WASHINGTON — While the Obama administration's efforts to boost small-business lending languish on Capitol Hill, lawmakers are pressing an alternative.

Sen. Carl Levin, D-Mich., on Tuesday proposed a reserve fund that a bank could tap when collateral posted by a small-business borrower declined in value. This reserve would be funded by contributions from small businesses and matching dollars from states and the federal government.

Levin said the move would help community banks continue to lend to well-known small businesses.

A "reason the banks don't lend is the collateral value has gone down," Levin testified before a Senate Banking subcommittee hearing. "It's the same collateral; it's the same machinery; it's the same equipment. But the value of that collateral, having gone down, the banks are unable, because of the regulatory reasons, to make the loan. … So what we need to do is find ways to support the collateral, the borrower, as well as to infuse more capital into the banks."

The plan is similar to House legislation introduced by Levin's brother, Rep. Sander Levin, also a Michigan Democrat, and co-sponsored by House Financial Services Committee Chairman Barney Frank. Observers said the bill is likely to pass the House, but its chances in the Senate are unclear.

Sen. Levin said other proposals have focused on giving capital to banks, but have ignored the deteriorating collateral of small-business borrowers.

"It's addressing the problem in a way that has not yet been addressed, as far as we know, by helping the borrowers who have decreased collateral value," he said.

The idea is modeled after the Michigan Capital Access Program, which funds reserve accounts to support loans to businesses that need collateral support. The $24.3 million in public and state funding committed to the program so far has supported $628.7 million in bank lending. About 28 states have similar programs.

Under the Levin plan a small-business borrower would pledge 3.5% to 7% of a loan's value as collateral into a reserve account at the lending bank, which would be matched by state and federal funding.

Art Johnson, the chairman and chief executive of United Bank of Michigan in Grand Rapids, has used the program.

"There are many instances where borrowers … that have performed and yet they are having trouble obtaining a loan now because of the fallout of their collateral value," said Johnson, who testified at the hearing on behalf of the American Bankers Association.

"A program like the pilot program in Michigan where funds are deposited into the bank into an interested earned account that is in turn pledged to the additional collateral for a small-business loan fills that collateral gap. That is a problem with many of the anecdotal cases we are hearing about. … Filling that collateral gap is certainly one of the things that needs to be done in order for us to be able to fill the supply gap."

Sen. Debbie Stabenow, D-Mich., also testified at the hearing in support of the idea, saying such a program is essential to help banks begin lending again.

"Even a healthy bank won't make a loan to a borrower who doesn't have enough collateral," she said.

In an interview later, Johnson said lenders cannot make a loan if the underlying collateral has deteriorated.

"What banks are having a difficult time doing in today's regulatory environment is making a loan that an examiner will classify as substandard the day we make the loan," he said.

The problem, Johnson added, is that most states can't pay for this kind of program due to budget constraints.

"The program had an awful lot of acceptance and exposure in its pilot stage in Michigan, but it's very hard for Michigan to come up with the money to keep the program going," he said.

Eric Gillett, vice chairman and CEO of Sutton Bank in Attica, Ohio, who testified on behalf of the Independent Community Bankers of America, also supported the program.

"The [Michigan] program is oversubscribed, and I think that speaks to the value of that program," he said.

Though sources said the Treasury Department also supports the plan, many details still need to be worked out. For instance, it is unclear how in either federal or state funds would be committed. The program is meant to be separate from the Troubled Asset Relief Program, though it could potentially use some of its funds.

Lawmakers said the plan to support collateral is designed to complement, rather than replace, the Obama program to funnel $30 billion fund to small businesses through community bank loans.

"To solve this credit crisis on Main Street is going to require multiple strategies," said Sen. Jeff Merkley, D-Ore. "I look forward to hearing and working with Sen. Levin and Sen. Stabenow … at ideas how to take this on."

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