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FDIC REPORT ON PREFERENTIAL BANK
THURSDAY, MARCH 16, 1978
Washington, D.C. The committee met at 10 a.m., in room 5302, Dirksen Senate Office Building, William Proxmire, chairman of the committee, presiding.
Present: Senators Proxmire, Sparkman, and Tower.
OPENING STATEMENT OF CHAIRMAN PROXMIRE The CHAIRMAN. The committee will come to order. The purpose of today's hearing is to receive from the FDIC, the Comptroller, and the Federal Reserve a report on the special survey of banking practices undertaken last fall at my request. The banking practices covered by the survey have to do with bank stock loans, loans to insiders of the reporting banks, loans to insiders of other banks, and overdrafts to bank insiders and public officials. Questions about such banking practices and preferential lending were raised by the investigations into the banking practices of former Budget Director Bert Lance conducted by the Comptroller's office last summer. At that time serious questions were raised, but there was no evidence to indicate how widespread these practices were in the banking system.
For the first time we now have quantitative information about these banking practices. The survey results give us a clear, and I believe an accurate, picture of lending practices by commercial banks.
The survey shows a substantial volume of loans to insiders at preferential rates, especially during periods of high interest rates and tight money when bank lending is restrained. The survey also shows that rates charged on loans to insiders of other banks are lower when those banks maintain correspondent balances with the lending bank.
The survey also shows that the banks permit a very substantial volume of overdrafts each day-2 million overdrafts totaling almost $2 billion. Most of those overdrafts are interest free.
The banking practices survey clearly underscores the need for prompt action to strengthen bank regulations and to begin to curb insider loan abuses. It renews my view that S. 71 ought to be passed quickly by the House of Representatives so that its requirements can be enacted without delay. As you know, we have already passed S. 71 in the Senate; not on the basis that S. 71 is the final
word, but on the basis that it is a reasonable bill and it is needed now.
This survey took a lot longer to complete than I had hoped. It was also quite costly. The need for the survey and the extraordinary time and money spent by the agencies and the banks suggests that the bank regulatory agencies need to collect information on bank stock loans, insider loans, and overdrafts on a regular and routine basis. This should be done not only to reduce costs, but also so that they can know in a more timely manner what is going on in the banking system, and where actual and potential abuses occur.
Mr. LeMaistre, Mr. Heimann, and Governor Partee, we are happy to have you with us today to get your views on the survey results and recommendations that you may have to stop preferential lending. I realize that the time pressures you have been working under have been severe. I look forward to hearing your report. I understand that Mr. Heimann has an engagement and will have to leave a little later this morning. Is that correct, Mr. Heimann?
Mr. HEIMANN. At noon, Mr. Chairman.
The CHAIRMAN. I do understand that a summary of the survey has been prepared by the staffs of the three agencies and that you want to have it included in the hearing record. That will be done.
[The report is reprinted beginning at page 51.]
We would appreciate it if you could limit your remarks, abbreviate your remarks as much as possible, and we will include the entire statement that you have in the record.
Mr. LeMaistre, proceed-I beg your pardon. My esteemed colleague who's been on this committee for about 453 years and is of course a distinguished expert in this area has a brief statement he would like to make.
Senator SPARKMAN. Well, I will say I was on this committee when this fellow was just a boy and I have enjoyed it throughout the years. As a matter of fact, this is my 31st year as a member of this committee. I have enjoyed all of the work. I have enjoyed working with the various financial institutions and others with which we have been concerned and I share the concern of the chairman and all other members of the committee over abuses of insider transactions.
Banks and other financial institutions continue to be an important segment of our economic life and it is essential that the health and vitality of the financial industry be maintained. Illegal or unethical insider transactions are harmful to the economic well being of the institutions involved and for that reason alone are not in the public interest. In addition, such transactions represent a breach of trust to depositors and to the public generally. This cannot be tolerated.
Having said that, I want to emphasize the fact that we are talking about abuses. Insider transactions, as such, are not illegal. We have controls on such transactions in order to prevent abuses. The question before us is whether our controls are sufficient. We cannot and should not abolish insider transactions. Many financial institutions would find it impossible to attract capable management personnel or directors if such people were denied access to credit and other financial services. This is especially true in small
and medium sized cities where the economic life of the community revolves around the business of industrial organization.
I am confident that the committee will act constructively to deal with whatever problems we have to study. Thank you, Mr. Chairman.
The CHAIRMAN. Thank you, Senator Sparkman.
