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credit may in some circumstances cause certain segments of the economy to be more severely hurt than others when the overall supply of credit is curtailed.

The FDIC is in the process of reviewing the available data as to recent credit flows in States like Tennessee, Arkansas and Montana that might be affected by the proposed legislation and will file this information with the Subcommittee as soon as possible. Most State usury laws, however, already exempt loans to corporate borrowers from the ceilings they impose and others have significantly higher limits for corporate borrowers than the usury limits of the three States mentioned. Four States in the latter category, with ceiling rates for corporate borrowers apparently set by statute at 12 percent per annum, could also be immediately affected by the proposed legislation since it would authorize a corporate usury ceiling higher than 12 percent per annum at least initially.

Our natural preference would lie in a reevaluation by each State of the competitiveness of credit markets affected by its usury ceilings. When it appears that competition in such markets is adequate to protect the public interest, usury ceilings could gradually be removed, in a manner similar to that recommended in the December 1972 report of the National Commission on Consumer Finance, so as to foster the free flow of available credit within a competitive market structure. S. 3817, by limiting the duration of its provisions to three years, concedes the desirability of such a State-by-State review but also recognizes the fact that obtaining such a review and then implementing it effectively might not be feasible in time to alleviate immediate lending dislocations in a number of States because of legislative or constitutional procedures which might apply. The provisions of S. 3817 would, however, be limited to only a small number of States in immediate impact and would not constitute an undesirable precedent for Federal preemption of State usury ceilings generally or permanently.

In lieu of tying the higher, temporary Federal usury ceiling to the Federal Reserve discount rate, we would suggest that better results might be obtained by using a market-determined rate, such as the prime commercial paper rate or the Treasury bill discount rate. Changes in the Federal Reserve discount rate are made with a number or factors in mind and have frequently lagged behind market rate movements. The rate today appears substantially out of line with market rates applicable to both short-term and long-term loans to corporate borrowers. Some of this problem is, of course, overcome by setting the permissible Federal rate 5 percent above the Federal Reserve discount rate.

However, whether the Subcommittee adopts this suggestion as to the base rate to be utilized or not, the Corporation would strongly support enactment of S. 3817 or a bill of similar substance under present economic conditions.

Senator BROCK. Mr. Sinclair, I appreciate your coming and ask you to proceed at your own pace. If you can sum it up I'll appreciate it.



Mr. SINCLAIR. Thank you, sir. It is a pleasure to be here, Mr. Chairman.

I am Hugh Sinclair. I am Commissioner of Banks of the State of Tennessee. This is my testimony statement. Some background information is necessary to an understanding of the proposed amendments to the National Banking Act and Federal Deposit Insurance Act.

These amendments would allow national and insured State banks, respectively, to charge interest of up to 5 percent in excess of the prevailing discount rate on corporate loans, any State usury law to the contrary notwithstanding.

For over a century, Tennessee has had a Constitutional 10 percent limit on interest. This restriction applies to both corporate and individual borrowers and to both commercial and noncommercial loans.

Prior to the current inflationary upsurge, this usury ceiling had little apparent effect either on the soundness of financial institutions in Tennessee or on economic development there. However, under present conditions, Tennessee's usury law actually mandates a negative true rate of interest, when the inflationary depreciation in the value of the dollar over the term of a loan is taken into account.

The effects of the squeeze between the law and inflation are twofold: On the one hand, loans are becoming increasingly unavailable ; on the other, the liquidity of Tennessee banks is adversely affected.

On the first point, the unavailability of loans, banks in Tennessee are now turning away borrowers in droves. To the extent that corporations cannot obtain funds for expansion, Tennessee's economic development will be crippled. The ultimate result will be increased unemployment in Tennessee, which will have a depressing effect in other States as well, particularly border States.

Furthermore, small borrowers are also affected adversely. The larger corporate borrowers may be able to obtain loans from out-ofstate banks. However, in so doing, they may well have to maintain compensating balances with such banks. Since these deposits will in most cases be taken from Tennessee banks, a reduction in loanable funds for small as well as large borrowers will result.

As I mentioned earlier, the current squeeze also represents a potential threat to the liquidity of Tennessee banks. This threat stems both from an abnormal curtailment of banks' profits and from an outflow of deposits. To the extent that this, in combination with other factors, adversely affects the financial soundness of Tennessee banks, a remedial amendment to the Federal Deposit Insurance Act is most appropriate, both to protect the banks themselves and to reduce the threat of claims against the Federal Deposit Insurance Corporation's insurance fund by curtailing the possibility of bank failures.

