United States. Congress. House. Committee on Small.

The effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 online

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Online LibraryUnited States. Congress. House. Committee on SmallThe effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 → online text (page 9 of 21)
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same time. Uncertainties associated with these developments can dampen
small business lending. They should be resolved.

Congress has passed the Riegle-Neal Interstate Banking and
Branching Efficiency Act of 1994. Riegle-Neal will add further
efficiencies to interstate banking operations. Interstate branching,
due to occur in June of 1997, may allow even more efficiency
opportunities for smaller banks. If the Congress does not otherwise
object, the Office of the Comptroller of the Currency will shortly enact
proposed changes in its Rules, specifically Part 5 thereof. (Part 5 -
Rules, Policies and Procedures for Corporate Activities, Title 12, CFR,
as revised October 15, 1980 in 45 Federal Register 68568.) The
structural operations allowed by the proposed rule will provide small
banks with critical operating efficiencies in the offering of non-
traditional banking services and products through operating
subsidiaries, rather than through separate affiliates in the holding
company format. Combined with new power to branch across state lines,
efficiencies afforded by combining new Part 5 structures with Interstate
Branching suggest that small and large bank consolidation in pursuit of
beneficial operating efficiencies is likely to continue. In some cases,
the structural and operating efficiencies of holding companies will not
be necessary. For small banks, this can mean a great deal. For small
business this means more sources of services and credit.

Significantly, the ability to diversify products and services under
Part 5 without efficiency barriers posed by excessive "firewalls" and
affiliation requirements that may be unnecessary can also provide
further safety and soundness for small banks through increased
efficiencies. Indeed the Comptroller has made it clear that such
diversification itself can be essential to the maintenance of safe and
sound operation in the newly-competitive world. Part 5 is important to
smaller banks. Its "universal" banking format is a boon to banks whose
size could otherwise preclude their offering a broader mix of financial
service products. As technology progresses, and deposits become more
dependent on the individual needs of customers, the particularized
customer service capacity afforded by offering a broad range of
financial service products able to be combined for specific customer
needs will be needed to attract deposits. These deposits are essential


if loans to small business are desired. Further reduction of regulatory
burden and increased consolidation have thus led to more and better
small business financial services.

It should also be emphasized that further steps by Congress and
banking regulators to facilitate the formation of operating structures
that further promote operational efficiencies are very important. Since
history tells us that small business is the first to feel the pinch when
banking margins are compressed by cyclical downturns, it is important
that structural and operational flexibilities be enhanced now, so that
present operating efficiencies can be maintained later. At this point
in the credit cycle, it is also appropriate to watch for the
reappearance of any excesses on the asset side of bank balance sheets,
but it is hard to imagine why properly monitored measures that promote
efficiency will be anything other than constructive in that regard.
Consolidations that lead to uncompetitive market power could also lead
to a diminution of available and appropriately priced banking services.
At present, however, there is no sign that consolidations intended to
promote efficiency have led to an anti-competitive atmosphere. In fact,
the ability of banks to seek their own size and the product and service
mix that best suits them, has led to a very competitive and highly
creative small business bank service market in New England. By
strengthening banks, these developments have benefited small business.
There is still more to be done. Measures that promote banks' operating
efficiencies should be encouraged. They enable banks to better serve
small business.

Recent Federal Reserve Call Report Data indicates that small
businesses of every size are well-served by regional and community bank
lenders. A quick look at Concord, N.H. is instructive in this regard.

Concord Savings Bank (CSB) , a community bank now serving Concord,
N.H., maintains a portfolio of small business loans (loans under $1
million) in excess of $10 million. Fleet, New England's largest bank,
has a branch in Concord. It lends nearly $144 million into the Granite
State with $31 million in loans under $100,000. Fleet's average size
small business loans are about $95,000, whereas CSB's average loan is
about $68,000. In Concord, both banks compete head-on. Each bank,
however, has its own mix of products and services. Each has its own
marketing emphasis. Their diversity of offerings is as important as
their overlap. They offer choice among basic services and special
services for special needs.

