Preliminary
Comments welcome
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The “Marketization” of Bank Business Loan Rates in the United States*
William B. English**
Bank for International Settlements
Basel, Switzerland
June 2003
Abstract
The cyclical behaviour of bank business loan rates in the United States changed considerably
around 1970. Before that time, loan rates reacted only sluggishly to changes in market rates. By
contrast, by the mid-1980s loan rates moved essentially one-for-one with short-term market rates.
The 1970s and early 1980s represent a transitional phase. This paper employs a new consistent
time-series measure of bank lending rates to demonstrate this change in behaviour. A simple model
is presented that can explain the earlier muted response of loan rates to market rates as the result of
an implicit contract between banks and their borrowers. This model can also explain how changes
in the banking industry and the financial sector more broadly -- including the development of
market-priced bank liabilities and improved access by firms to the capital markets -- undermined
this implicit contract in the 1960s and 1970s, leading to loan pricing that followed market rates
more closely.
Key words: Bank lending, loan interest rates.
JEL Classification: E43, G21, and N22
_______________
*The views expressed in this article are those of the author and do not necessarily reflect those of the BIS. I thank
Marvin Goodfriend, Jacob Gyntelberg, and colleagues at the Federal Reserve Board and the Bank for International
Settlements for useful comments and discussions. Lisa Sanchez, Debbie McMillan, Amanda Cox, and especially
Mauricio Fernholtz provided excellent research assistance. All remaining errors are mine.
**Mailing address: Bank for International Settlements, Centralbahnplatz 2, CH-4002 Basel, Switzerland. E-mail:
bill.english@bis.org
I. Introduction
Before the late-1960s, business loan rates moved very sluggishly in response to movements
in market rates. Most dramatically, business loan rates appear to have changed very little between
1961 and 1965, a period during which short-term market rates rose more than 2 percentage points.
However, over a period of about a decade, from the end of the 1960s to the early 1980s, this
adjustment accelerated considerably, and since the mid-1980s business loan rates appear to have
followed short-term market rates very closely.
In this paper I present a consistent measure of the business loan rate at large U.S. banks
constructed from the results of Federal Reserve surveys. Using this new data, I document the
changing behaviour of loan rates over time. I provide a possible explanation of the stickiness of
bank loan rates in the early period based on an implicit contracting model of the relationship
between banks and their customers. I argue that banks smoothed loan rates over time in order to
share the income risks associated with interest rate fluctuations. In this regime, banks could not
generally obtain funding at the margin because Regulation Q constrained deposit rates.1 As a
result, banks engaged in "asset management," under which they attempted to arrange their
securities holdings in order to maintain their liquidity and so their ability to make loans. When, in a
period of strong loan demand, a bank became "loaned up," -- i.e., could not fund additional loans -or was afraid that it soon would be loaned up, it would ration credit to borrowers. This rationing
involved restricting lending to new or risky customers while continuing to lend to established
customers for ongoing business purposes.
In this view, the increased marketization of bank loan rates in the 1970s and early 1980s
reflected developments in banking and financial markets -- including new financing alternatives for
both banks and businesses -- that made the implicit contract untenable. Starting in the mid-1960s,
banks became increasingly able to obtain funds at the margin in the negotiable CD market, the
federal funds market, the Eurodollar market, and market for bank holding company commercial
paper. These new markets had two effects. First, banks’ cost of funds became much more closely
linked to market rates, making it more difficult for banks to lend at smoothed interest rates without
inducing very large fluctuations in their earnings. Second, since banks had access to funds beyond
1
Regulation Q set ceilings on deposit interest rates. Those ceilings were set by the Federal Deposit Insurance
Corporation under the terms of the Banking Act of 1933. The Regulation Q ceilings were phased under the Depository
Institutions Deregulation and Monetary Control Act of 1980, with the last restrictions on savings deposits rates ending
in 1986. See Mahoney et al. (1987), Appendix A.
1
their core deposits, albeit at market interest rates, they no longer became "loaned up." Making loans
at average cost while borrowing additional funds at market rates, however, would put further
downward pressure on bank earnings in periods of high market interest rates and strong loan
demand. Thus, the availability of new sources of market funding provided an incentive for banks
to price loans at rates closer to those prevailing in the markets.
This incentive was reinforced by the expansion of the commercial paper market, which
allowed larger and higher-quality bank customers to borrow at market rates. Thus, such customers
could borrow opportunistically from banks when bank loan rates were low relative to market rates,
but they could borrow in the commercial paper market when market rates were low relative to bank
loan rates. The ability of borrowers to arbitrage between the money market and the bank loan
market could provide strong pressure for the market pricing of loans.
The next section briefly describes the construction of a new series on bank business loan
rates since 1939 based on data from Federal Reserve surveys. Section III presents some empirical
results demonstrating the change in the behaviour of bank lending rates. Supporting evidence from
the behaviour of the prime rate is provided to ensure that the change is real and does not reflect
problems with the construction of the data. Section IV lays out a simple implicit contracting model
that appears to be consistent with both the smoothing of loan rates before the late 1960s and the
lack of smoothing thereafter.
Section V presents some evidence supporting this view, while
Section VI discusses the changes in the environment that could explain the breakdown of the
implicit contract. A final section presents some concluding remarks.
II. A Consistent Series for Business Loan Interest Rates
The raw material for the construction of a consistent business loan rate series for the United
States is the output from two Federal Reserve surveys: the Quarterly Interest Rate Survey (QIRS)
and the Survey of Terms of Business Lending (STBL). 2 Between 1939 and 1976 the QIRS
collected data on business loan rates at large banks. From 1977 on, similar data for business loan
rates at banks of all sizes has been collected on the STBL. The results of the QIRS and the STBL
2
The Survey of Terms of Business Lending was called the Survey of Terms of Bank Lending to Business between
1977 and 1997. I will use the current name throughout.
2
are published on the Federal Reserve's E.2 Statistical Release and in the Federal Reserve Bulletin.
In addition, the microdata for the STBL is available in archival files at the Federal Reserve Board. 3
By splicing together data from the various versions of the QIRS one can construct a time
series for short-term (maturity between one month and one year) business loan rates at large banks
from 1939 to 1976.4 The resulting loan rate series has a number of discontinuities, however, owing
to periodic changes in the survey. These discontinuities include changes in the types of loans
covered by the survey, changes in the panel of respondent banks, and changes in the method used
to calculate national averages based on the sample responses. The coverage, panel, and averaging
method of the surveys for various periods are reported in Appendix A. In most cases, the sizes of
the effects of changes were reported in articles in the Federal Reserve Bulletin, and the series can
be adjusted to remove the effects of the resulting discontinuities. Moreover, in some cases, the
effects of changes in weighting method can be removed by recalculating the average loan rate
based on the published disaggregated data (e.g., rates by region or size of loan) and an alternative
set of weights.
Finally, one can splice the QIRS-based series to a comparable series constructed from the
STBL data for 1977 on. Doing so requires a number of adjustments to take account of differences
between the two sources, and these adjustments can be calibrated based on published information
or calculated directly using the micro data,
In a few cases there is no data available to evaluate the size of the effects of changes in the
survey method on the reported average loan rate.
However, given the size of the known
adjustments, it seems unlikely that the resulting discontinuities are large enough to cause significant
problems.
The details of the adjustments made in the calculation of the loan rate series are provided in
Appendix B.
3
Some archival files from the QIRS also have been retained, but many tapes from the 1970s are missing and the
documentation is not complete. As a result, these data have not been utilized here.
4 Rates on long-term loans (maturities over a year) are not available before 1967, and are not considered here.
Without information on the changes, if any, in the average maturity and repricing interval of such loans, it would be
difficult to interpret such a series.
3
III. The Changing Behaviour of Business Loan Rates
The adjusted series for the interest rate charged by large banks on business loans with
maturities between one month and one year is shown in Figure 1. The figure also shows the yield
on three-month Treasury bills as a measure of the market interest rate at a similar maturity and the
yield on a ten-year Treasury note as a representative long-term rate.5 It is immediately clear from
the figure that the loan rate was very sluggish before the mid-1960s, generally adjusting only
partially and gradually to changes in the bill rate. By contrast, the loan rate appears to have
adjusted more rapidly in the 1970s, and it has moved very closely with the bill rate since the early
1980s.
A. Some Empirical Results
While the change in the behaviour of business loan rates seems apparent from Figure 1, it is
helpful to quantify the transition before continuing. Table 1 presents simple error correction
models documenting the behaviour of the business loan rate relative to market and policy rates over
a number of periods.6 The error correction models include a lagged change in the loan rate and the
current and lagged changes in a comparable rate in addition to the error correction term: 7
rlt = *rlt-1+ 2*rmt + 3*rmt-1 - a4*(rlt-1 - 0 - rmt-1)
I use the federal funds rate, the discount rate, the three-month Treasury bill rate, the ten-year
Treasury note yield, and the yield on AAA-rated corporate bonds as alternative rates.8 Over the
entire period for which there is data (1939Q2 to 2002Q2), the business loan rate appears more
closely linked to short-term rates than to longer-term rates. In all cases, the loan rate appears to
adjust roughly one-for-one to changes in market rates (the 1 coefficient), with much of the
5
As noted in the appendix, the surveys have been conducted on a quarterly basis, but the timing of the survey within
the quarter has changed over time. The timing of the bill and note rate series shown -- as well as the other market and
policy rates employed below -- matches that of the loan rate surveys. See Appendix C for details.
6
The error correction models are used because they make it easy to read off the short-run and long-run reactions of the
loan rate to changes in the market rate. If interest rates are taken to be stationary, then the significance levels shown in
the table are correct. If the interest rates are non-stationary, then the significance levels for the coefficients on the
levels variables are not correct. Wu and Zhang (1996) provide panel data evidence that nominal interest rates in the
OECD are stationary.
7
These lags appear to be sufficient to capture the empirical relationship between the rates. The regressions also include
dummy variables to account for the Treasury-Federal Reserve Accord in 1951, the change in the timing of the QIRS in
1967 (see Appendix C), and the 1980 credit controls. Earlier research has suggested that bank business loan rates may
adjust asymmetrically to changes in market rates (see, e.g., Goldberg (1982) and Mester and Saunders (1995)), but I
leave an examination of such asymmetry for future work.
8
The discount rate is not really a market rate, but over much of this period it was a crucial determinant of short-term
market rates.