Normally, it is the responsibility of the particular State concerned to remedy a problem occasioned by its own laws. However, the problem in this instance consists of Tennessee's usury law combined with inflation. While the former might normally be solely a State responsibility, inflation is a national problem, and curbing it is a national responsibility.

In addition, as a practical matter it is impossible for Tennessee to lift its usury ceiling in the near future. Since it is fixed in the State Constitution, an act of the legislature would probably be ineffective. At best, the Constitution could not be amended prior to the latter part of 1977, even assuming that such an amendment was unopposed. Passage of the proposed amendments to the National Banking Act and Federal Deposit Insurance Act offer by far the best chance of relief, and would serve the best interests of both Tennessee and the Nation.

In conclusion, in my 50 years of banking, I have not experienced such a disturbing condition in financial institutions as it exists today, particularly in Tennessee, with the possible exception of the Depression of the late twenties and early thirties, of course.

As Commissioner of Banks for the State of Tennessee, I urge you to continue to work for the immediate passage of this amendment in the Senate and just as soon as possible in the House.

I thank you.

Senator BROCK. Thank you, very much. You're short and to the point and I appreciate it very much.

Mr. SINCLAIR. Thank you.

Senator BROCK. I was particularly interested in your comment that at best we could effect some remedy in the State of Tennessee by 1977.

Mr. Sinclair, if we don't do something about this problem before then, nobody is going to be asking for any money.

Mr. SINCLAIR. I agree. We can't wait 3 years, 4 or 5, no.

Senator BROCK. I do believe this is beyond legislative remedy. I don't see any particular legislation that can be passed other than a Constitutional amendment. In order to do an honest job, we might be able to run around the barn with that with you; I'm not sure that would stand up.

You know, back in the good old days, Mr. Chairman, when I was in the candy business, we used to have to borrow an awful lot of money in the spring and summer to build our inventories for fall shipment. And if you're going to sell any, you've got to borrow a ton to fill those inventories. It isn't a matter of spending money on frill to put in a corporate jet. It is a matter of survival.

I assume the companies still have the same borrowing needs. I know an awful lot of companies in Tennessee do. It isn't a question of trying to do something to allow, even in some instances of allowing them to have enough working capital to stay in business at all, and they can't get those funds because they're simply not available. You cannot have a bank paying 12, 13, 14 percent and loaning it back at 10. That is a very short road.

Is it not true that our larger corporations already have gone out of State with their funds! They don't have any choice. As a matter of fact, I would wager that some of them are down in Birmingham borrowing in competition with your money.

Senator SPARKMAN. Don't you think some are up in Nashville ?

Senator BROCK. They can't get any money. A Tennessee bank cannot loan even to an out-of-State corporation in excess of 10 percent; that's correct, isn't it! Mr. SINCLAIR. That's right.

tor BROCK. I would ask really just one question, Mr. Sinclair, and that is on the testimony we had previously both the Federal Reserve and the Home Loan Bank Board suggested we apply this to any borrower, incorporated or unincorporated, given the fact that an awful lot of builders for example are partnerships or unincorporated firms.

First, would you agree with that, and secondly, I believe you have some understanding—as I mentioned I had $100.000 minimum in an early bill. Ore of the previous witnesses suggested a $50,000 minimum. I'd like your comments on these two.

Mr. SINCLAIR. Well, we don't have the magic figure either. But I recall that your original bill did state a hundred thousand to an individual. I would agree with that if it could be incorporated into the bill, but, if not, we would like the bill anyway.

Senator BROCK. Mr. Chairman, do you have anything?

Senator SPARKMAN. Not at this time, thank you.
Mr. SINCLAIR. I would like to say one more word.

I believe, Senator, and you mentioned, that the crunch in Tennessee, particularly will come this fall when the crops begin to come in and the demands for business come in. And it will permeate down to the smallest banks because the small banks usually go to the medium banks and the medium-sized banks go to the largest banks. And that is where the buck stops. We just don't have the money.

Senator BROCK. Not only for crop harvesting but you go right around the circle on the horns in the spring when you've got to plant. The same problems will exist then that exist now.

Mr. SINCLAIR. That is true.

Senator BROCK. There is one area we would like to ask you to comment on.

I think, well, I'm not sure which one of our previous witnesses suggested that this problem was not only a problem for the consumer, the business or individual who wants to borrow money and simply cannot get it at any price, but it also is a problem for the banks as institutions, in terms of liquidity and perhaps maybe even solvency.