Concord Savings Bank offers a mix of basic business services that
includes a range of business deposit accounts, management, convenience,
and loan services. But it also pursues credit opportunities that
require a particular local assessment, especially within the borrower's
local market, where the bank's familiarity enables it to assess business
plans in a local competitive context. What might appear to some to be
"character"-type loans are in fact underwritten with a deep appreciation
of a local business 's prospects for success in a market that the bank
knows very well. Other community banks offer the same service.
Continued capacity to perform this service requires more opportunities
for efficient operation.


Fleet's size and structure enables it to focus efficiently on a
broad range of loans and services to business. Its number one position
in N.H. in loans of less than $100,000 to smaller business shows that
the Fleet approach can be the best choice for some. Fleet offers
services similar to Concord Savings Bank's, but with respect to certain
loans, especially the smaller business loans, Fleet has an efficiency
advantage, using tools of analysis and comparison available only to
institutions of its size. Significantly, small business has a choice.
That choice has created competition which has driven Concord's banks to
focus on what each can do best and most efficiently. Concord's business
is the beneficiary.

Competitors to be sure, these banks co-exist in complementary
fashion as well. Concord Savings Bank has become a leader statewide in
loans to auto purchasers, a service valued highly by the auto dealers
who use Fleet for other purposes. Fleet has offered small business
served by smaller community banks the benefits of foreign exchange and
trading services essential to their operation in foreign markets. Small
business in New Hampshire now competes in Southeast Asian markets using
cash and credit services, as well as interest rate hedges no smaller
bank could offer, while retaining their relationships with local
community banks for more localized services. Fleet has recently
enhanced the lending power of the New Hampshire Small Business
Development Corporation by providing new sources of capital that enable
$1 million in added small business development lending, and has
established a below market rate lending program for small business job
retraining in conjunction with New Hampshire's Department of Resources
and Economic Development. Its size enables Fleet to provide these
services. Many of the businesses served will simultaneously maintain
their business relationships with local community banks. The point is
everybody benefits by the ability of each respective bank to seek a size
and operating structure that suits it. In Concord, banks require more
relief from regulatory burden. One has gone through more consolidation,
but each must be efficient if it wishes to effectively compete and serve
its markets. As long as each can do so efficiently, and thus
competitively, those markets will be well-served.

Thus, the trends today towards operating efficiencies for banks are
healthy. Their continuation is essential. They are matched by the
needs of small business for greater operating efficiencies themselves.
The markets force small business to become more efficient. For banks,
such efficiencies are still the province of Congress, the courts, and
the regulators. It is important that these government structures allow
their wards, the banks, to keep up. Any excess regulation of banks is
a danger to small business — banking's key constituency. If banks are
burdened with surplus regulation, barriers to efficient operating
structures, or blocked from forming mass appropriate to their product
and service mix, they cannot serve small business. It is that simple.
It is that important to small business. It is thus that critical to New
Hampshire and New England.




A Study of Small Business Trends
in the Granite State

By Lisa K. Shapiro, Ph.D.
Gallagher, Callahan & Gartrell

Sponsored by

The New Hampshire Delegation to

The White House Conference on Small Business

in cooperation with

First NH Bank

March 1995


New Hampshire's delegation to the White House Conference on Small Business (WHCSB),
an independent commission created by Congress, is developing recommendations on how
Congress and the White House can improve the economic climate for small business. Joining
with First NH Bank, the state's leading small business lender, WHCSB sponsored this study of
small business trends in New Hampshire. Banking on Small Business in New Hampshire,
authored by Dr. Lisa Shapiro, an economist at Gallagher, Callahan & Gartrell, looks at where
most of the jobs are in New Hampshire, where job growth is, and where economic trends are
taking us

The adage, "Small business is the backbone of the NH economy," is evidenced by the fact that
63 percent of all jobs in New Hampshire are provided by small businesses.

