the institution’s 

total asset size, complexity of activities, and the level 

of capital and earnings with respect to the level of 

market risk exposure. FIL-17-97, FDIC, 3/7/97; FIL-105-96, 

FDIC, 12/26/96; Regional Directors Memorandum, 97-004, FDIC, 1/8/97. 

36 
Recent Developments 

Year 2000 Conversion 

The FFIEC issued a statement to financial institutions addressing the Year 2000 date change. The 

statement provides guidance on the activities needed to make computer systems capable of recognizing dates after 1999. The statement encourages 

financial institutions to reprogram their computer 

systems to adapt for the date change. The FFIEC 

included a five-point plan—awareness, assessment, 

planning, validation, and implementation. The 

statement indicated that bank regulators will 

review financial institutions’ efforts by mid-1998. 

FIL-50-97, FDIC, 5/9/97. 

Office of Thrift Supervision 

Lending Rule 

The Office of Thrift Supervision (OTS) finalized 

a new rule that allows federal thrifts to lend twice as 

much to commercial borrowers. The rule will allow 

thrifts to lend up to 20 percent of assets, with stipulations for small-business loans. The rule became 

effective April 3, 1997. AB, 4/9/97. 

Holding Company Report 

According to an OTS report titled “Holding Companies in the Thrift Industry,” one-third of all thrift 

assets are held by savings-and-loan companies with 

some non-banking-related activities. The OTS 

reports that ownership of a thrift by a commercial 

firm includes the following advantages: enhanced 

access to capital markets, lower borrowing costs, 

and customer service advantages. BBR, 4/21/97, pp. 758­

59. 

Liquidity Level 

The OTS has proposed a rule change to lower its 

minimum liquidity requirements for SAIF-insured 

institutions. The OTS would lower the liquid asset 

requirement to 4 percent. BBR, 5/19/97, p. 958. 

New Federal Thrifts 

The OTS has initiated new rules to simplify the 

paperwork requirements and reduce administrative 

costs for forming a new federal savings institution. 

The new rules are effective July 1, 1997. BBR, 5/26/97, 

p. 1,007. 

Thrift Depositor Protection

Oversight Board 

The House Banking Committee unanimously 

agreed to abolish the Thrift Depositor Protection 

Oversight Board. The Board was created in 1989 

during the savings-and-loan debacle with the purpose of overseeing the Resolution Trust Corporation 

(RTC). The RTC was abolished in 1995. BBR, 9/15/97, 

p. 400. 

National Credit Union 

Administration 

The Supreme Court on February 24, 1997, agreed 

to rule on whether credit unions may serve employees at more than one company. The Court will be 

making a decision whether to overrule the federal 

appeals court decision requiring all members of a 

credit union to share a single, common bond. This 

case originally began in North Carolina in 1990. AB, 

2/25/97. 

Federal Housing Finance Board 

New Ruling 

The FHFB approved a rule that allows Federal 

Home Loan Banks to lend to borrowers that are not 

members of the System. Previously, FHFB approval 

was required. Nonmember institutions must meet 

several criteria to be eligible to receive advances. AB, 

2/20/97. 

Mortgage Partnership Finance 


Program
 

The FHFB approved a pilot program to find new 

ways of funding and managing home mortgages. 

The Mortgage Partnership Finance Program is being 

tested at the Chicago FHLBank. The potential benefits of the pilot include greater credit availability for 

housing finance and increased profitability for member banks. BBR, 1/13/97, p. 79-80. 

Qualified Thrift Lender 

The FHFB approved an interim final rule on 

February 6, 1997, to aid the FHLBank System in 

determining whether commercial bank and credit 

union members satisfy the qualified thrift lender 

(QTL) requirements. The new rule allows 

FHLBanks to accept supplemental financial information not available in quarterly Call Reports. The 

rule allows for more assets that savings associations 

are permitted to use to qualify for the QTL standards. Savings associations may now include the 

full amount of educational, small-business, and 

credit-card loans. BBR, 2/10/97, p. 270. 

