Statement by John P. LaWare, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Financial Institutions Supervision, Regulation and Deposit Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, October 6, 1994

Federal Reserve Bulletin, December 1994 | Go to article overview

Statement by John P. LaWare, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Financial Institutions Supervision, Regulation and Deposit Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, October 6, 1994


I am here this morning to discuss the availability of credit to small and minority-owned businesses and to comment on the data collection proposed in H.R.918.

Small businesses play an essential role in the health of our economy, in the creation of jobs, in the generation of new ideas, and in the competitive process that is so important to a free-enterprise economy. Of the 21 million entities that filed business tax returns in 1992, all but 14,000 were small businesses--using the Small Business Administration's guidelines that define a small business as one with fewer than 500 employees. In fact, the great majority of these enterprises had fewer than 20 employees.

Minority-and women-owned businesses are a growing share of this small business community. In 1987, the latest year for which data are available, it is estimated that there were 1.2 million minority-owned businesses and more than 4 million women-owned businesses, an increase of more than 64 percent and 57 percent respectively from five years earlier.

More significant than the number of small businesses is the contribution that these firms make to economic growth and employment. The Small Business Administration estimates that small businesses account for more than half of private employment and about half of private-sector output. There is no doubt that a vibrant small business community is an essential ingredient for the economic health of our nation, both in urban centers and rural communities.

BANKS AND SMALL BUSINESSES

Commercial banks historically have had a crucial relationship with small businesses. The Federal Reserve's 1989 National Survey of Small Business Financing revealed that local commercial banks are the primary suppliers of most financial products used by established small firms. In addition to commercial loans, banks supply other types of credit and lease financing and a wide range of deposit, brokerage, and trust services. The lending relationship is especially important to small firms whose access to public capital markets is limited. Data from the 1989 survey indicated that almost half of the external debt financing of small businesses came from commercial banks. In addition, small firms rely on credit from nonbank depository institutions and finance companies, on trade credit, and on loans from family and friends.

Just a few years ago, when the banking industry was under severe stress from problems in real estate and agricultural loans, and lingering problems on loans to developing countries, there were very real concerns about the negative implications for financing small businesses. Commercial bank failures rose sharply in the last half of the 1980s and remained high during the 1990--91 recession; the cost of these failures prompted the Congress and the regulatory agencies to adopt new, more stringent regulatory standards. Many banks undertook major programs to bolster the quality of their assets, restructure their balance sheets, and reduce operating losses, with the result that new lending--especially business loans secured by real estate--slowed dramatically. Many long-time customers of banks were unable to renew loans or had credit lines reduced. The severity of the so-called "credit crunch" prompted questions about the longer-term direction the banking system was taking and raised concern about financing for small businesses.

Fortunately, the credit crunch had a relatively short life span. Since 1991, efforts by banks to strengthen operating efficiency and build capital positions have paid off. Over the past couple of years, banks have earned record profits; the industry's rate of return on assets in 1993 was the highest in decades and has declined only a bit this year. Both large and small banks have substantially strengthened their capital ratios; for the industry as a whole, the ratio of equity capital to assets, at 7.8 percent, and the total risk-based capital ratio of 13.

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Statement by John P. LaWare, Member, Board of Governors of the Federal Reserve System, before the Subcommittee on Financial Institutions Supervision, Regulation and Deposit Insurance of the Committee on Banking, Finance and Urban Affairs, U.S. House of Representatives, October 6, 1994
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