Are Small Rural Banks Credit-Constrained? A Look at the Seasonal Borrowing Privilege in the Eight Federal Reserve District

Article excerpt

A TRADITIONAL belief about rural credit markets, particularly agricultural credit markets, is that small rural banks have limited access to sources of funding and limited opportunities to lend outside their immediate communities. Rural banks' ability to meet local loan demand, so the theory goes, is constrained by a relatively inelastic supply of local deposits and insufficient access to nonlocal or national credit markets. Moreover, such institutions tend to experience deposit outflows during periods of high seasonal loan demand as individuals with a seasonal need for funds (like farmers) draw down their deposit balances. To meet the seasonal loan demand of such industries as agriculture and tourism, many observers argue that rural banks must keep a relatively high proportion of their assets in low-interest-bearing, highly liquid securities during other times of the year.

The Seasonal Borrowing Privilege (SBP), one of three Federal Reserve discount window programs, was designed to address this problem by permitting banks with strong seasonal patterns in loans or deposits to obtain funds from Federal Reserve Banks. Although the program is highly popular among participants, some observers have questioned a key historical feature of the SBP, as well as the program's justification itself. Noting that seasonal loans were made at a below-market rate of interest (the discount rate), critics have argued that the lack of credit availability, even if it were a problem, was no reason for the Fed to step in and provide credit at a subsidized rate.(1) Other critics, citing the tremendous innovations in financial markets since the program began in 1973, have questioned whether rural banks continue to face funding constraints today or whether they are still the only source of credit for their communities.(2) The criticism has increased with the volume of lending through the SBP.

This article describes the seasonal borrowing program and examines its usage by banks in the Eighth Federal Reserve District from 1984 through 1990.(3) The Eighth District has a large number of agricultural banks; in some years, District banks have accounted for as much as one-third of all borrowings under the SBP. A key question to be addressed is the extent to which the program has fulfilled the objectives set out by the Federal Reserve Board in 1973. The article then presents an analysis of the program's continued necessity.

DEFINING THE PROGRAM

Purpose of the Program

The seasonal borrowing program was established in April 1973 by the Board of Governors of the Federal Reserve System (hereafter, the Board) to help member banks meet seasonal funding requirements. The program was adopted as part of amendments to Regulation A, "Advances and Discounts by Federal Reserve Banks," which became effective April 19, 1973. Under Section 201.2 of the revised Regulation A, "General Principles," the Board outlined its rationale for the program:

Extending credit to member banks to accommodate

commerce, industry, and agriculture is a

principal function of Reserve Banks.... Federal

Reserve credit is available for longer periods

(than adjustment credit) to assist a member

bank that lacks reasonably reliable access to national

money markets in meeting seasonal

needs for funds arising from a combination of

expected patterns of movement in its deposits

and loans.(4)

The Board's decision to establish the SBP was based in large part on the findings of a 1971 Federal Reserve study of the discount window. In evaluating the sources and uses of funds at small rural banks, the study found that

the available information supports the view that

small rural banks, concentrated in the sixth

through eleventh Federal Reserve districts, have

serious disadvantages relating to their organizational

structure. …