4
adjustment coming in the quarter of the move in market rates (the 2 coefficients are large) but
subsequent adjustment is fairly gradual (the 4 coefficients are small).
However, as discussed earlier, the behaviour of the loan rate changed considerably over
time. To examine these changes, I divide the sample into four subperiods based on the timing of
macroeconomic and other events. The first subperiod runs from the start of the loan rate series to
the end of the Korean War.9 The behaviour of interest rates in this period was likely influenced
heavily by war-time controls on spending, direct government intervention in credit markets, and
Federal Reserve efforts to limit Treasury costs (at least until the Treasury-Federal Reserve Accord
reached in March 1951). Thus, loan pricing in this period may not reflect the pricing that banks
would otherwise have put in place. The second subperiod runs from the end of the Korean War to
the credit crunch of 1969. The credit crunch, and the higher interest rates and inflation it reflected,
marked the end of the period of relatively low and stable inflation and interest rates that prevailed
over the previous decade and a half. The third subperiod runs from 1969 to 1983, covering the
period of very high and volatile inflation and interest rates. The final subperiod runs from 1984 to
2002, covering the period during which inflation and interest rates declined and then were again
low and stable. Clearly, the timing of the starts and ends of these subperiods (with the possible
exception of the first subperiod) are fairly arbitrary. The empirical results discussed below do not
depend importantly on their exact dating.10
In the first subperiod, the business loan rate is not as closely related to any of the market
rates as it is in the other subperiods. The R2 of the regressions are less than a quarter, rather than a
half or more, and a number of the estimated parameters are not statistically significant. Except in
the case of the discount rate, the loan rate does not appear to move contemporaneously with
changes in the market rates, and subsequent adjustment is modest.
By contrast, in the second subperiod, the loan rate appears to be more closely related to the
market rates. In this period, at least judging by the R2s, loan rates were about as closely related to
long-term rates as to short-term rates. In all of the cases, the loan rate appears to move roughly
one-for-one with market rates in the long-term. But it can be seen either as moving relatively
sluggishly in response to short-term rates or more rapidly in response to long-term rates.
9
Note that the federal funds rate data are not available before 1953.
One possible exception to this generalization is that the performance of the regression based on the discount rate
deteriorates considerably in the late 1960s. This may reflect the decline in the discount rate relative to market interest
rates in the mid-1960s, possibly as a result of political pressure to limit discount rate hikes.
10
5
The period from 1960 to 1965 is particularly striking. In this period the average bank loan
rate was virtually unchanged, while short-term rates rose fairly smoothly by about 250 basis points
(Figure 1). By contrast, the AAA bond yield changed fairly little over this period, remaining about
in line with the loan rate (Figure 2A). Indeed, as shown in Figure 2B, the spread of the loan rate
over the AAA bond yield was remarkably stable through the second subperiod, though it rose
notably in 1966 and 1969, consistent with higher rates on bank loans during those two credit
crunches. Moreover, this spread was quite stable in much of the first subperiod as well, although it
widened steadily between 1949 and 1952, perhaps reflecting the actual and expected effects of the
Accord on the relationship between short-term and long-term rates.
The empirical relationship between the loan rate and market interest rates changed
considerably in the period after 1969. As can be seen in Figure 2B, the spread of the loan rate over
the AAA bond yield became far more variable at this time. The empirical results in Table 1 show
that in the third subperiod the loan rate is much better explained by short-term rates than long-term
rates, with similar fits provided by the federal funds and Treasury bill rates. Moreover, loan rates
adjusted more quickly to movements in short-term rates in this period than in the previous one, as
evidenced by the larger coefficients on the contemporaneous changes in the market rates ( 2) and
the larger coefficients on the error correction terms (4).
Since the Treasury bill rate varied somewhat less than the loan rate over this period, the
bank loan rate adjusted more than one-for-one with changes in the discount rate over the long run.
Taking this difference into account, Figure 3 shows the spread of the loan rate over the discount
rate multiplied by a factor of 1.24 -- the estimated long-run coefficient on the bill rate over the 1969
to 1983 period shown in Table 1. This spread varies in a range between zero and two percentage
points over most of this period. The sharp spike in the second quarter of 1980 reflects the credit
controls at that time (dummy variables control for this spike in the regressions). The spread
measure also varied sharply in the early 1980s -- as do loan spreads measured relative to other
market rates -- reflecting the very high volatility in market rates at that time.11
11
Moreover, some of the wide swings in the spread during the early 1980s may reflect in part the effects of
measurement error. It is possible that some of the loan rates reported on the STBL were not priced in the survey week
(either because of lags in the posting of loans to the respondents’ reporting systems or because informal agreements
reached before formal loan extensions affect loan pricing). As a result, there may be small discrepancies in the timing
of the loan rates and the market rates. Since short-term market rates were quite volatile in the early 1980s, such
discrepancies could lead to wide swings in the measured spread.
6
In the most recent subperiod, loan rates move most closely with the federal funds rate.
Moreover, the speed of adjustment picked up further, with more than 90 percent of the adjustment
completed within the quarter and nearly half of any remaining deviation from the long-run
relationship eliminated every quarter. Figure 4 shows the spread of the business loan rate over the
federal funds rate. Before 1984, this spread was highly variable, but since that time it has been
relatively stable, ranging between 150 and 250 basis points. Indeed, since the early 1990s, the
spread has remained in a very narrow band of only about 50 basis points.
The relatively poor performance of the discount rate over this period is somewhat
surprising, but may reflect the Federal Open Market Committee’s move to an operating procedure
based on a target for the federal funds rate over the course of the 1980s, and the consequent deemphasis of the discount rate. Indeed, since 1994, changes in the FOMC’s target for the federal
funds rate have been announced, with the actual level of the target announced since 1995.
The more rapid reaction of the loan rate to market rates over time is summarized in Figure
5, which shows the reaction of the business loan rate to a 100 basis point increase in the federal
funds rate over the various periods. (In the first period a 100 basis point rise in the three-month bill
rate is used because the federal funds rate data are not available.) In the 1939-1953 period, the
adjustment is gradual and only partial even in the long run. In the 1954-1969 period adjustment is
complete, but very gradual. By the 1970s, the adjustment is much more rapid, with the bulk of the
adjustment complete in two quarters, and it is faster still in the most recent period, with nearly
complete adjustment in the quarter of the rise in the market rate.
B. Can This Really Be Right?
Given the changes in the survey instrument used, it is natural to ask whether the apparent
change in the behaviour of loan rates between the late 1960s and the early 1980s reflects an actual
change in loan pricing or differences in measurement. However, the sluggish adjustment of the
survey measure of the actual average loan interest rate is corroborated by data on the prime rate.
Figure 6 shows the average loan rate and the prime rate. Through the 1970s, the two series move
very closely together, suggesting that the risk spread on loans did not vary much over time, and
confirming the sluggishness with which loan rates adjusted through this period.12 Starting in the
late 1970s, the loan rate follows the prime rate considerably less closely, but the average spread
12
For a discussion of the prime rate in the 1970s and early 1980s, see Goldberg (1982). For a discussion of the prime
rate in the 1980s and early 1990s, see Mester and Saunders (1995).
7
seems broadly similar until about 1990.
At that time, however, the average loan rate falls
substantially relative to the prime rate. This development reflected a sharp rise in the prime rate
relative to other market rates. This change, in turn, may have owed to a deterioration in the average
quality of prime-rate borrowers, as well as a reduction in such borrowers’ size. (In the presence of
fixed loan costs, smaller loans require a higher rate to cover banks’ costs.) These changes initially
owed to a shift in the base rate for loans to larger and lower-risk firms to market rates (Brady
(1979), Simpson (1988)). More recently, the prime rate has become an increasingly important base
rate for loans to households, including credit card loans and loans drawn down under home equity
lines of credit (Board of Governors (1993)).
IV. An Implicit Contract Model of Sluggish Loan Rates
While the facts appear clear--business loan rates began to adjust increasingly rapidly to
short-term market rates starting in the late 1960s--the reason for this transition is not. In this
section I develop a model of the bank-borrower relationship in which banks and their customers
share risks associated with movements in market interest rates as part of an implicit contract. This
contract is based on three key stylised facts characterizing the banking environment in the period of
loan rate smoothing.
First, banks and borrowers had long-term relationships, reflecting the
information that incumbent banks had about their customers (which made it difficult for their
customers to move to other banks), the lack of market alternatives to banks as a source of shortterm finance for most firms, and the inability of most banks to obtain new customers outside their
market area. Second, the interest rate on bank deposits responded little, if at all, to changes in
market rates, since deposit rates were limited by Regulation Q. Third, banks had little access to
other sources of funds at market rates.13
13
My model focuses on the borrowing relationship between firms and banks. However, since deposits did not earn
market returns, banks and firms also had important relationships via deposits, and these two relationships may well
have interacted. Indeed, the Federal Reserve surveys discussed below found evidence that some banks raised
compensating balance requirements for some customers in order to limit lending in periods of strong loan demand
(Federal Reserve (1958)). Such a policy amounts to increasing the loan interest rate. However, while deposit balances
may have affected loan pricing to some degree, the model presented here suggests that loan pricing behaviour can be
explained without taking account of deposits. Thus, Hodgman (1963) may go too far when he argues that banks
provided loans at subsidized prices in periods of high interest rates and strong loan demand in order to retain firms’
deposits.
8
In the course of the 1960s and 1970s, these key features of the environment changed,
reflecting the modernization of the financial system. I argue below that the result was that the
implicit contract broke down, and loan rates came to reflect market rates much more closely.
A. The Environment
The model of loan price stickiness is similar to those used in the implicit labour contracting
literature (see, e.g., Rosen, 1985). Freid and Howitt (1980) also consider the possible effects of
implicit contracting on loan interest rates and loan supply, but they assume that risk-neutral banks
borrow at market rates and provide (implicit) insurance to their borrowers by lending at smoothed
rates. The model here is intended to capture more closely the institutional features of the lending
environment in the 1950s and 1960s, and also to offer a way to assess the effects of changes in
those features in the 1970s and 1980s.
For simplicity, the model has only one “timeless” period (see Azariadis (1975) and Rosen
(1985)). In practice, the fact that there are multiple periods may be important in keeping both
parties’ behaviour in line with the implicit contract (the cost of deviating may be that the benefits of
the contract are lost in future periods), but that issue is not made explicit here. There are two types
of agents in the model, banks and firms. There are many competitive banks. Firms are identical
and atomistic. There is, on average, a continuum of measure 1 of firms per bank. Banks and firms
agree in advance to a loan contract. The contract implies certain lending behaviour by the bank
depending on the state. The state is assumed to be observable and there is no private information.
