Should banks make loans more on the basis of borrowers' character than collateral or cash flow?

Should bank examiners ease up on lenders to facilitate loans to small businesses?

President Clinton has made clear he believes the answer to both questions is yes. And he has urged bank examiners to be less strict in enforcing rules and regulations.

As one who has observed the banking industry first as a bank examiner and then as a financial analyst, I doubt that either of these ideas will work. The President's plan is well intentioned, but he's approaching the problem from the wrong direction.

Within reasonable limitations, there's nothing wrong with character lending. In fact, it is nothing new. Typically, a banker will say, "I've done business with you for 20 years, I know you, I trust you, I know your business. I'll give you a loan on a handshake."

But bankers are going to be skittish about lending on the basis of character when they don't know the prospective borrower.

Good character and never having declared bankruptcy don't equal creditworthiness. Bankers should and will insist on thorough credit checks, analyses of business fundamentals, and evaluation of collateral. This is just prudent business.

Examiners Go by the Book

As for the bank examiners, they're not likely to be influenced by anything less than a change in the regulations they're supposed to enforce. Examiners aren't paid to be relaxed; like any regulators, they are supposed to protect the depositors and maintain the integrity of the banking system.

That attitude is perfectly understandable. The examiners remember the 1980s, when some of them were hauled before Congress and asked how they could relax standards and allow certain lenders to fail.

President Clinton also seeks to reduce overlapping examinations by the banking regulators. This is another commendable goal, but it too is unlikely to be realized.

At least three entities regulate commercial banks, and there's no question that each looks at banks differently and duplicates the others' efforts. The only solution to overlapping examinations would be to combine the three regulators into one.

President Reagan recommended this 11 years ago and got nowhere. It's doubtful that President Clinton would fare any better.

It is Congress, not the banks or regulators, to which Mr. Clinton should appeal to make loans easier for small business to obtain. That is because Congress is largely responsible for the banks' reluctance to lend to small business.

In the 1980s, Congress ignored warnings of the impending disaster in the savings and loan industry. The response to the disaster was the Financial Institutions Reform, Recovery, and Enforcement Act of 1989 -- basically an exercise in tighter supervision.

For an encore, Congress passed the Federal Deposit Insurance Corporation Improvement Act of 1991, which said to bankers: We don't trust your judgment anymore. The restrictive formulas established have played a big part in reducing the availability of bank credit.

Repeal the 1991 Law

To deal effectively with the credit crunch on small business, President Clinton should press Congress to repeal or amend the oppressive 1991 law.

Let bankers go back to their own guidelines and practices in making loans -- but warn them that if they're not prudent, they'll suffer the consequences.

And tell the examiners to be vigilant but understand that making loans is just as important as safeguarding deposits.

Mr. Chaney, a financial analyst, covers the banking industry for Sutro & Co., a San Francisco-based securities firm.

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