Eligibility and Pricing Rule 

The FHFB on February 19, 1997, approved a rule 

that establishes uniform eligibility and pricing 

requirements for FHLBank System advances to nonmember state housing finance agencies. BBR, 2/24/97, p. 

368. 

37 
FDIC Banking Review 

Community Support Program 

The FHFB adopted new rules governing its 

Community Support Program. The new rules 

streamline the program’s documentation review 

process and reduce compliance requirements to a 

one-page community support statement. The ruling also addresses uniform performance standards 

for all members of the FHLB System and a commitment to promote housing finance and support 

local communities. BBR, 5/12/97, p. 903-904. 

Securities and Exchange Commission 

The SEC approved a rule requiring extensive disclosure about the financial risks posed by derivatives. 

The rule should enable investors to understand better 

how a company uses derivatives. The rule becomes 

effective in 1998. WSJ, 1/29/97. 

STATE LEGISLATION AND REGULATION
 

Alaska 

Alaska enacted a new trust fund law on April 1, 

1997. The state has removed all limits on the life of 

a trust established in the state. And there will not be 

any limits on how long individuals can remain beneficiaries of their own trust. AB, 4/21/97. 

Arkansas and Nebraska 

Arkansas and Nebraska have enacted interstate 

branching legislation, effective May 31, 1997. BBR, 

3/31/97, p. 611. 

Colorado 

Colorado’s Governor approved legislation allowing 

banks and other financial institutions to sell insurance. Banks, thrifts, and credit unions will be 

allowed to sell insurance and annuities. The new 

rule supersedes the limitation of selling insurance in 

communities of less than 5,000 people. Both banking and insurance professional associations favored 

the legislation. BBR, 5/19/97, p. 951. 

Connecticut 

Connecticut’s state legislature has developed a 

new state charter to encourage the formation of new 

banks. The purpose of the new community bank 

charter is to increase the availability of banking services to small businesses and other customers not 

served by large banks. The new charter is expected 

to be approved by the Connecticut General Assembly. AB, 1/24/97. 

Connecticut’s state legislature passed legislation 

that would allow state-chartered banks to sell insurance. The Governor of Connecticut approved this 

legislation on July 8. AB, 6/10/97. 

Delaware 

Delaware’s state legislature passed legislation this 

summer that protects trust assets from creditors. 

The new trust legislation also waives public filing of 

trust agreements and assigns trust rulings to the state 

chancery court instead of local courts. This law was 

passed to enable Delaware to remain competitive 

with the recently enacted Alaskan trust law. AB, 

7/24/97. 

Illinois 

Both houses of the Illinois General Assembly 

approved legislation that would allow state-chartered 

banks to sell insurance products. BBR, 6/2/97, pp. 1,038-39. 

Maine 

The Maine state legislature approved a smallbusiness bank charter, with the institutions termed 

merchant banks. These merchant banks, considered 

nonbanks, will not accept deposits nor be regulated 

by federal bank regulatory agencies. AB, 4/21/97. 

On June 5, Maine’s legislature created a new charter for financial institutions in the state. All new 

charters issued in Maine will be universal banks, 

with all institutions granted the same powers. Prior 

restrictions applicable to savings banks and thrifts 

have been eliminated. State-chartered banks, savings banks, and thrifts became universal banks and 

will share powers that were previously unique to 

each charter. AB, 6/11/97 and BBR, 6/16/97, p. 1,147. 

Mississippi 

On March 10, 1997, the Governor of Mississippi 

signed legislation that clarifies that state-chartered 

banks have insurance powers equal to those of 

national banks. BBR, 3/31/97, p. 611. 

Montana 

The Montana legislature has voted to opt out of 

the Riegle-Neal interstate branching law. The newly 

signed state law will forbid interstate branching until 

September 30, 2001. The state will allow statewide 

branching for the first time; previously, banks could 

only branch within their home county and adjoining 

counties. Montana and Texas are the only two states 

to opt out of interstate branching. AB, 4/8/97. 