STATEMENT OF SENATOR TOWER Senator TOWER. Mr. Chairman, during these hearings the committee will be exploring the results of a special survey conducted by the bank regulatory agencies of certain banking practices. This survey grew out of the so-called Bert Lance affair. The purpose of this survey was to determine the extent to which banks in this country engaged in banking activities associated with Mr. Lance.
There are several points I feel should be made about this survey. For one thing, it involved a great deal of time, money and effort on the part of the agencies and the banks to produce the survey results. The question is whether or not it was worth the effort. Obviously, it is preferable to legislate in the light than in the dark. All too often, there is a tendency to legislate without knowing all the facts.
In this case, however, I have serious concerns about the reliability or usefulness of the survey results. My concerns in this matter were heightened by Governor Partee's statement in his testimony presented on behalf of the Federal Reserve Board. He states that:
*** The Board believes the data to be a good deal lower in quality than most regularly collected banking data, and has serious reservations about its reliability.
In my view, there is a great deal of information surrounding the types of banking practices that were surveyed which cannot be explored or explained in a survey of this type. Because of this, the raw data are subject to various interpretations and in some cases they are incomplete. For example, in the case of overdrafts to public officials, there is no way to know if the overdraft was tolerated by a bank because that person was a public official or if the overdraft occurred on an account which that person maintained as a local businessman.
I am hopeful that the witnesses appearing before the committee will address this issue. In my opinion, it would be a mistake to base any new legislation on these survey results until the reliability and usefulness of those survey results have been explored. Once that issue has been addressed, the question will be whether or not any additional legislation will be needed beyond S. 71, which the Senate passed last year.
The CHAIRMAN. Mr. LeMaistre, you're front and center. Go right ahead, sir. STATEMENT OF GEORGE LeMAISTRE, CHAIRMAN, FEDERAL
DEPOSIT INSURANCE CORPORATION Mr. LEMAISTRE. Thank you, Mr. Chairman.
As you pointed out, we have had the staff of the three agencies prepare a summary of the findings in the survey, but even that summary is 22 pages plus a number of appendixes, so if I may, I
would like to capsulize that summary a little bit before getting into any specific recommendations as to legislation or regulation.
As you know, the survey focused on loans secured by bank and bank holding company stock, loans to the insiders of other banks, loans to the insiders of the bank making the report, and overdrafts.
In the category with respect to bank stock lending, we find that 6.4 percent of the 14,137 banks that reported, reported bank or bank holding company stock loans on September 30 of last year. This was a total of 10,214 stock loans and the balances totaled $2.7 billion. To put it in perspective, these loans amount to 1 percent of the total dollar amount of all outstanding loans at those reporting banks that reported stock loans and one-half of 1 percent of total loans at all insured commercial banks. We find the percentage of the banks that reported loans secured by bank stock increases with the size of the bank. Approximately 40 percent of the stock loans were known to have been associated with a change in control of the bank or control of the holding company. About 88 percent of the number and dollar volume of stock loans involved a bank having a demand deposit with the lending institution.
Fixed rate loans where the bank whose stock was pledged and did not maintain correspondent accounts generally had higher interest rates than fixed rate loans where the bank did maintain such deposits. However, the average amount of the correspondent balances relative to the average stock loan balance generally did not appear to be related to the rate charged on stock loans. Of the outstanding stock loans that were extended to the insiders of other banks after 1969, 7.4 percent carried interest rates below the average prime rate that prevailed during each of the 11 time periods for which fixed rate stock loan data were collected. The prime rate that we used for comparison is the prime rate of the large money center banks.
During 1976 and 1977, a period which accounted for 85.4 percent of outstanding stock loans, only 1.9 percent of such loans were extended at rates below the average prime rate.
Extending loans below the prime rate is not necessarily abusive. Local market conditions, other lending terms, usury ceilings and the bank's interest rate policies with respect to loans generally all must be considered in determining whether a preferential rate has really been granted.
State-by-State comparisons indicated that bank stock lending to insiders of other banks was concentrated principally in the 15-unit banking States. Such loans were concentrated most heavily in banks located in States in the southwestern and central regions of the country
The results regarding bank lending to insiders of other banks indicated that approximately half of the banks had outstanding loans to such insiders as of last September 30 and 15 percent of the banks had outstanding loans to insiders of other banks where the other bank maintained a demand deposit with the lending bank.
More loans were made to insiders of other banks where a demand deposit was maintained with the lending bank than where no such balance existed. There was an apparent relationship between the interest rate charged on loans to insiders of other banks and the maintenance of a demand deposit at the lending bank.