According to 1990 data on employment in all SO states by firm size, in NHs total workforce the
slime of jobs field in small firms is 13 percent greater than it is generally regionwide or
nationwide. Additionally, over 95 percent of the state's 35,000 businesses employ fewer than 100
persons - and that number does not even reflect the number of people who are self-employed.

Tlie proportional sluve of the small business sector varies significantly across regions of and
industry in New Hatnpslure. With 78 percent, Carroll County has the highest percentage of jobs
in small firms, Strafford County, with less than 48 percent, has the lowest. Nearly 80% of all
retail jobs in New Hampshire are in small firms Three-fifths of the jobs in finance, insurance,
real estate and the service sector are in small business. About one-third of the manufacturing
jobs in the state are in small firms.


New Hampshire has outpaced both the region and the nation in the creation of new and successor
businesses since 1991. About 4700 new NH businesses were created in both 1991 and 1992.
In 1993, the number jumped to 5500. While the national number of new businesses was 5.8
percent higher, and the regional figure was 4.7 percent higher, the number of new NH businesses
was 16 percent higher in 1993 than in 1991.

Small business may be the only sector in which net job growth occurs during the early stages of
recovery from a recession. Small business has been the primary creator of net job growth during
the slow recovery from NH's most recent recession. It remains to be seen whether this is part
of the natural ebb and flow of the business cycle, or whether this signals a shift toward an even
greater contribution by small business in job creation in New Hampshire. Trends indicate that
small business will continue to be big business in the New Hampshire economy.

Small businesses have a higher market share in the service industries and are tlierefore likely to
benefit as tlie national economy sltifts from manufacturing toward tlie service sector, altlwugh
tlie average size of firms in tlie service industry is increasing.

Tlie national economy is transforming itself from an industrial-based economy to an information-
based economy. The cost of computer hardware and software has dropped precipitously. The
demand for niche software and other business-related services is growing rapidly. These changes
provide markets for the growing network of small companies both in rural areas and throughout
the state.

As some large firms in tlie region continue to downsize and increase tlieir reliance on
outsourcing, we can expect to see continued growth in markets for small businesses. Small
product development and processing firms in particular are likely to benefit from increased
outsourcing by large manufacturing and technology firms Employment in the rubber and plastics
industries has increased by more than 10.5% from 1993 to 1994, with net job growth in small
firms outperforming large firms nearly 2 to 1. Employment at small firms that manufacture
durable goods outpaced job growth at larger firms by 3 to 1 from 1993 to 1994, with a net
increase of nearly 50 new small firms.

As location becomes less important, small, start-up, and rapidly growing businesses in New
Hampslure will have increased access to tlie global market. A case in point is NH's home-grown
PC Connection, Inc.— a large business by NH standards, but small by standards worldwide PC
Connection, Inc. has experienced phenomenal growth rates to become a leading direct reseller
of software and peripherals. In addition, over 800 software firms employing 10,000 people are
located throughout New Hampshire.

Tlie preponderance of small business in New Hampslure slwws at tlw very least tliat our state's
economic climate is favorable to small-sized operations. Trends in our national economy indicate
that small business may play an increasingly important role nationwide in the overall job mix
The important role played by small business in NH's economic past and present may be eclipsed
by the critical role it can play in our state's future. Therefore, maintaining the elements that
contribute to the growth and development of small business becomes an important business and
public policy priority.


Financial System Evolution

By Alex J. Pollock

Chief Executive Officer
Federal Home Loan Bank of Chicago

1. Darwinian Competition Between Pubs and Markets

The efficiency of the financial system's intermediation, how well it is doing for the consumers of
financial services, is measured by the total spread between what the ultimate investor gets as a yield on
savings and what the ultimate entity being financed has to pay. The less the financial system takes out of
the middle, the more efficient it is.