New Hampshire 

New Hampshire state banks will be able to sell 

insurance in communities with 5,000 or fewer resi38 
Recent Developments 

dents beginning in 1998. The state insurance commissioner will regulate the sale of insurance by financial institutions. The law requires that banks keep 

banking and insurance activities separate. BBR, 7/7/97, p. 26. 

Pennsylvania 

Pennsylvania’s Governor signed legislation allowing state banks to sell insurance. The new law was 

passed without any restrictions on where state-chartered banks may sell insurance. The law does prohibit the receiving of a loan based on the borrower 

purchasing insurance from the same bank. AB, 6/30/97. 

Utah 

Utah’s Governor signed legislation ending a tenyear freeze on the issuance of industrial loan company charters. Industrial loan companies will be permitted to make loans and are FDIC-insured. The 

new law allows companies to enter the banking business without the Federal Reserve Board supervision 

required for bank holding companies. The industrial loan charter will allow similar powers to those 

of a national bank except for checking services. AB, 

4/3/97. 

Wyoming 

The Wyoming legislature has voted to opt in to the 

Riegle-Neal interstate branching law. The interstate 

banking bill will allow interstate branch banking and 

bank mergers in the state. The Governor is expected to sign the legislation later this year. BBR, 2/24/97, p. 

365. 

BANK AND THRIFT PERFORMANCE
 

1996 Results 

Commercial banks’ full-year earnings were $52.4 

billion in 1996, setting a new record. This was an 

increase of $3.6 billion (7.5 percent) over 1995. Commercial banks’ full-year return on average assets 

(ROA) rose to 1.19 percent, up from 1.17 percent in 

1995. This is the second-highest annual ROA 

reported by the industry, after the 1.2 percent registered in 1993. 

Approximately $13.7 billion in net earnings was 

reported for the fourth quarter of 1996. This represented the third-highest quarterly net income ever 

reported. Approximately 60 percent of insured 

banks reported earnings gains for 1996, and more 

than two-thirds of all banks reported full-year ROAs 

of 1 percent or higher. Noninterest income contributed heavily to the record level of earnings in the 

fourth quarter, which was 13.3 percent higher than in 

the fourth quarter of 1995. The number of problem 

banks dropped to 82 in 1996, down from 144 for 

1995. The total assets of problem banks declined 71 

percent during 1996, falling to $5 billion. 

Profits earned by FDIC-insured savings institutions reached $2.2 billion in the fourth quarter, for an 

average annualized ROA of 0.85 percent. Net interest margins held relatively steady in the fourth quarter, rising to 3.24 percent from 3.22 percent in the 

third quarter. The number of problem savings institutions fell to 35 in 1996, down from 49 in 1995. The 

assets of problem savings institutions fell 50 percent, 

to $7 billion in 1996. FDIC Quarterly Banking Profile, Fourth 

Quarter 1996; PR-16-97, FDIC, 3/13/97. 

First-Quarter Results for 1997 

Commercial banks’ average return on assets—the 

industry’s performance barometer—was 1.26 percent 

in the first quarter. It was the 17th consecutive quarter that the industry’s ROA exceeded one percent 

and the fourth-highest ever reported. Insured commercial banks earned a record $14.5 billion in the 

first quarter. Earnings were fueled by strong growth 

in interest-earning assets and continued increases in 

noninterest income. The number of problem banks 

dropped to 77, down from 82 in 1996. There were no 

bank failures in the first quarter of 1997. 

Profits earned at FDIC-insured savings institutions were $2.4 billion in the first quarter, for an average annualized ROA of 0.96 percent. This 

represents a decline in earnings of $136 million from 

the same period last year. The number of problem 

savings institutions remained unchanged from yearend, at 35. The total assets of problem savings institutions declined to $5.3 billion from $7.0 billion. 

FDIC Quarterly Banking Profile, First Quarter, 1997; PR-42-97, FDIC, 

6/17/97. 