This contract is assumed to be implicit rather than explicit because both parties realize that
unforeseen changes in factors not taken account of in the contract could make it undesirable. But
both parties can benefit from the contract given unchanged circumstances, and so they are willing
to participate in it so long as they believe that the other party will.
By assumption, once banks and firms have agreed to their contracts, firms cannot borrow
from any other bank and the bank cannot lend to any other firms. Under the contract, the bank will
provide credit to some of the firms to fund their investment projects. The contract specifies, for
each state of nature, a loan rate and the probability that a firm with access to a project will obtain a
loan. The state of nature also determines the odds with which firms have access to an investment
project. Projects are of fixed size, and are funded entirely with debt. Those firms having access to
a project receive credit from the bank with a probability determined by the contract, and invest.
For simplicity, firms that have an investment opportunity and obtain a loan repay the loan with
9
certainty at the end of the period. (It would be straightforward to have a fixed probability of
default.) Firms that do not receive loans do not invest.
Banks have a fixed amount of deposits,
and the deposit interest rate is fixed by regulation and does not depend on the state. If the bank
does not lend all of its deposits, it purchases risk-free securities with the remainder, earning the
market interest rate (which differs depending on the state of nature).
There are two possible states of nature, one with high loan demand (state H) and the other
with low loan demand (state L). In state H, a fraction pH of firms have access to an investment
project. This project requires a loan of size 1, and yields a gross return on RH. In state L, a fraction
pL (pL < pH) of firms have access to an investment project also requiring a loan of size 1, but with a
gross return of RL (RL ≤ RH). Banks have deposits of D in either state, and I assume that pL ≤ D ≤
pH. As a result, all firms with projects in the low demand state can receive loans, but deposits are
not sufficient to fund all investment projects in the high-investment state. This assumption is
consistent with anecdotal evidence that banks became “loaned up” in periods of high loan demand,
and chose to ration credit.14 The loan rates set in the contract are RLH and RLL in the two states. The
gross deposit interest rate is RQ in both states. The gross market rates of interest in the two states
are RMH and RML, respectively.15 The market interest rates in each state are assumed to be less than
the gross returns on projects in those states, so that borrowing and investing is optimal.
The resulting loan contract can be thought of as smoothing interest rates across states if:
RLH - RLL < RMH - RML
Whether this will be optimal or not depends on the parameters of the model.
B. The Optimal Contract16
Since banks are competitive ex ante, they will offer the contract that gives borrowers the
highest expected utility subject to the banks’ participation constraint, which is that the banks’ utility
must be at least as high as it would be if it did not contract with firms and instead invested its
14
In practice banks would still have bonds on their books in such situations, but they did not want to sell the bonds to
provide additional cash for loans because doing so would force the realization of capital losses on the bonds. See
English (1979) for an anecdotal description and Federal Reserve (1958) for results of a survey of banks.
15
Since there is no risk of default in the model, the market rates and loan rates are risk-free rates. Below, I will think of
the market rates as rates on government securities.
16
If firms and banks cannot commit to a long-term contract, so that firms can shop for loans across banks after the state
is realized and banks can either enter or leave the market after the state is realized, the outcome would be for the loan
rate in state L to be RML and the loan rate in state H to be RMH . In other words, there would be no smoothing.
10
deposits in securities yielding the market interest rate. This contracting problem is given by:
Maximize: D u(RH-RLH) + (1-) pL u(RL-RLL)
RLH, RLL
subject to:
 v(D (RLH-RQ)) + (1-) v(pL (RLL-RQ) + (D-pL) (RML-RQ))
≥  v (D (RMH-RQ)) + (1-) v (D (RML-RQ))
(1)
where  is the probability of the high-investment state, u(.) is the utility function (defined over
income) of the firms, v(.) is the utility function of the banks, and u(0) is assumed to be zero.
The first-order conditions for this problem are the constraint (holding with equality) and:
u’(RH-RLH) = v’(D (RLH-RQ))
u’(RL-RLL) =v’(pL(RLL-RQ) + (D-pL) (RML-RQ))
where is the Lagrange multiplier on the constraint. These two equations can be rewritten as:
u’(RH-RLH)/ u’(RL-RLL) = v’(D (RLH-RQ))/[ v’(pL(RLL-RQ) + (D-pL) (RML-RQ))]
(2)
This equation shows that the optimal contract requires equalization of the marginal rates of
substitution of banks and firms with investments across the two states. If banks and firms have
constant relative risk aversion preferences with coefficients of relative risk aversion of B and F,
respectively, then this can be written as:
(F+BD)(RLH-RMH) = (F+B pL)(RLL-RML) – 
(3)
where
= F(RMH-RML-(RH-RL)) + BD(RMH-RML)
Given these preferences, the bank’s participation constraint can be written as:
 exp{-BD (RLH-RQ)} + (1-) exp{B[pL (RLL-RQ) + (D-pL) (RML-RQ)]}
(4)
=  exp{-BD (RMH-RQ)} + (1-)exp{-BD (RML-RQ)}
This constraint runs through the point where RLH = RMH and RLL = RML. Linearizing around this
point, (4) can be approximated by:
(RLH-RMH) = -[(1-)/][pL/D] (RLL-RML)
where
 = exp{BD(RMH-RML)}
11
(5)
Equations (4) and (5) can be solved for the loan rate in the two states:
RLL = RML + /
(6)
and
RLH = RMH – [(1-)/](pL/D) (/)
where
 = (F+BD)[(1-)/](pL/D) (F+B pL)
Subtraction yields:
RLL - RLH = RMH - RML – S
(7)
where
S = {[(1-)/](pL/D) (/)
If S is positive, then the contract results in smoothing. Since  and  must be positive, there
is smoothing if  is positive. This will be the case for all positive values of F and B, if:
RMH - RML  RH - RL
(8)
So the contract will result in smoothing so long as the profitability of investment in the highinvestment state is not much higher than in the low-investment state--in other words, so long as the
high-investment state primarily reflects greater opportunities for investment rather than a higher
profitability of investment.17
The intuition for this result is straightforward. If there were no smoothing, then given the
condition in (8), borrower profits would be no higher in the high-demand state than in the lowdemand state, and if (8) holds strictly, then profits would be lower in the high state. But with
deposit rates equal to RQ in both states, bank profits would be strictly higher in the high-demand
state. Thus, both borrowers and the bank could be better off if the loan rate in the high-demand
state were cut (boosting the income of borrowers and cutting that of banks in that state) and the
loan rate in the low-demand state were increased (raising bank income and trimming that of
borrowers). Thus, some degree of smoothing would be optimal.
17
This result generalizes that in Fried and Howitt (1980). In their model, banks are risk-neutral and borrower utility
depends only on the interest rate on the loan received (and is independent of the state). As a result, banks insure
borrowers completely, offering the same loan rate in all states.
12
C. A Numerical Example
To show how the implicit contract can result in the smoothing of loan interest rates relative
to market rates, I construct a numerical example. Assume that the preferences of both the firms and
the banks are constant absolute risk aversion with a coefficient of absolute risk aversion of 1.0, and
that the high and low-investment states are equally likely. Assume also that 80 percent of firms
have access to an investment project with a return of 12.5 percent in the high-investment state and
that 70 percent of them have access to an investment project with a return of 10 percent in the lowinvestment state. Banks have deposits of 0.75 that pay a Regulation Q interest rate of 5 percent in
both states, while the market interest rates in the high- and low-investment states are assumed to be
10 and 5 percent respectively. Given these assumptions, one can show that the loan rates satisfying
the first-order conditions of the contracting problem are 8.2 percent in the high-investment state
and 6.9 percent in the low-investment state. So in this case, the contract results in considerable
smoothing--a 500 basis point difference in market rates leads to only a 130 basis point difference in
the loan rate.18
V. Evidence for the Implicit Contract
Are the assumptions needed to justify the smoothing of loan interest rates plausible in the
period before 1970? As shown in Figure 7, the average rate paid on bank liabilities (measured as
gross interest expense divided by average liabilities) was very smooth until the early 1970s,
suggesting that the regulations on deposit rates considerably limited the response of deposit rates to
market rates.19 Figure 8 shows the profits of nonfinancial firms before taxes and interest payments,
as a percentage of firm assets (on both book value and market value bases). The profit rate of
nonfinancial firms has trended lower over time, but it appears to fluctuate by only a few percentage
points over the business cycle, suggesting that the condition in equation (8) is plausible. Of course,
this is an average profit rate, while it is the expected variation in the marginal profitability of
investment funded with bank loans that should influence the loan contract.
Results from Federal Reserve surveys in the 1950s provide more direct evidence for the
existence of an implicit contract limiting interest rate increases for firms having a relationship with
18
This numerical solution is solved without linearizing the constraint. The effect of the linearization is very small.
The smooth rise in banks’ cost of funds in the 1960s reflects increases in the Regulation Q deposit rate ceilings (see
Mahoney et al., 1987), as well as the development of ways around the ceilings (see below).
19
13
a bank. During the period between 1955 and 1957, business loans at banks expanded rapidly and
short-term market rates increased by about 2-1/2 percentage points. Over the same period, the
business loan rate at banks rose less than 1 percentage point, implying a narrowing of the spread of
bank loan rates over market rates of more than 150 basis points (Table 2).
With loan demand outstripping growth in deposits, banks reportedly employed a number of
alternatives to higher rates to limit their loan growth (Federal Reserve, 1958, p. 431). In addition to
tightening their lending standards, a Federal Reserve survey of more than 1500 banks found that
banks were giving priority in lending to “regular borrowers as opposed to new customers ... [or]
those who were ‘shopping around’ for credit, or ... national concerns approaching the bank for the
first time.”20 The survey also found “frequent expression of reduced willingness to grant loans to
nonlocal borrowers, mostly sales finance companies and commodity dealers.” The mention of sales
finance companies is particularly interesting since the finance companies were the major issuers of
commercial paper at that time (Selden, 1963). Since these companies would be paying market rates
on their paper, they would of course have been eager to increase their borrowing from banks at the
relatively low rates being charged on bank loans at the time. Not surprisingly, however, banks did
not want to provide loans to them at the rates they were charging their existing customers.