The financial system designed in the 1930's created large spreads, for example between holders of
passbook savings on one hand, and corporate borrowers at prime rate or more, plus fifteen percent
compensating balances (as it used to be), on the other hand. The financial evolution of the last two decades,
shrinking the aggregate spread to intermediation, has continually reduced the role of the 1930's design, and
makes it impossible to support its former overhead structures.

In the broadest terms, what is happening in the United States and the world is a shift to market-based
intermediation and away from institutional intermediation, from matching of savings and investments within
the balance sheets of chartered financial institutions, to intermediation carried out by markets The shift is
away from bank loans to the creation of assets which are actively sold, distributed, traded and have public
bid and asked prices. The most fundamental reason for this shift is that markets tend to be more efficient
in the sense defined, to reduce the total cost of the intermediation which is bome by the consumers of the
financial services, and thus to be preferred by them.

This shift is reflected in a number of ways. It means a reduction in the share of all financial assets held
by the chartered financial institutions, a proportion that is steadily dropping It means loans being replaced
by financial assets held in marketable or securitized form. It means an especially noteworthy dominance
of the residential mortgage business by securitization, and the imminent disappearance of a separately
defined thrift industry. It means the decline of deposits as a funding base. It forces us to ask whether there
are any limits to securitization in sight.

Picture a Darwinian struggle between two financial species:

1) Chartered institutions, which allocate financial resources, price them, and hold them, based on their
own balance sheet, and which make decisions based on heavy and detailed regulation and direction
by bureaus of the chartering government, which in turn reflect complex political compromises.

2) Markets, which set prices and allocate resources based on active bidding, asking and trading assets
among a large number of informed, voluntary actors.

Which is generally the better resource allocator: the market or a heavily regulated institution? There
is a world-wide consensus that markets tend to better match up prices and risks. They do, that is, if there
is relatively low cost information and communication. All organizations, including markets, are systems of
knowledge and its use. If information and communication are cheap, then markets are superior systems for
gathering, applying and acting on knowledge.


By the transforming power of computing technology in this last quarter of the century, information costs
and communication costs have been driven very low, and markets therefore are gaining very rapidly at the
expense of chartered institutions.

One aspect of this contrast is that groups of chartered institutions in traditional, stable conditions tend
to form associations or "clubs" to reduce risk, limit competition, and protect profits. Clubs are most
successful when information is expensive and limited to insiders. For a club to persist, it must be able to
enforce its rules and to exclude outsiders from competing. In his provocative monograph, "The Evolution
of Central Banks," Charles Goodhard suggests that the function of enforcing rules and excluding outsiders
is best performed by a "club manager." The central bank evolves as the manager of the banking club,
operating to insure the common interests of safety and profits (it also serves the interests of the chartering
government, of course).

However, when conditions shift away from favoring the institutional, club systems to favoring market
systems, then the clubs can no longer hang together, and the club manager is faced with fundamental
dilemmas. We are living through a rapid shift to market based intermediation in the Darwinian struggle,
and the governmental club managers experience the stress along with the club members.

On an international view, we can say there are two fundamental kinds of financial systems: capital
market-based systems and bank-dominated systems Historically, there were only two capital market systems
in the world — those of the United States and United Kingdom. In a capital market system, banks are just
one element of an encompassing market, just one set of bidders for and offerers of funds among others, and
not the best rated ones, at that. The international trend is for this to be increasingly the case, because
information and communication are getting cheaper everywhere

2. The Irrelevance of the "Level Playing Field"

Discussion of what to do to adjust to the passing away of the 1930's government-sponsored financial
clubs is usually formed by the interests of the suppliers of financial services In addition, we have a
regulatory system naturally inclined to protect existing institutions So we hear countless times, "We have
to have a level playing field " This horribly dull term is repeated ad nauseam It is a supplier or industry

As the increasing combination of investment banking, commercial banking and thrift industries continues,
the point should not be to worry about whether the investment banks or the commercial banks or thrifts get
equally protected. The question should be what does the best for the consumers of financial services, not
what does the best for the suppliers. The question should be did we encourage or stifle the efficiency of
the financial system

As the system becomes more efficient, there is accordingly excess capacity which should leave and be
utilized elsewhere. Therefore, the shift away from clubs and club managers naturally protective of their
members, toward market systems, means consolidation.