Second-Quarter Results for 1997 

Commercial banks’ average return on assets 

(ROA) was 1.25 percent in the second quarter, up 

from 1.18 percent in the first half of 1996. This is the 

18th consecutive quarter that the industry’s ROA 

exceeded 1 percent. Insured commercial banks 

earned a record $14.6 billion in the second quarter— 

a $154 million improvement over the record the 

industry set in the first quarter. Earnings were 

fueled by a surge in commercial and industrial lending. The profitability of credit-card lenders—74 

institutions where credit-card loans are more than 

half of their total loans—has significantly eroded 

over the past three years. Almost half of these institutions reported declining income in the second 

quarter, with 14 credit-card banks losing money in 

39 
FDIC Banking Review 

the quarter. This drop in profitability is because of 

a rise in charge-offs, with credit-card charge-offs 

accounting for two-thirds of all loan charge-offs 

reported by commercial banks during the second 

quarter. The number of problem banks dropped to 

74, down from 82 in 1966. There were no bank failures in the first half of 1997. 

Profits earned at FDIC-insured savings institutions reached $2.4 billion in the second quarter, for 

an average annualized ROA of 0.95 percent. The 

number of problem savings institutions fell to 29 at 

midyear from 35 institutions at the end of the first 

quarter. Assets of problem savings institutions 

declined to $2.8 billion. FDIC Quarterly Banking Profile, Second 

Quarter, 1997. 

RECENT ARTICLES AND STUDIES
 

The U.S. General Accounting Office (GAO) 

released a study on January 6, 1997, titled, “Japanese 

Bank Regulatory Structure.” AB, 1/8/97. 

A Federal Reserve Board study finds that nonbanks are making gains against traditional consumer 

lending institutions. The study found that finance 

and other loan companies are growing faster than traditional sources of consumer lending. The study was 

published in the January 1997 issue of the Federal 

Reserve Bulletin. AB, 1/16/97. 

On March 26, 1997, the GAO released a report 

titled, “Material Loss of Oversight Information From 

Interstate Banking Is Unlikely.” The report concludes that interstate branching is unlikely to result 

in a material loss of information needed for regulatory oversight and modification of regulatory reporting 

requirements is not necessary. GAO/GGD-97-49, March 1997. 

The Federal Reserve Bank of Boston published a 

study on bank consolidation with regard to borrower 

concentration limits. The study, “Have Borrower 

Concentration Limits Encouraged Bank Consolidation?”, reviews motivations for bank mergers and 

their regional patterns. FRB of Boston, New England Economic 

Review, January/February 1997. 

The GAO issued a report on March 27, 1997, 

warning of the risks associated with mergers between 

banks and nonfinancial firms. The GAO report predicted few benefits from combining banking and 

commerce. AB, 3/31/97, p. 459. 

The Federal Reserve Bank of New York released 

a report detailing information that increased household debt tends to signal increased consumer spending. The more common thought is that spending 

will drop as debt increases. BBR, 3/10/97, p. 459. 

The Federal Reserve Bank of St. Louis released a 

study finding that the new policy of immediately disclosing Federal Open Market Committee decisions 

has been beneficial. The study found that the concerns about an announcement effect and increased 

financial market volatility were unwarranted. WSJ, 

5/2/97. 

The Federal Reserve Bank of St. Louis and the 

University of Missouri produced a report titled, “Do 

Markets and Regulators View Bank Risk Similarly?”. 

The conclusion of the research was that market 

forces are not a substitute for government regulation 

of banks, because regulators and investors view risk 

differently and regulators require adequate capital to 

guard against bank failure. AB, 5/9/97. 

The Federal Reserve Bank of Cleveland has concluded that the central bank can increase consumer 

spending in the short term but is unable to increase 

real economic growth. The report is titled, “Monetary 

Policy and Real Economic Growth.” AB, 6/31/97. 

The Congressional Budget Office released a study 

claiming that a separate thrift industry is no longer 

needed because of the fact that home mortgage loans 

are readily available to the public. The large secondary market for mortgage debt is a significant reason for the CBO’s finding. BRR, 6/23/97, p. 1,181. 

The Office of the Comptroller of the Currency 

published a study stating that deposit insurance 

does not give banks a significant subsidy. The study 

claims that the net insurance-related subsidy 

enjoyed by a bank is minimal and may be negative. 

