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We like to think that when we deposit a dollar at the bank, it goes into a big vault and we can pull out that same dollar at any time. But that¿s not how the U.S. banking system works. Banks take that money and invest it to make money themselves, so cash gets spread around. This, naturally, leads to a big risk: What happens if those investments go sour? Well, you¿d be out of luck. You can¿t get your dollar back.
The Federal Reserve doesn¿t like that scenario, so it prohibits banks from putting all the cash it has on deposit on the line. In fact, the Fed forces banks to keep a portion of their assets at the Federal Reserve itself, to make sure that some of your assets won¿t get squandered if the bank¿s bets go south. These are called ¿reserves,¿ (hence, Federal Reserve. Got it? Good), and usually amount to 10% of the total cash kept in checking accounts.
These reserves are never exactly 10%, and banks like to keep a little extra in reserve ¿ not, as you might think, to make you more comfortable that they¿re in good financial shape, but rather so they can take that excess and lend it to other banks and make money off it. (They¿re banks, they can¿t help themselves.) The rate at which they make these loans is called the Federal Funds rate, which is set by the Federal Reserve¿s Federal Open Market Committee.
When you hear people chattering about how the Fed cut or hiked interest rates, this is what they¿re talking about: the interest rate banks can charge for lending money from their reserves. This begs the question: If these are essentially loans between banks, why is the Fed Funds rate so important for the rest of the economy?
Well, simply put, because loans make the financial world go round. Bank A lends Bank B $10,000 at a Fed Funds rate of 5%. Bank B then lends out $10,000 to a small business at 7%. The small business then takes that money and expands the business and hires new workers. Now someone is employed, Bank B has made interest off the loan, and Bank A is the richer for making it all happen. It¿s perhaps overly simplistic, but you get the idea. When you want the economy to thrive, you make lending cheaper.
Of course, sometimes you don¿t want the economy to thrive. In fact, you might want it to cool down, mostly to avoid money flooding the system and causing inflation. In that case, the Fed raises interest rates, making it difficult to lend or borrow.
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Friday, June 06, 2008
Kerry, Snowe Request Investigation of SBA Lender Oversight
Comtex
WASHINGTON, June 6, 2008 /PRNewswire-USNewswire via COMTEX/ ----Senators John Kerry (D-Mass.) and Olympia J. Snowe (R-Maine) this week asked the Government Accountability Office (GAO) to conduct an investigation of the Small Business Administration's (SBA) lender oversight system. In light of a recent Inspector General's report that found "major weaknesses" in the SBA's lender oversight, and detailed how the agency's poor oversight of four lenders created a loss of $329 million for the SBA's largest loan program, the Senators requested that the GAO examine the SBA's system for monitoring SBA lenders' portfolios and identifying risky lenders. Four years ago the GAO made recommendations for lender oversight improvement, yet the Administration has failed to enact appropriate changes.
"Despite warning signs that they don't have the correct oversight mechanisms in place, the Bush Administration has done nothing significant to improve their lender oversight," said Senator Kerry, Chairman of the Committee on Small Business and Entrepreneurship. "Since the string of reports by their own Inspector General hasn't been enough to spur them into action, this investigation is a wakeup call to the Bush Administration to get safeguards in place to keep these important programs strong. Especially during these tough economic times, we need to ensure that our nation's taxpayer dollars are invested wisely, and that our country's small businesses have access to the credit they need to grow their business."
"I am deeply concerned about the effectiveness of the SBA's lender oversight and monitoring system." said Senator Snowe, Ranking Member of the Committee on Small Business and Entrepreneurship. "As the SBA's Office of Inspector General has cited lender oversight and loan agent fraud as two greatest challenges facing the Agency, as well as issued a report detailing how poor supervision of four lenders created a cumulative net loss of $329 million for the 7(a) loan program, it is clear that the status quo must rapidly change. That is why we are requesting that the Government Accountability Office analyze and make recommendations to improve the SBA's lender oversight."
The Inspector General report issued last month found that the SBA had "major weaknesses" in four crucial oversight activities: untimely reviews of loan purchases, insufficient examinations of lenders' loan portfolios, inconsistent and inadequate implementation of corrective action plans, and poor remediation of bad loans. As a result, the Inspector General's review of four of the SBA's highest risk lenders found that the agency purchased over $239 million in guaranties on loans made by those lenders that failed to meet the performance benchmarks established by the SBA.