I wonder if you would comment on the effect the current situation is having on Tennessee banks as lending institutions and their ability to survive in this kind of climate?

Mr. SINCLAIR. Well, the larger banks have already stopped lending so to speak. They're not making any new loans. They're calling many of the loans they have outstanding.

The medium-sized banks are beginning to do that.

It is my hope that the smallest banks will also cut down to that extent as much as possible. There are some banks who are probably overloaned at this time. We are making every effort to insist that they cut down their loans.

Senator BROCK. In some words, Mr. Commissioner, you—I don't want to put words in your mouth, so I will ask you to specify: Are there institutions which may be jeopardized if some action isn't taken if the present market rates prevail for any extended period of time, or are they capable of just cutting back on their loans, which may be an enormous hazard for their customers?

I don't want to throw square words. I'm being very careful with my terminology.

Mr. SINCLAIR. Yes, sir. If they will cut back. I'm particularly speaking of the smaller banks now.

Senator BROCK. If they will cut back, they're going to be all right.
Mr. SINCLAIR. Right.
Senator BROCK. But that, of course, is their ultimate responsibility

Mr. SINCLAIR. All we can do is instruct the Board of Directors to instruct their officers to carry out the orders. If they don't do it, that is too bad.

Senator BROCK. If they do cut back, it is quite possible that the lack of funds may jeopardize the existence of some business ability.

Mr. SINCLAIR. Yes, sir.

and ours.

Senator BROCK. You would be more concerned about them in terms of their ability to stay in business than you would the banks themselves, which can survive?

Mr. SINCLAIR. That is true. It would cause unemployment.
Senator BROCK. Thank you very much.
Mr. SINCLAIR. It is a pleasure to be with you.

Senator BROCK. Mr. Chairman, I would ask consent to include at this point in the record a letter from the Governor of the State of Tennessee.

Senator SPARKMAN. Without objection.

Senator BROCK. And a letter to the chairman of the subcommittee, Senator McIntyre from Lawrence E. Kreider of the Conference of State Bank Supervisors. [The documents follow:]

STATE OF TENNESSEE, July 29, 1974. Hon. WILLIAM E. BROCK, III, U.S. Senator, old Senate Offioe Building, Washington, D.O.

DEAR BILL: It has come to my attention that you are planning to introduce a bill designed to affect the level of interest which banks can charge to large corporate borrowers. I am writing to advise you of my views on interest levels as they currently apply to Tennessee.

As you are aware, the Federal Reserve Board, in attempting to halt our inflationary spiral, has been stringently exercising its control over interest rates through its use of discount policies. As interest rates rise across the nation, money flows are restricted, loan funds become scarce and expansion is reduced. I agree with these policies on a national scale, as I realize that this inflationary period must be limited.

But when the Board applies its pressure on rate structures, it does so with the expectation that activity will be restricted uniformly. I feel that each state should bear an equal burden of reduced economic activity; yet in the present circumstances those states with constitutional usury ceilings such as Tennessee are forced to share an inequitably high portion of the results. In Tennessee, borrowers cannot pay above ten percent rate for money. So long as discount rates force prime and secondary lending rates well above this limit, activity will be stymied. Large corporate borrowers will be compelled to close loans out of state, resulting in an outflow of capital as well as compromised business relations with Tennessee lenders. Small businessmen, unable to borrow in other states, will continue to forgo expansions and in some cases will face serious financial constraints on their current operations.

As a Governor, I believe that our problems should be solved at the state level. However, in this instance, remedial action on our part involves a constitutional revision process which is too lengthly to overcome this problem which has recently arisen. Any attempt to amend our constitution in Tennessee cannot be culminated for several years. I therefore support your effort to amend the National Bank and Federal Deposit Insurance acts as a three-year interim measure. This legislation will solve our problem temporarily, as we attempt to find more permanent answers within our boundaries.

With respect to the specifics of the bill, I recommend further insurance that residential mortgage and consumer loan rate ceilings will not be affected by its provisions. I suggest that your proposal be modified to set a minimum eligible loan size or corporate as well as noncorporate borrowers, thus preventing forced incorporation in order to attain borrower status.

With this modification, I strongly favor the proposed temporary legislation as an interim means of alleviating the pressing restrictions within our state's financial markets. I would appreciate your bringing these thoughts to the attention of the committee during its hearings. Sincerely,



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