The relative treatment of large and small borrowers described in the surveys is also
consistent with what the implicit contracting model might lead one to expect. As noted, the
existence of the implicit contract depends on borrowers not having direct access to financial
markets, since if borrowers have access to non-bank finance, they can borrow directly when n the
bank may not be able to sustain a loan rate far above the market rate in times of low credit demand,
since the borrowers could turn to other credit sources instead, while still borrowing from the bank
at relatively low rates in times of high credit demand. As a result, one would expect less smoothing
of loan rates for firms with better access to other forms of credit. In particular, one might expect to
see more smoothing for small borrowers, since they would be less likely to have access to direct
borrowing in the credit markets and also might find it harder to shift to another bank because of the
greater information asymmetry involved with smaller firms. Indeed, the Federal Reserve survey
shows that interest rates for smaller firms were smoother than those for larger firms. Between midThis view is supported by the description of “traditional credit crunches” in English (1979). He relates that, “No
matter how nimble a bank was...it eventually ran out of money to lend... As it approached this wretched state, the
bank...began to ration its funds. It began to say ‘no.’ It began to distinguish between good and indifferent customers,
and between worthy and speculative purposes.”
20
14
1955 and mid-1957, the average rate on short-term business loans at banks rose 80 basis points.
For large borrowers (those with assets of more than $100 million), the rise was 120 basis points,
while for the small borrowers (those with assets of less than $250,000), the rise was only 60 basis
points.21
In part, the different behaviour of the rates on loans to larger and smaller borrowers may
reflect the effects of state usury laws (which ranged from 6 to 15 percent in states having such laws
at this time; see Bach, 1963). Since smaller borrowers generally paid higher rates, they would be
more likely to be affected by the laws. However, corporate borrowers were exempt from usury
laws in many states (e.g., New York, see Hodgman, 1963, p. 130). Moreover, as shown in Table 3,
the size of the rate increase rises monotonically with the size of the firm, and the relationship
appears evident even for size classes with average loan rates in 1957 that were well under 6
percent.22
VI. Why Did the Implicit Contract Breakdown?
By the late 1960s, a number of aspects of the lending environment were changing in ways
likely to undermine the degree of smoothing of loan rates that could be sustained under the implicit
contract described above. These changes affected both parties to the implicit contract. First, during
the 1960s banks began exploiting funding sources that were not covered by the Regulation Q
ceilings on deposit interest rates. These methods included large negotiable certificates of deposit,
eurodollar deposits, federal funds, and holding company commercial paper issues.23 Second, larger
and more credit-worthy firms increasingly had direct access to financial markets, and so could
exploit differences between loan rates at banks and market interest rates.
A. The Effects of the Waning of Regulation Q
The availability of the new sources of funds for banks had two effects. First, it made the
banks’ cost of funds more sensitive to movements in market rates. As can be seen in Figure 6, the
21
A similar pattern is observable in the QIRS data over this period: rates on larger loans increased more than those on
smaller loans.
22
Unfortunately, there is no information on the distribution of loan rates within categories reported in Federal Reserve
(1958). Thus, it is not possible to evaluate rigorously the possible effects of usury laws or the statistical significance of
the differences across size category of borrower.
23
These developments are emphasized in English (1979). Rockefeller (2002, p. 197) notes that the negotiable CD was
introduced by the large New York banks in the early 1960s, somewhat earlier than they were employed in other banks
(see, e.g., English (1979)). The description of bank cyclical liquidity management in Woodworth (1967) notes the
availability of managed liabilities. However, that the “practical program of cyclical liquidity management” presented
by Woodworth was based on asset management, rather than liability management.
15
average cost of bank liabilities became much more responsive to movements in short-term market
interest rates in the early 1970s.24 The second effect of banks having access to funds at market
rates is that they no longer became loaned up--i.e., they no longer had to ration customers in
periods of robust loan demand. As English (1979) noted about commercial bank operations after
the introduction of the negotiable CD, “if loan demand increased and rates rose, one would simply
go out and pay more for CD money.... No more need to manage our assets. We would manage our
liabilities instead.”
As shown in Appendix D, if the earlier model is changed, so that deposit rates are equal to
market rates in each state, and banks are assumed to borrow funds at the market rate to extend loans
in the high demand state, equation (7) becomes:25
RLL - RLH = RMH - RML – S’
(7’)
where
S’ = {[(1-)/][pL/pH]  (’/’)
’ = (F+BpH)[(1-)/][pL/pH]  (F+B pL)
’ = F[RMH-RML-(RH-RL)]
The changes to the model have a number of effects on S, but one can show that the net
effect on the optimal contract is to reduce smoothing so long as banks are risk averse (see
Appendix D). Intuitively, at unchanged loan rates the assumed changes in the banking environment
will trim bank profits in the high investment state both because the deposit rate now changes with
market rates and because banks borrow funds at the margin at market rates and relend them at a
loss (if RLH < RMH, as one would expect). As a result, the banks’ marginal rate of substitution
between the two states will differ from that of the borrowing firms, and to re-equilibrate them the
loan rate in the high-demand state will have to rise relative to the loan rate in the low-demand state.
But that adjustment will reduce the degree of smoothing.
If the numerical example presented earlier is changed to reflect the elimination of
Regulation Q, the effect is a substantial decrease in smoothing. In this case, deposit interest rates
(which had been assumed fixed by Regulation Q at 5 percent in both states) are assumed to be
equal to market rates, and banks are assumed to borrow at market rates in the high-demand state to
Somewhat surprisingly, it is not clear from the figure that banks’ cost of funds rose on average, relative to market
rates, as methods were found to avoid Regulation Q or even as Regulation Q was phased out.
25
The effects would be the same if deposit rates were below market rates in both states, so long as the difference
between deposit rates across states was the same as the difference between market rates.
24
16
meet loan demand. The result is that loan rates change by 360 basis points in reaction to the 500
basis point difference in market yields across states, up from the 130 basis points found earlier.
Thus, loan rates are smoothed less than half as much. If this effect is decomposed into the portion
owing to variation in deposit rates and the portion owing to the ability of banks to borrow at the
margin to fund loans in the high-demand state, the latter effect proves to be very small. This
decomposition seems reasonable, since the increase in lending funded with such borrowing is fairly
small, and the loss on the resulting loans is also small, so that the combined effect should be quite
small. By contrast, having a higher deposit interest rate in the high-demand state has a large effect
on bank profits since it applies to all deposits, not just marginal funds. In practice, however, the
development of markets for managed liabilities also had the effect of raising the share of deposits
on which banks had to pay interest, so that the two effects were tied together. 26
B. Direct Access to Market Finance
The other change in the financial environment around 1970 was an increase in the ability of
firms to obtain short-term funding directly in financial markets. While the availability of marginal
sources of funds at market rates for banks leads to an optimal implicit contract that provides less
smoothing of interest rates across states, direct access to market funding by firms undermines the
existence of the contract itself. Such access could allow bank customers to take advantage of the
bank to reduce their average borrowing costs. In periods of strong loan demand, such customers
can take advantage of the smoothing of bank loan rates by borrowing at relatively low rates from
banks. However, in periods of weaker demand, the firms can avoid paying relatively high rates on
bank loans by borrowing directly in the financial markets.
As shown in Figure 9, nonfinancial commercial paper increased as a percentage of bank
loans from under 2 percent in 1965 to nearly 7 percent in 1970, with the increase presumably
largest among larger and more credit-worthy firms.27 While these fractions are small, it is not so
much the actual use of alternative sources of funds, but the possibility of such use that makes the
Or as Rockefeller (2002, p. 197) put it, negotiable CDs and Eurodollars “solved the ‘availability of funds’ problem”
that banks had previously faced, but at the cost of forcing banks to pay interest on a larger fraction of their (business)
deposits.
27
Rockefeller (2002, p. 380) notes that by the early 1970s the profitability of lending to major corporations had been
eroded by competition from other lenders and “even more important...from the growing use of commercial paper.”
26
17
implicit contract impossible to sustain. Unless borrowers can credibly promise not to borrow from
other sources, banks will not be willing to continue with the smoothing arrangement.28
Further evidence on the breakdown of previous loan pricing arrangements can be gathered
from the interventions of the Committee on Interest and Dividends (CID). The CID was formed in
1971 as part of the Nixon Administration’s wage and price control program. The Committee was
intended to ensure that banks and others did not profit at the expense of firms and households that
were constrained by the various wage and price control regimes that were put in place. For a time
in 1973, the CID successfully pressured banks to limit rises in the prime rate. The resulting low
level of the prime rate relative to market rates (which is visible in the bottom panel of Figure 3) led
large businesses with access to the commercial paper market to shift their borrowing from that
market to banks, boosting bank lending substantially, as shown in Figure 10 (for a discussion, see
Francis (1973)). This shift is consistent with the view that improved access to financial markets by
large firms allowed them to take advantage of relatively low rates on bank loans, and so likely
made the earlier degree of loan rate smoothing difficult to sustain.
Also in 1973, the CID introduced a two-tier prime rate regime, under which banks were to
have a separate prime rate for small businesses.29 The CID indicated that the standard prime rate
was supposed to reflect current market conditions, while the small-business prime was intended to
move more gradually, and only in response to changes in banks’ (average) cost of funds or other
lending costs. While this arrangement was imposed on banks, some commentators thought it was
appropriate in any case, suggesting some support for interest rate smoothing. Moreover, the
differential treatment of larger and smaller firms continued well after the controls expired and the
CID was disbanded in April 1974.30 Figure 11 shows the two prime rates as well as the 3-month
eurodollar rate for the period for which data on the dual prime rates were collected and published. 31
Over this interval, the standard prime rate appears to have moved relatively closely with the
eurodollar rate, while movements in the small business prime appear to have been far more muted
and to have lagged movements in market rates. While this is what you would expect under the CID
guidelines, it continued to be the case for more than a year after the controls ended, suggesting that
28
Concern about the same sort of opportunistic behaviour can interfere with implicit labour contracts. See Rosen
(1985), p. 1170.
29
The CID controls were voluntary, but they appear to have been widely adopted by banks. See Hutnyan (1973).
30
See the American Banker editorial on 9 April 1973 and Hutnyan (1974).
31
The Federal Reserve collected and published data on the two prime rates between mid-1973 and mid-1975.