Senators Kerry and Snowe have actively pressed the SBA to improve their lender oversight system. Last month in a letter to the SBA, Kerry and Snowe questioned the wisdom of placing the lender oversight office within the SBA's Office of Capital Access, the office which promotes the agency's lending programs. Kerry and Snowe also criticized the SBA for moving forward with a proposed rule that the Senators believe is insufficient to improve lender oversight. In November 2007 and January 2008, Kerry and Snowe held hearings pressing the Administration to strengthen lender oversight in the wake of a $76 million fraud scheme involving loans originated by one of the SBA's largest lenders, Business Loan Center, LLC (BLX).
The letter sent to Gene L. Dodaro, Acting Comptroller General of the United States, is below:
June 5, 2008
Mr. Gene L. Dodaro
Acting Comptroller General of the United States
Government Accountability Office
441 G Street, NW
Washington, DC 20548
Dear Mr. Dodaro:
We are seriously concerned about the effectiveness of the Small Business Administration's (SBA) lender oversight activities. In 2002, the SBA began implementing its loan and lender monitoring system (L/LMS), an internal tool used by the SBA to assess the risk of 7(a) lenders and 504 Certified Development Companies. The result of those efforts was a risk rating system, designed by Dun & Bradstreet, to predict the likelihood of defaults in lenders' portfolios and identify the SBA's riskiest lenders. The system was supposed to enable the SBA to manage its loan portfolios and reduce loan defaults and losses.
As you may know, in June 2004, the Government Accountability Office (GAO) reported that the SBA's L/LMS reflected some best practices, but also indicated that the SBA had not developed an effective strategy for its use. At that time, the GAO recommended how the SBA could better use the L/LMS to develop and implement a successful oversight program. Unfortunately, since 2004, oversight difficulties have persisted in SBA lending. Recently, the SBA's Office of Inspector General (OIG) cited lender oversight and loan agent fraud as two of the nine greatest challenges facing the SBA. Separately, last month the OIG issued a report detailing how poor oversight of four lenders created a cumulative net loss of $329 million for the SBA's 7(a) loan program.
Since the SBA has utilized L/LMS for over 5 years, we request that the GAO validate the improvements, efficiencies, cost savings, and enhanced oversight outcomes the tool has created for the SBA's 7(a) and 504 loan programs. To that end, we request that the GAO evaluate the SBA's current lender oversight and loan monitoring processes and provide the Committee with answers to the following questions:
1. How reliable is the L/LMS and risk rating system at assessing and predicting the 7(a) and 504 lenders' portfolio performance?
2. How does the SBA's use of L/LMS and the risk rating system compare to the risk rating systems used by other private lenders and financial regulators which the GAO cited as industry best practices?
3. Does the L/LMS and risk rating system utilize information from the Fiscal and Transfer Agent (FTA) and Central Servicing Agent (CSA) for 7(a) and 504 loans? Given the information provided from the FTA and CSA to the SBA, what additional outcome and performance benefits are generated from the L/LMS and the risk rating system?
4. How relevant and accurate are credit scores in assessing the potential risk of the SBA's 7(a) and 504 loans that are more than $150,000? How does relying on credit scores to predict larger loans' performance impact the reliability of the SBA's "small business predictive score?"
5. What analysis has the SBA performed to ensure the predictive capability of the risk rating system? Was this analysis sufficient to accurately analyze the predictive capability of the score for all loan sizes?
6. How well does the SBA incorporate the results of L/LMS in its oversight practices, including onsite examinations of the SBA lenders and enforcement actions taken by the SBA with regard to higher risk lenders?
As part of your investigation, we encourage the GAO to meet with the SBA's OIG, the SBA's Office of Capital Access, as well as participating 7(a) and 504 lenders.
Thank you for your assistance on this matter. Please keep our staffs apprised of the GAO's progress on this request. If you have any questions, or need any additional information, please do not hesitate to call us. Your staff may contact our staff at (202) 224-5175 on the Senate Committee on Small Business and Entrepreneurship.
Sincerely,
John F. Kerry
Chairman
Olympia J. Snowe
Ranking Member
SOURCE U.S. Senate Committee on Small Business & Entrepreneurship
Copyright (C) 2008 PR Newswire. All rights reserved
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