Community bankers in Arkansas say a state law capping loan interest rates at 10% is driving them out of business.

"We need to address this issue before we look up and realize there are no local banks left," said Daniel G. Bailey, executive director of the Arkansas Bankers Association.

Arkansas law puts a ceiling on rates of five percentage points above the federal discount rate. Applying the formula, loans are currently capped at 10%.

So while multistate institutions such as Regions Financial Corp., based in Birmingham, Ala., or NationsBank Corp., Charlotte, N.C., can charge whatever the market allows, Arkansas banks are limited to 10%.

Without the flexibility to charge higher rates for risky borrowers, Mr. Bailey said, it is dangerous to reduce rates on more dependable customers. The out-of-state players can charge 7% to a good credit risk, knowing they can make up for it by charging 13% to a higher-risk customer.

"It is impossible to compete for the good customers without shrinking margins down to nothing," said Wayne Clark, president and chief executive officer of $120 million-asset First National Bank of Berryville, Ark. "Down the line, it leaves little choice for local banks other than to just get out."

In February the Office of the Comptroller of the Currency ruled that national banks may ignore interest rate caps imposed by states where they operate branches. The agency said these banks must follow only the interest rate laws in force in the states where they are headquartered, as long as key lending decisions are made there. The Federal Deposit Insurance Corp. issued a similar rule for state-chartered banks soon after.

During the last 15 years, the trend has been away from regulating rates in most states, said Mathew H. Street, assistant general counsel of the American Bankers Association. But Arkansas is an exception.

"There is no question it is one of the most restrictive lending environments in the country," he said. Many states no longer have restrictions, and most states with ceilings cap rates in the high teens or low 20's, he said.

Changing the law in Arkansas would require a referendum vote to alter the state constitution. An effort to do so failed in 1988, and there is no reason to believe the outcome would be different now, Mr. Bailey said.

"It is very hard to convince people that better credit risks are paying a higher rate than they have to because they are subsidizing poorer credit risks," he said. "Everyone just sees it as the banks trying to raise rates."

The Arkansas Bankers Association is trying to persuade Congress to intervene by overriding state law. Trade group officials will meet with members of the state's congressional delegation this summer to discuss the problem.

"The local institutions that know entrepreneurs best may not be able to provide a risky start-up loan," Mr. Bailey said. "This is an economic drag for the whole state."

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