18
banks chose to provide some insurance to their small business customers.32
Perhaps most
strikingly, over the last few months of the period, as market rates fell sharply, the standard prime
rate fell below the small business prime rate, suggesting that the buffering of high rates that small
businesses enjoyed over much of 1973 and 1974 would be offset by relatively high rates in the lowinterest-rate period that followed, exactly as the implicit contract view would suggest.
In the case of larger business customers, a number of banks began explicitly indexing their
standard prime lending rates to market rates in this period, perhaps in order to avoid pressures from
the CID (Goldberg (1982)). In the late 1970s, these political complications had passed, but the
prime rate continued to move closely with market rates (see Goldberg, 1982). Moreover, banks
began to price loans for their largest customers directly off of market rates, rather than pricing them
relative to the prime rate (Brady, 1979; Simpson, 1988).
By the mid-1990s, even small businesses paying loan rates tied to the prime rate no longer
had access to smoothed loan interest rates. As noted earlier, since the middle of the decade the
prime rate has equalled the target federal funds rate plus 300 basis points. The apparent
unwillingness of banks to provide small business customers with insurance against changes in
market interest rates likely owed to a number of factors. First, the end of Regulation Q (which was
phased out over the first half of the 1980s) meant that the rate banks paid on deposits moved more
closely with market interest rates. As a result, banks would have found providing the insurance
more costly in terms of the variability in their own profits. Second, the continued development of
financial markets (e.g., the development of commercial paper conduits) provided more firms with
relatively direct access to market financing. Third, the increased role of other credit providers,
most notably finance companies, as well as greater competition among banks in the market for
small and medium-sized business lending may have made implicit contracts difficult to sustain.
VII. Concluding Remarks
Between the mid-1960s and the mid-1980s business loan rates in the United States became
increasingly similar to short-term market rates. This change in behaviour can be attributed to
changes in the banking and financial environment that made it more difficult to sustain an implicit
contract under which banks and borrowers shared the risk of fluctuations in interest rates. Given
32
Moreover, the continued difference in the responsiveness of rates on large and small loans is also visible in the
subsequent QIRS data, which show sluggish movement in small loan rates relative to rates on larger loans.
19
this interpretation, there are two natural questions to ask. First, why did the change come when it
did?
Second, did this change in loan pricing behaviour matter for the behaviour of the
macroeconomy?
The breakdown of the smoothing regime may have owed in part to the higher inflation and
interest rates that prevailed in the late 1960s. Higher interest rates made the Regulation Q ceilings
on deposit rates bind more tightly as banks became disintermediated. In response, banks made
efforts to find ways around the regulation, and their customers were encouraged to find alternative
sources of funds. But, as noted here, these responses, by changing the environment in which
lending took place, reduced the attractiveness of smoothing loan rates.
As for the second question, in the model presented here, the elimination of loan rate
smoothing has no implications for the macroeconomy. The implicit contract between banks and
borrowers smoothes the pricing of loans across states, so that periods of high market rates and
strong loan demand are characterized by credit rationing at low loan rates rather than market
clearing at high rates. But the allocation of lending is not affected. As is the case with the wage in
many implicit contract models of the labour market, the price in a given state -- in this case the loan
interest rate -- does not affect the quantity supplied or demanded in that state (Rosen (1985)).
Thus, for example, it would be wrong in this view to believe that the relatively rapid and more
complete adjustment of loan rates to changes in market rates since the 1960s necessarily has
implications for the speed with which monetary policy changes have fed through to changes in
borrowing and spending.33
It is possible, however, that in a more complex model there would be some effects of the
implicit contract. For example, in the labour contracting literature, private information can have
important implications for the efficiency of labour market outcomes under implicit contracting
(Rosen (1985), pp. 1168-69). Moreover, the importance of having an ongoing relationship with a
bank in order to obtain credit in the high-investment state could have macroeconomic effects. To
the extent that new firms find it hard to get credit in periods of high credit demand, it may be that
innovation is damped as a result of the implicit contract. Similarly, banks, constrained in the
interest rates they felt could charge, may have been less willing to lend to riskier firms in periods of
33
Of course, this need not be the case if the sluggish adjustment of lending rates to changes in market rates reflected
other factors, such as lack of competition or other features of the banking environment. For example, less than full
pass-through of increases in market interest rates to loan interest rates in periods of strong loan demand could result
from the need to limit monopoly profits in order to sustain collusion among imperfectly competitive banks, as in
Rotemberg and Saloner (1986). See the introduction to BIS (1994) for a discussion.
20
high loan demand, potentially affecting the characteristics of the investments undertaken. Finally,
to the extent that smoother interest rates helped support firms’ income in periods of high interest
rates, they may have reduced the likelihood of financial distress, and so may have eased the effects
of higher rates on employment and investment.
More generally, the developments in banking and financial markets that led to the
breakdown in loan rate smoothing likely had broader macroeconomic effects. For example, the
phasing out of Regulation Q ceilings on deposit interest rates meant that banks and thrifts were no
longer disintermediated when market rates rose above the Regulation Q ceilings. As a result, high
interest rates no longer had outsized effects on sectors that were heavily dependent on
intermediated credit, especially housing. At the same time, the development of both market and
intermediary-based sources of business finance presumably added to the stability of the financial
system, since difficulties in one channel could be buffered by an expansion of credit from the other.
Indeed, in the fall of 1998, when financial markets were in turmoil, banks were able to step in and
provide substantially more credit for a time, thereby contributing to the resilience in the U.S.
economy (Greenspan, 1999).
21
Appendix A
Available Series on Business Loan Rates34
This appendix presents information on the business loan rate series collected by the Federal
Reserve since 1939. The Quarterly Interest Rate Survey (QIRS) was introduced in 1939, and
changes were made to the survey in 1948, 1959, 1967, and 1971. In 1977 the QIRS was replaced
by the Survey of Terms of Bank Lending to Business (later, the Survey of Terms of Business
Lending--both are referred to here at the STBL). This Appendix notes the changes in the coverage
of the surveys, the weighting system used to convert the survey data to national averages, and the
availability of the resulting series.
I. Quarterly Interest Rate Survey (QIRS)
A. 1939-1948 (See Collier, 1939)
Coverage: New commercial loans with maturities of 30 days to 12 months, inclusive. The
definition may have included agricultural loans, but the Bulletin (January 1939, p. 17) claims that
such loans were negligible. The loans were included if made during the first 15 days of the last
month of each quarter. The survey covered about 90 large banks in 17 cities. Whereas previously
the banks had reported a prevailing rate on prime business loans, the survey now required the
reporting of the dollar volume of lending at various rates and in various rate ranges.
Weighting: City averages are based on the sum of the reports of the reporting banks in the city.
City averages are then accumulated using weights shown in the Bulletin (1939, p. 965). The
weights were calculated based on commercial and industrial loans outstanding at all weekly
reporting banks. Regional weights were based on the share of loans at weekly-reporting banks in
each region. City weights within each region were based on the loans of weekly-reporting banks in
that city relative to loans at weekly-reporting banks in all of the surveyed cities in the region.
Availability: The Bulletin published data for 3 regions. The weights used to construct the overall
average series from these 3 series can be found in the 1939 article.
B. 1948-1966 (See Youngdahl, 1949)
Coverage: New commercial loans and renewals with maturities of less than a year made in the first
15 days of the final month of each quarter. Starting in September of 1959, excluded loans to
nonbank financial institutions. As before, the survey covered about 90 banks in 19 cities (the
number of banks dwindled over time). The panel changed slightly in 1948. Note that data were
now reported for each loan extended rather than for the volume of loans extended at particular rates
or in particular rate ranges. This change allowed for the calculation of average rates by size as well
as region.
Weighting: Average rates for each of 9 size categories (by loan size) were calculated for each of
the three regions using all of the data reported by banks in that region (no city weights). These nine
rates were then combined into 4 broader size categories based on weights taken from a 1946 survey
of the stock of business loans outstanding. The resulting 12 (4 sizes for three regions) series were
combined into regional, size, and overall averages based on weights obtained from the 1946 survey.
34
Earlier surveys, running back to 1919, asked large banks to report the prevailing rate on prime commercial loans on a
monthly basis. The subsequent surveys reported here collected the actual distribution of rates charged. There appears
to be a significant break when the new series was introduced in 1939. The development of a consistent series for the
1919-1938 period is left for future work.
22
Availability: The Bulletin published data for 3 regions and 4 size categories (12 series in all). The
(1946) weights used to construct the overall average series from these 12 series are available in the
March 1949 Bulletin (p. 235).
C. 1967-1971 (See Eckert et al., 1965; Bulletin, May 1967)
Coverage: New commercial loans and renewals during the first 15 days of the middle month of
each quarter. Excludes loans to foreign businesses and business instalment loans. (As noted in the
May 1967 Bulletin article, these had not been reported by many respondents in any case, p. 721;
looks like about half in Eckert et al.(1965)). Loans separated into short-term, long-term, and
revolving credit. Revolving credit loans had been included in both short-term and long-term loans
before (see the May 1967 Bulletin article, p. 722). The panel was expanded from 66 banks (note
the substantial decline from about 90 back in the 1940s) to 126; the number of cities was increased
from 19 to 35. The survey still generally was of large banks in large cities. Published data includes
six regions (rather than three) and five (new, larger) size categories.
Weighting: Based on the actual volume of new loans reported during 1967.
Availability: Aggregate data is available by type of loan, size and region for 1967-1970 in the June
1971 Bulletin.
D. 1971-1977 (See Weaver and Fry, 1971)
Coverage: Accounts receivable loans were dropped from the survey because they generally had
fees that were hard to convert to interest rate equivalents. For most respondents, the reporting was
cut to the first seven business days of the middle month of the quarter.
Weighting: Revised to reflect the volume of loans reported in 1971.
Availability: Aggregate rate data is available by type of loan, size and region in the annual
statistical digest. The volume of loans of each type is available in the E.2 statistical release (on
microfilm in the Board’s Research Library).
II. Survey of Terms of Bank Lending to Business (STBL)
A. 1977 to present (See Boltz, 1977)
Coverage: All new commercial and industrial loans and renewals during the first full week in the
middle month of each quarter. Construction and land development loans, including those
collateralised with real estate, were included until 1989. The panel was expanded to include a
stratified random sample of up to 348 banks of all sizes in all parts of the country.