The study entitled, “The Competitive Implications 

of Safety Net-Related Subsidies,” is available from 

the OCC. AB, 7/11/97. 

Support Group for Modern Banking 

A new banking group entitled the Support Group 

for Modern Banking was formed in March. The 

managing trustee, Carter Golembe, stated the purpose of the group is dedicated to preserving recent 

gains and expanding the national bank franchise. 

Eighteen industry leaders are the founding members 

with the goal of participating in litigation, filing comment letters, and writing policy papers; lobbying is 

not planned. AB, 3/31/97. 

40 
Recent Developments 

INTERNATIONAL DEVELOPMENTS
 

Basle Committee 

The Basle Committee on Banking Supervision has 

issued a 12-point list of principles to improve bank 

management of interest-rate risk. The list, which 

was issued on January 21, 1997, also eliminated the 

effort to incorporate a capital charge for interest-rate 

risk into its bank risk-based capital rules. Overall, 

the principles state that banks need a risk management process that identifies and monitors interestrate risk. BBR, 1/27/97, pp. 177-78. 

Canada 

The Canadian government announced on February 14, 1997, that foreign banks will be allowed to 

operate in Canada directly through branches. 

Presently, foreign banks operate through subsidiaries, meeting costly capital and regulatory 

requirements. The United States has long favored 

this change. Canada expects this decision will 

encourage new banks to enter the Canadian market 

and to improve the competitive environment for foreign banks. Legislation to enact this change in bank 

policy will occur later in 1997. WSJ, 2/18/97. 

China 

China is preparing to permit more foreign investment in the country’s insurance and banking sector. 

China has indicated a readiness to allow more foreign 

investment but has not established a time-line for 

relaxing the current limitations. BBR, 3/1/7/97, pp. 527-28. 

England 

The British government announced in May that 

the Bank of England will exercise its monetary policy responsibilities independent of the Treasury and 

that the Bank’s supervisory powers will be transferred to the Securities and Investments Board. The 

Securities and Investments Board is an umbrella 

organization that oversees a variety of other regulators. British authorities based the removal of bank 

supervision on the fact that the distinctions between 

banking, securities firms, and insurance companies 

are no longer clear. The Financial Times, 5/21/97, p. 1. 

Japan 

Japan has agreed to lift its ban on the formation of 

holding companies, beginning January 1998. However, the formation of holding companies will not be 

allowed if it leads to an excessive concentration of 

business power. A holding company exceeding $125 

billion in assets will be subject to close government 

examination. The Japan Fair Trade Commission is 

expected to issue effective cease-and-desist measures for violations. BBR, 3/3/97, p. 426. 

Japanese consumers are placing substantial funds 

in foreign-currency deposits and other products sold 

by foreign banks in Japan. Low interest rates and 

bad-debt troubles are two contributing factors. Two 

years ago, foreign banks’ share of foreign-currency 

deposits equaled 5 percent; today, it is 15 percent. 

BBR, 9/8/97, p. 382. 

Bank of International Settlements 


Quarterly Report
 

The 1997 first-quarter report of the Bank of International Settlements (BIS) stated that the international banking market remained healthy but there is 

cause for concern. The area of concern is the large 

cross-border investment flows because of interestrate differentials. The BIS recommended tighter 

rules for credit risks and the need to strengthen international risk-control systems. Also of concern is the 

establishment of the European Monetary Union. 

BBR, 6/2/97, p. 1,056. 

Romania 

Romania has legalized the privatization of state 

banks. The measure was signed on May 19, 1997. 

The government of Romania is scheduled to sell five 

state banks this year. The state-owned banks will be 

marketed to local or foreign investors through capital 

increases, share auctions, or both. BRR, 6/2/97, p. 1,060. 

Russia 

The Russian Central Bank has developed new 

restrictions for foreign banks operating in Russia. 

The restrictions include the doubling of capital and 

the adding of more Russian citizens as employees. 

The rules became effective May 15, 1997. BBR, 5/19/97, 

p. 973. 

41