In summary, there is a natural and desirable movement toward markets replacing chartered institutions,
riding on the back of cheap information and cheap communications There is a natural movement to
combine previously separate financial industries, since they use similar knowledge, and serve similar
economic functions for the same customers. There is no end in sight of the applied potential of cheap
computing and communications technology. Wherever the limits to securitization might be, they have not
been reached The trends are international.

Darwinian selection will continue.



John Gould

President & Chief Executive Officer

Associated Industries of Massachusetts

March 4, 1996

House of Representatives

Committee on Small Business

Subcommittee on Taxation and Finance

Field Hearing

'he Effects of Bank Consolidation
on Small Business Lending"
Boston, Massachusetts



For the record, I am John Gould, President and Chief Executive Officer of Associated
Industries of Massachusetts, an employer association that represents more than 3,500
Massachusetts companies. A.I.M.'s mission is to advocate public policy that advances economic
stability and promotes economic growth that benefits Massachusetts employers and employees
alike. Our members range from sole proprietorships to start-ups to firms that are household
names and all sizes in between. Every SIC code doing business in the Commonwealth is
represented in the A.I.M. membership. Sixty percent of our members are manufacturers, and the
balance are in the service sector of the economy. Our average member employs 50 or fewer

The late 1980s and early 1990s was a difficult period for banks and employers alike.
Higher capital requirements, especially for certain commercial loans, and more stringent risk
capital requirements for smaller borrowers, coupled with an economic recession, put a
tremendous strain on both bankers and employers. Fortunately, toward the mid-1990s, the
economy of the region started to move forward. For example, in December 1991, A.I.M.'s
Monthly Business Confidence Index reached an all-time low of 41.5 indicating that employers
were very pessimistic about business conditions and the prospects for their companies, the state
and the nation. In December 1995, however, the Business Confidence Index was 59.2 - more
than 1 7 points higher indicating much more confidence by employers regarding current and
future business prospects.


One of the reasons for the improvement in the state's economy since the late 1980s and
early 1990s most certainly is the expansion of bank credit. Starting as early as 1992, several area
banks, including the Bank of Boston and Fleet Bank, initiated major programs to stimulate bank
lending activities to Massachusetts employers. It is my opinion that these initiatives helped in
large measure to do much to improve people's confidence in the Commonwealth's economy. In
September 1991, in a special survey on credit availability, 17 percent of the members surveyed
indicated that they had lines of credit canceled, demanded and/or suspended, while 74 percent
did not. In January, 1993, only 10 percent of respondents indicated having lines of credit
canceled or suspended, while 90 percent did not. Moreover, in 1993, 66 percent of the
respondents indicated that the credit availability situation had either remained the same or had

Regarding small business lending by banks, The Federal Reserve Bank of Boston in its
fall 1995 report on New England banking trends, reported that small business lending rose a
modest two percent at New England banks from June 30, 1993 through June 30, 1995. In the
previous year, the bank reported a 2.8 percent decline in lending. The report also noted that the
growth in small business loans lagged behind the national growth in small business loans and

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Online LibraryUnited States. Congress. House. Committee on SmallThe effects of bank consolidation on small business lending : joint hearing before the Subcommittee on Taxation and Finance and the Subcommittee on Government Programs of the Committee on Small Business, House of Representatives, One Hundred Fourth Congress, second session, Boston, MA, March 4, 1996 → online text (page 9 of 21)