Weighting: The banks are divided into six strata by size, and the loans in each stratum are
weighted by the inverse of the ratio of business loans at surveyed banks in that size stratum to
business loans at all banks in that stratum. Weights are calculated based on the most recent but one
Call Report. The resulting overall average rate is an estimate of the average rate on all loans
extended by all domestically chartered commercial banks in the survey week.
Availability: The microdata is available on the Federal Reserve Board computer system. Average
rates and the volumes of new loan extensions are reported by size and maturity of loan on the E.2
statistical release and in the E.2 historical package, as well as in the Federal Reserve Bulletin.
23
Appendix B
Adjusting for Breaks in the Series
When the various loan rate series from the QIRS and the STBL are spliced together there
are breaks in the combined series resulting from three types of changes: the weighting method used
to calculate the overall average rate, the types of loans covered, and the panel of banks covered. It
is generally possible, however, to obtain an estimate of the size of the resulting breaks from either
published or unpublished sources, or--for the STBL--to calculate such an estimate from the
microdata. These breaks are then removed from the series in one of two ways: proportional or
tapered break adjustments. Proportional adjustments are used for breaks in the series that one could
reasonably expect to affect all earlier observations equally, such as breaks caused by the inclusion
or exclusion of certain types of business loans. In such cases, the affected loan rate observations
are multiplied by a factor (either greater or less than one) that removes the effect of the break at the
time it occurred. By contrast, the effects of some breaks are known to have cumulated over time
(for example the effect of reversing in one step a slow attrition of banks from the survey panel). In
these cases, the multiplicative factor is tapered smoothly to one over the period to be adjusted, so
that earlier data are unaffected.
I. Adjusting for the Effects of Changes in Weighting Method
The method used to calculate an estimate of the overall average rate on short-term loans at
all large banks based on the data reported by the panel banks has changed several times since 1939.
Between 1939 and 1948 the reported data was averaged for each of 19 cities,35 the city averages
were then averaged using city weights based on the distribution of large bank business loans within
each of three regions in the late 1930s to form three regional averages (New York City, Other
Northern and Eastern Cities, and Other Southern and Western Cities). These in turn were averaged,
again using weights based on the distribution of large bank business loans, to form a national
average. (For details, see Collier, 1939.) The weights used were not updated over time.
The weighting method was changed in mid-1948 to take explicit account of the size
distribution of loans. This was possible because banks began reporting both the rate and size of
individual loans at that time. For each of the three regions an average rate--weighted by the volume
of lending--was calculated for 9 size categories of loan (these averages were not published). The
nine averages were then combined into averages for 4 broader size categories using weights
calculated from the panel banks' responses to a 1946 Federal Reserve survey of the characteristics
of the stock of bank business loans by size of loan. The overall average rate was then calculated as
a weighted average of the 12 (4 sizes times 3 regions) published region-size averages. Again the
weights were based on the panel banks' responses to the 1946 survey. (See Youngdahl, 1949, for
details.)36
The weighting method was changed again in 1967. At that time, the number of regions was
increased to six, and the broader size categories were redefined and the number of such categories
35
Note that this average was weighted by the volume of loans at each rate (rather than by the number of loans).
Youngdahl (1949) also reports a revised series for 1939 to 1948Q1 intended to be comparable recalculating the old
average rates based on the 1948 weighting system. I have not used that series for two reasons. First, I do not want to
use fixed weights, but rather weights that move over time reflecting the actual distribution of loans extended. Chain
weights might be best for this, but fixing the weights at their 1948 levels is not right. Second, the calculation is
necessarily very approximate (since the sizes of loans were not reported until 1948); Youngdahl only reports rates
rounded to the nearest 10 basis points.
36
24
increased. It is not indicated in the description of the changes published in the Federal Reserve
Bulletin (Bulletin, 1967) if the number and definitions of the narrower size categories used in the
construction of the data were changed. The average rates for these narrower categories continued
to be unpublished. In addition, the weights used to construct the overall average from the regionsize specific averages were changed. Initially these weights were based on the volume of loans
reported on the February 1967 survey, but revised rates were published later based on the volume
of loans reported on all of the 1967 surveys.37 (The effect of the revisions was very small. The
revised series have been used here.) Unfortunately, the new weights were not published and cannot
be backed out of the reported data because of a lack of data.
These changes in the weighting method are handled in two steps: first by calculating revised
aggregate loan rates using interpolated weights, and, second, by smoothing additional effects of
changes in the weighting method over the period during which the weights were fixed. For the
period from 1939 to 1946, I interpolate quarterly series for the regional weights using the weights
selected in 1939 and those from the 1946 survey as endpoints. For 1947 to 1966 I interpolate and
extrapolate region/size weights using the 1946 survey weights and a second set of region/size
weights reported in Eckert et al. (1965, Appendix 3) that reflected the actual volume of loans
reported in the survey in 1964. I then use these interpolated weights to calculate an overall average
rate based on the regional rate series reported in 1939-48 and the regional/size rate series reported
in 1948-66.
Youngdahl (1949) and the 1967 Bulletin article show the effects of the changes in the
weighting methods in 1948 and 1967. Unfortunately, the reweighing described above removes
only a small portion of these effects (only 2 of 12 basis points in 1948 and 1 of 7 basis points in
1967). The difference in 1948 may result from the change from purely geographic weights to
weights based on both loan size and geography, while the difference in 1967 may reflect a large
change in the distribution of loans between 1964 and 1967. In addition, changes in the (unreported)
weights used to combine the (unpublished) narrow region-size category series into the published
broad region-size series may matter. In any case, the effects not accounted for by my reweighing
are smoothed over 1939-1948 and 1948-1966 respectively.
In 1971 the weights were changed to reflect the distribution of the volume of loans reported
in that year. (As in 1967, the preliminary results were based on the volumes in the February
survey, and these results were later revised to reflect the volumes reported in all four surveys in
1971. Again the effect of the revision was very small.) The effect of the change in weights (8 basis
points) is shown in Weaver and Fry (1971). Since the new weights, like those introduced in 1967,
were not published, I have simply smoothed the effect of the change over the 1967-71 interval.
Starting in 1977, the STBL weighting system is based on the size of banks, rather than the
size and geographical distribution of reported loans. Initially, the STBL included the 48 largest
banks in the country and then 5 strata of 60 banks of declining size. Coverage of the largest banks
is no longer complete, although it is nearly so. Each stratum is assigned a weight ("blowups
factor") equal to the inverse of the share of the surveyed banks in the total business loans of all
banks in that size category on the most recent available Call Report. Thus the blowups factor for
37
Initially it seems unattractive to use the reported volumes of loans extended rather than the stock of loans
outstanding to calculate the weights. So long as the maturity structure of the loans does not differ across size/region
categories, however, the weights are the same. Oddly, there was a 1955 survey similar to the one in 1946, but it was
not used to update the QIRS weights. Eckert, et al. (1965) presents evidence that the effects of different weighting
schemes are fairly small.
25
the top stratum of 48 banks was 1 (and is still nearly 1) and the blowups factors are larger for the
samples of smaller banks, owing to their more limited coverage. Because the QIRS surveyed only
large banks, I focus here on the loans reported by the top two stratums. Since the weights used in
1971 were not published, it is not possible to evaluate the size of the effect of shifting to the new
weighting system, although the effect of applying the stratum blowups factor to the loans of the
stratum 2 banks is accounted for below. It seems likely that the effect of shifting from the 1971
weights to weights based on the current volume of loans extended (effectively what I do here)
would be similar in size to the shift in weights between 1967 and 1971 (i.e. about 10 basis points).
Since there is no available information, however, I cannot made an adjustment.
II. Adjusting for the Effects of changes in Loan Coverage
The types of loans included in the QIRS were changed in 1948, 1959, 1967, and 1971.
There are proportional break adjustments reflecting the changes in 1959, 1967, and 1971. The shift
to the STBL in 1977 requires a further proportional adjustment.
Between 1939 and 1948 the QIRS excluded loans with maturities under 30 days. However,
the effect of including such loans starting in June 1948 was not noted in Youngdahl (1949), which
reported on the changes in the survey at that date.38 It is likely that there were few such loans at
that time, and so their inclusion had very small effects.
Starting in September 1959, loans to non-bank financial institutions were excluded from the
QIRS. The effect of excluding such loans in the September survey was reported in the Bulletin
(Jan. 1960, p. 49) by size of loan and region of the country. I used the weights for that date to
calculate the effect on the overall average rate (about 1/2 basis point), and made a proportional
adjustment to the earlier data to reflect the change.
In the 1967 revision of the QIRS, loans to foreign businesses and a particular type of
business instalment loan were excluded. These loans had not been reported by a "substantial
number of banks" in any case (Bulletin, 1967, p. 721). Unfortunately, the 1967 Bulletin article
does not provide an estimate of the size of this break. Eckert, et al. (1965, p. 11) estimate,
however, that the effect of excluding foreign loans was to reduce the overall average rate by "a few
basis points" in 1965. Translating "a few" as 3, I removed the break with a proportional adjustment
to the data for 1939-1966.
The excluded business instalment loans were loans on which interest payments were
calculated on the basis of the original principal of the loan even after part of the principal was
repaid. Evidently, some banks priced small business loans in this manner, which led to an
understatement of the effective interest rate by roughly a factor of two. These were presumably
high-cost loans, and had the effective rates been calculated correctly their exclusion would have
reduced the reported average rate on business loans. But, since the effective rate was understated,
the effect may have been to increase the average rate. In any case, no estimate of the effect of the
exclusion is provided in Eckert, et al. (1965), or in the Bulletin (1967), and I have made no
adjustment. The effect of the exclusion was likely small in any case, since Eckert, et al. (1965, p.
13) report that only about 40 percent of the respondents were including such loans in their reported
data, and business instalment loans tended to be quite small (Bulletin, 1967, p. 722).
38
Similarly, the QIRS may have included farm loans (not secured by real estate) between 1939 and 1948. Such loans
were included in a preliminary version of the QIRS that was fielded in September 1938, but Collier (1939, p. 17) notes
that the effect of including farm loans is negligible.
26
Between 1967 and 1976 loans were reported as short-term loans (those with maturities
under a year), term loans (with maturities over a year), or revolving credits (drawdowns under
revolving credit agreements). Before 1967, loans were categorized as either short-term or term,
and revolving credits were generally included in the term loan category, although one Reserve
Bank included them in the short-term loan category (Eckert, et al., 1965, p. 7n). Loans under
revolving credit agreements would generally have maturities under a year, and it is not possible to
separate them from other short-term loans on the STBL after 1976. Thus, I include revolving credit
loans between 1967 and 1976, and adjust the data before 1967 for their exclusion. Between 1971
and 1976 the volumes of short-term and revolving credit loans are available from the E.2 Statistical
Release, and I have used these reported volumes to form a weighted average of the published rates
on short-term loans and revolving credits. For 1967 to 1970, I used the ratio of short-term loans to
revolving credits in the February 1971 survey to form the weighted average. I then used the ratio
of the combined average rate to the average rate on short-term loans to make a proportional
adjustment to the pre-1967 data.
Between 1971 and 1976, accounts receivable loans were excluded from the survey because
it was felt that difficulties in calculating a correct effective interest rate on such loans -- taking
account of fees and other institutional arrangements that were not reported on the QIRS -- made it
not worthwhile (Weaver and Fry, 1971, pp. 468-9). Like revolving credits, however, accounts
receivable loans cannot be excluded from the STBL data available from 1977 on. Fortunately,
Weaver and Fry provide an estimate of the effect of excluding these loans in the February 1971
survey for short-term loans and revolving credits. I have used these estimates to make a
proportional adjustment to the short-term and revolving credit rates between 1971 and 1976. These
adjustments are then combined to construct the adjustment to the total short-term rate.39
As noted above, the STBL data available from 1977 on include all types of business loans,
including revolving credits, accounts receivable loans, and business instalment loans. Moreover,
these loan types are not reported separately, and so they cannot be excluded. Changes to the report
form allowed for the correct calculation of the effective interest rate on business instalment loans,
eliminating the problem that caused these loans to be dropped in 1967. The STBL also included
(until 1989) construction and land development loans collateralised with real estate. Such loans are
not commercial and industrial loans, and had not been included on the QIRS. Fortunately, these
loans can be identified, and I have not included them in the calculation of the average effective
rate.40
The STBL data include more detailed information on maturity than the QIRS. Between
1977 and 1982 the maturity of each loan in months was reported, and since that time the maturity in
days has been reported. In addition, some loans (for example, many prime rate drawdowns under
revolving credit agreements) have no stated maturity. These "demand" loans comprise about a
quarter of the loans reported. In defining short-term loans for the STBL, I included all loans with
maturities between one month and one year, and loans with no stated maturity. I exclude loans
with maturities of less than a month because their share of total short-term loans varied widely over
time, and this variation would have large effects on the behaviour of the average loan rate. Loan
39
I used the ratio times 11/12 to take account of the one reserve bank that was including the revolving credits in shortterm loans.
40 I have, however, included the very small number of construction and land development loans not secured by real
estate. These loans are commercial and industrial loans, but they were not included in the calculations of the published
business loan rates during the period when they were reported. The effect is extremely small because the volume of
such loans is very small.
27
with maturities under a month were only about 5 percent of the dollar volume of STBL loans in
1977, but their share expanded rapidly over the next few years, peaking at just over 3/4 of the
volume of new short-term loans extended in the surveys in November 1982 and February 1983
before falling back. Since the mid-1980s these very short-term loans have accounted for about onethird to one-half of the volume of lending in the STBL. Since these loans are likely for cash
management purposes rather than traditional commercial and industrial purposes--such as the
financing of inventories or investment--I exclude them. If they are included, the overall average
rate on short-term loans looks very much like the federal funds rate from the early 1980s on since
most of the excluded loans are made at narrow spreads over the funds rate.
Since loans with maturities under a month were included in the QIRS between 1948 and
1976, I have made a proportional adjustment over that interval based on the calculated effect of
excluding them in 1977. The effect is very small (less than 2 basis points in February 1977).
III. Adjusting for the Effects of Changes in the Panel
The size of the QIRS reporting panel declined from 91 banks in 1948 to just 66 in 1966. As
part of the 1967 revisions to the QIRS, the panel was expanded to 126 large banks. The series
break caused by the increase from 66 to 126 respondents was 5 basis points (Bulletin, May 1967, p.
726). I divide the 5 basis points into two parts: 2 basis points (which is 5 basis points times (9166)/(126-66)), which represents the effect of bringing the panel back to its 1948 level; and 3 basis
points, which represents the effect of increasing the sample size from 91 to 126. The 2 basis point
effect is removed with tapered break that is zero before 1948, and the 3 basis points is removed
with a proportional break for 1939-1967.
There is a break reflecting the change from the QIRS data to the STBL data in 1977. From
1977 on, I have used the weighted average rate for banks in the top two strata of the STBL panel (a
total of 108 banks) weighted by the factors used in the STBL. The blow up factors for the two
strata indicate that this part of the panel represents roughly 150 commercial banks. If one
calculates an average rate on all loans reported by the largest 126 banks in the STBL panel in order
to mimic the QIRS approach, the resulting rate is about 1-1/2 basis points lower than the rate based
on the STBL weights. I have made a proportional adjustment to the earlier data to remove this
break.
IV. Adjusting for Other Breaks in the Series
In 1967 and again in 1971, the method used for calculating the effective interest rate on
discounted loans was changed. In both cases, the effect of the change was reported in the Federal
Reserve Bulletin (Bulletin, 1967, p. 726; Weaver and Fry, 1971, p. 470). The effects of these
breaks were removed by making proportional adjustments to the earlier data.
28
Appendix C
Constructing Comparable Alternative Rate Series
There are two complications when calculating the comparable rate series employed here.
First, daily market rate data are not available over the entire period of the loan rate series. Second,
the timing and duration of the survey period changes over time. I deal with the first problem by
interpolating daily rate observations based on the lower frequency data that are available using a
cubic spline. This interpolation is required before 1953 for the 3-month treasury bill rate (using
monthly data), before 1962 for the 10-year Treasury note rate (using monthly data), and before
19xx for the AAA bond yield (using monthly data). Data on the federal funds rate are available
daily from 1954, and are not available at all before that time. Data on the discount rate (in the New
York District) and the prime rate are available throughout.
Given these daily rate series, I can then calculate the average rate for the appropriate survey
interval for each quarterly observation. The survey was for the first 15 days of the last month of the
quarter until 1966. Between 1967 and 1970 it was for the first 15 days of the middle month of the
quarter. Between 1971 and 1976 it was for the first 7 business days of the middle month of the
quarter. From 1977 on it has been for the first full week in the middle month of the quarter. In the
regressions, I have included dummy variables to account for the change in timing in 1967.
Note that I have used the bond-equivalent yield on the 3-month bill in all cases.
29
Appendix D
A More General Model
If the deposit rate differs across states and banks borrow at the margin to fund loans in the
high-demand state, then the contracting problem is:
Maximize: pH u(RH-RLH) + (1-) pL u(RL-RLL)
RLH, RLL
subject to:
 v(pH (RLH-RQH) - (pH-D) (RMH-RQH))
+ (1-) v(pL (RLL-RQL) + (D-pL) (RML-RQL))
(D1)
≥  v (D (RMH-RQH)) + (1-) v (D (RML-RQH))
where RQH is the deposit rate in the high-demand state and RQL is the deposit rate in the low
demand state. If, as before, one assumes that both banks and firms have constant absolute risk
aversion utility, and one linearizes the bank’s participation constraint (1’) around the point R LH =
RMH and RLL = RML, then the equilibrium loan rates are determined by the optimal risk sharing
condition:
(F+BpH)(RLH-RMH) = (F+B pL)(RLL-RML) – ”
(D2)
where
”= F(RMH-RML-(RH-RL)) + BD(RMH-RML- (RQH-RQL))
and the participation constraint:
(RLH-RMH) = -[(1-)/][pL/pH] ”(RLL-RML)
(D3)
where
” = exp{BD(RMH-RML - (RQH-RQL))}
Equations (4) and (5) can be solved for the loan rate in the two states:
RLL = RML + ”/”
and
RLH = RMH – [(1-)/](pL/D)” (”/”)
where
” = (F+BpH)[(1-)/](pL/pH)” (F+B pL)
30
(D4)
Subtraction yields:
RLL - RLH = RMH - RML – S”
(D5)
where
S” = {[(1-)/](pL/pH)” (”/”)
If one assumes that deposit rates are fully deregulated, then they should equal the market
rate in each state. In this case, the degree of smoothing is given by:
RLL - RLH = RMH - RML – S’
(7’)
where
S’ = {[(1-)/][pL/pH]  (’/’)
’ = (F+BpH)[(1-)/][pL/pH]  (F+B pL)
’ = F[RMH-RML-(RH-RL)]
as shown in the text.
The difference between S and S’ can be written as:
S’- S = {[(1-)/](pL/pH) (’/’) - {[(1-)/](pL/D) (/)
(D6)
so:
S’- S ={[(1-)/](pL/pH)’ - {[(1-)/](pL/D) ’/ (’)
Substituting in the expressions for ,’, , and ’, then multiplying out the terms and collecting
them, one can show that the numerator of S’-S is given by:
-F[RMH-RML-(RH-RL)] {([(1-)/]pL)2B/D+[(1-)/]pLpL/D)B + [(1-)/]pLB (D7)
BD(RMH-RML) {([(1-)/]pL)2B/D+[(1-)/]pLpL/D)B
+ [(1-)/]pLpL/pH)B+F+BpL)
FBD(RH-RL){ ([(1-)/]pL)2(1/(pHD))+[(1-)/]pL /D) + [(1-)/]pL1/pH)}
-aB[F(RMH-RML-(RH-RL))](D-pL)
Each of the terms in the braces is greater than or equal to zero, as is the term in square brackets at
the end. The leading terms outside the terms in braces are also positive, so (given that all of the
terms have negative signs) this expression is less than or equal to zero. Since’ is positive, S’-S
will be negative so long as B is nonzero and the effect of eliminating regulation Q will be to
reduce smoothing.
31
If B is zero, then the expression is zero since each term is multiplied by an B. Thus, if
banks are risk-neutral, eliminating Regulation Q has no effect on smoothing. This is not a surprise,
since in that case, the risk sharing condition simplifies to:
RLH =RLL +(RH-RL)
(D8)
so that the degree of smoothing is determined only by the returns on investment. In this case,
allowing deposit rates to vary across states and banks to borrow to meet loan demand in the highdemand state will raise both loan rates (since it will adversely affect bank profits), but the degree of
smoothing will not change.
32
References
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Studies, Homewood, IL: Richard D. Irwin, Inc., 1963.
Bank for International Settlements, National Differences in Interest Rate Transmission, March
1993.
Board of Governors of the Federal Reserve System, “Senior Loan Officer Opinion Survey on Bank
Lending Practices,” November 1993.
Boltz, Paul W., "Survey of Terms of Bank Lending: New Series," Federal Reserve Bulletin 63,
May 1977, pp. 442-455.
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797-815.
Collier, Raymond J., "Commercial Loan Rates at Banks in Principal Cities," Federal Reserve
Bulletin 25, January 1939, pp. 963-969.
Eckert, James B., "Member Bank Lending to Small Business, 1955-57," Federal Reserve Bulletin
44, April 1958, pp. 393-411.
Eckert, James B., Dorothy M. Nichols, Ruth V. Wilson, and George Budzeika, "Report of the
Adhoc Subcommittee on the Quarterly Interest Rate Survey," Mimeo., Federal Reserve Board,
October, 1965.
English, James F., Jr., “Credit Crunches I have Known,” speech before the Twilight Club, Hartford,
CT, 1979.
Federal Reserve System, Financing Small Business: Report to the Committees on Banking and
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Credit and Banking 12(3), 1980, pp. 471-87.
33
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1987.
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34
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35
Table 1
Business Loan Rate Regressions
(Quarterly Data)
Market Rate
1939:2-2002:2
Funds Rate
Discount Rate
Bill Rate
Treasury Note
AAA Bond
1939:2-1953:4
Discount Rate
Bill Rate
Treasury Note
AAA Bond
1954:1-1969:2
Funds Rate
Discount Rate
Bill Rate
Treasury Note
AAA Bond
1969:3-1983:4
Funds Rate
Discount Rate
Bill Rate
Treasury Note
AAA Bond
1984:1-2002:2
Funds Rate
Discount Rate
Bill Rate
Treasury Note
AAA Bond
1

3

0

R2
-0.16**
0.66**
0.31**
0.15**
1.63**
1.03**
0.86
-0.07
1.41**
-0.08
0.25**
0.96**
1.28**
0.75
-0.13**
0.68**
0.37**
0.22**
1.45**
1.13**
0.83
0.04
0.84**
0.50**
0.15**
0.61
1.06**
0.55
0.03
1.07**
0.63**
0.16**
0.42
0.97**
0.51
-0.21*
0.28
0.45
0.26**
2.60**
0.60
0.20
-0.19
-0.18
-0.13
0.28**
2.96**
0.45**
0.18
-0.13
0.00
-0.14
0.30**
1.30
0.88*
0.10
-0.11
0.03
-0.17
0.35**
1.03
0.88**
0.10
-0.22
0.29**
0.10*
0.10*
2.36**
0.96**
0.55
0.13
0.50**
-0.10
0.11*
1.22
1.23**
0.57
0.00
0.20**
0.09
0.11*
1.78**
1.13**
0.46
0.23**
0.36**
0.08
0.30**
0.64*
1.10**
0.51
0.38**
0.63**
0.07
0.45**
0.77**
0.98**
0.60
-0.18*
0.66**
0.35**
0.18**
1.59
1.04**
0.88
-0.11
1.71**
0.04
0.47**
-0.41
1.42**
0.84
-0.13
0.72**
0.35**
0.41**
1.18
1.16**
0.88
-0.00
1.16**
0.78**
0.24**
0.72
1.05**
0.59
-0.00
1.46**
1.02**
0.30**
-0.06
1.05**
0.55
-0.26**
0.93**
0.26**
0.45**
1.91**
1.02**
0.89
0.04
1.14**
-0.05
0.23**
2.25**
1.09**
0.57
-0.30**
0.87**
0.46**
0.33**
1.62**
1.12**
0.84
0.34**
0.66**
0.13
0.10**
-0.54
1.16**
0.44
0.38**
0.86**
0.01
0.11**
-2.60
1.26**
0.38
* = significant at the 10 percent level.
** = significant at the 5 percent level.
36
Notes: The table shows the coefficients from a regression of the form:
rlt =  rlt-1+ 2 rmt + 3 rmt-1 - a4 (rlt-1 - 0 - rmt-1)
where the interest rate listed at the left is the market rate, rmt, in the equation, and rlt is the bank loan
rate.
A dummy variable to account for the effects of Federal Reserve pegging of the rates on
Treasury bills before the Accord in March 1951 has been included in all regressions including data
from before the Accord. A dummy variable to account for the effects of quantitative controls on
bank lending between March 1980 and July 1980 has been included in regressions covering that
quarter.
The funds rate is the effective rate on federal funds. Data on the funds rate are only
available since 1954:2. The discount rate is the rate at the Federal Reserve Bank of New York.
The Treasury bill rate is the secondary market yield on three-month bills, on a bond-equivalent
basis. The Treasury note yield is the constant maturity yield at a maturity of 10 years. The AAA
bond yield is from Moody’s. For the construction of the comparable rates, see Appendix C.
37
Table 2
Business Loan Rates by Size of Borrower
(Short-term Business Loans at Banks, Percent)
Size of Borrower
(Assets in $thousands)
<50
50-250
250-1000
1000-5000
5000-25,000
25,000-100,000
>100,000
All sizes
1955
1957
Increase, 1955-57
5.5
5.0
4.6
4.1
3.7
3.4
3.2
4.2
6.1
5.6
5.4
5.1
4.8
4.6
4.4
5.0
0.6
0.6
0.8
1.0
1.1
1.2
1.2
0.8
Note: The table shows the average rate charged on loans between July 1 and the survey date in the
fall of each year. The “All sizes” category includes some loans to borrowers of unknown size.
Source: Board of Governors of the Federal Reserve System (1958), p. 388.
38
Figure 1: Bank Loan Rate and Market Interest Rates
25
Percent
20
15
10
5
0
2002
1999
1996
1993
10-Year Note
1990
1987
1984
39
1981
Note: Data are quarterly.
Source: See text.
1978
3-Month Bill
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
Bank Loan
Figure 2A: Bank Loan Rate and AAA Bond Yield
25
Percent
20
15
10
5
0
1996
2002
1996
1993
1999
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
Bank Loan
AAA Yield
Figure 2B: Bank Loan Rate Spread Over AAA Bond Yield
8
6
Percent
4
2
0
2002
1999
1990
1987
1984
40
1981
Note: Data are quarterly.
Source: See text.
1978
-4
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
-2
Figure 3A: Bank Loan Rate and the Treasury Bill Rate
25
Percent
20
15
10
5
0
1993
1996
1999
2002
1993
1996
1999
2002
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
Bank Loan
3 Month Bill
Figure 3B: Bank Loan Rate Spread Over the 3-Month Bill Rate
8
6
Percent
4
2
0
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
-2
-4
Note: Data are quarterly. In the bottom panel the bill rate has been multiplied by 1.16 (the long-run
coefficient for the period 1969-1984, as shown in Table 1). See text.
Source: See text.
41
Figure 4A: Bank Loan Rate and the Federal Funds Rate
25
Percent
20
15
10
5
0
2001
1999
1997
1995
1992
1990
1988
1986
1983
1981
1979
1977
1974
1972
1970
1968
1965
1963
1961
1959
1956
1954
Bank Loan
Federal Funds Rate
Figure 4B: Bank Loan Rate Spread Over the Federal Funds Rate
8
6
Percent
4
2
0
2001
1999
1997
1995
1992
1990
1988
1986
42
1983
Note: Data are quarterly.
Source: See text.
1981
-4
1979
1977
1974
1972
1970
1968
1965
1963
1961
1959
1956
1954
-2
Figure 5: Loan Rate Response to 100bp Rise in Federal Funds Rate
120
100
Basis Points
80
60
40
20
0
40
37
34
31
28
25
22
19
16
13
10
7
4
1
-2
-5
-20
-40
Quarters Since Change in Federal Funds Rate
1939-1953
1954-1969
1969-1983
1984-2002
Note: Based on the regression results reported in Table 1. In the 1939-1953 period the federal
funds rate data are not available, and so the figure shows the response to a 100 basis point rise in
the 3-month Treasury bill rate instead.
43
Figure 6A: Bank Loan Rate and the Prime Rate
25
Percent
20
15
10
5
0
2002
1999
1996
1993
1990
1987
1984
1981
1978
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
Bank Loan
Prime Rate
Figure 6B: Bank Loan Rate Spread Over the Prime Rate
8
6
Percent
4
2
0
2002
1999
1996
1993
1990
1987
1984
1981
44
1978
Note: Data are quarterly.
Source: See text.
1975
-4
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
-2
Figure 7: Average Cost of Liabilities
25
Percent
20
15
10
5
0
1999
1996
1993
1990
1987
Bill Rate
1984
1981
45
1978
Note: Data are annual.
Source: FDIC Historical Banking Data.
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
1942
1939
Average Rate Paid
Figure 8: Profits Before Taxes and Interest Payments
U.S. Nonfinancial Corporate Businesses
16
14
Percent of Assets
12
10
8
6
4
2
0
1946
1956
1966
1976
Market Value
Note: Data are annual.
Source: Unpublished flow of funds data.
46
Book Value
1986
1996
Figure 9: Commercial Paper of Nonfinancial Corporations
35
Percent of Bank Loans
30
25
20
15
10
5
0
2002
1999
1996
1993
1990
1987
1984
1981
1978
47
1975
1972
1969
1966
1963
1960
1957
1954
1951
1948
1945
Note: Data are annual.
Source: Flow of funds.
Figure 10: Prime Rate Spread and Bank Business Loan Growth
45
300
40
250
35
200
25
150
20
15
Basis Points
Percent
30
100
10
50
5
0
0
Jan.74
Sep.73
May.73
Jan.73
Sep.72
May.72
Jan.72
Loan Growth
Prime spread
Note: Prime spread is the spread of the prime rate over the 3-month Treasury bill rate. Data are
monthly.
Source: Federal Reserve, Statistical Release H.15.
48
Figure 11: The Small Business Prime Rate
16
14
12
10
8
6
4
2
0
Apr.75
Feb.75
Standard Prime
Dec.74
Oct.74
Aug.74
Jun.74
Apr.74
Feb.74
Dec.73
Oct.73
Aug.73
Jun.73
Small Business Prime
Euro$
Note: Data are monthly.
Source: Federal Reserve Statistical Release G.10, “Interest Rates Charged on Selected Types of
Bank Loans;” BIS Database.
49