While the Clinton administration counts on low interest rates to revive the economy, the banking industry is coming to a different conclusion: The demand for loans to expand business activity is so weak that lowering the prime rate is not worth their while.
"Simply stated, my customers don't borrow more because we lower rates; they borrow if they see an opportunity to use the borrowed money, and they don't see that opportunity," said Frank Lourenso, an executive vice president at Chemical Bank. His view was echoed in a half-dozen interviews with other bank executives and industry officials.
As the most publicized of bank lending rates, the prime serves as the peg for setting rates on tens of billions of dollars in home equity loans and, above all, on loans to small companies, which account for 20 percent of all business borrowing.
The fact that the prime has been stuck at 6 percent for 15 months -- while other interest rates have fallen sharply -- has meant that many small companies have not even had an opportunity to borrow at declining rates, in the event that some might have wanted to do so.
The reluctance of banks to lower the prime now -- despite their recent campaigns to encourage borrowing by small companies -- is one more sign of the difficulties in using lower rates to generate strong economic activity.
Interest rates have fallen, of course, for mortgages and for
corporations large enough to borrow outside the banking system, at rates below the prime rate. But Federal Reserve data show that the lower rates have generated very little net increase in lending this year in these sectors and in most other sectors of the economy.
Interest rates on mortgages, for example, are at their lowest levels since the 1960s. Even so, home sales and home construction have not risen enough to help lift the economy as strongly as in previous recoveries -- although Alan S. Blinder, a member of President Clinton's Council of Economic Advisers, insists that low rates will convert the present slow economic growth to accelerated growth by next year.
For the moment, however, the prime rate's stickiness limits the impact of the administration's lower-rate strategy. And the banks show no sign of dropping the prime, despite the existence of an unusually wide spread between what banks pay in interest for deposits and for other funds that the banks borrow and then lend out at the prime.
That spread has widened from less than 1.5 percentage points in 1989 to about 2 percentage points in July 1992, when the prime was last lowered, to more than 3 percentage points since late last year.
"The banks have room to lower the prime now, if that were in their best interest," said John LaWare, a governor of the Federal Reserve Board, who specializes on banking issues for the board.
"Their earnings are exuberant and their capital positions are strong, but they are not going to lower the prime if they do not believe that will increase their loan volume, and they do not believe it will," he said.
One problem is that because businesses are reluctant to borrow, the banks see a lower prime as costing them money, not increasing their income by attracting more business.
Chemical Bank, a big lender to small business, has more than $10 billion in loans outstanding at interest rates that vary with the prime, usually costing the borrower up to one percentage point over prime. That spread has fallen in recent months as Chemical, like other banks, tries to lend more.
But the prime rate has not budged. If it were to come down to, say, 5.75 percent, interest income from outstanding loans would drop automatically by a quarter of a percentage point.
Such income losses occur whenever the prime drops, and it has fallen from 11.5 percent in June 1989 to 6 percent, where it has been since July 2, 1992.
In the past, however, these losses have been offset by a jump in bank income from new borrowers attracted partly by the lower prime rate, but mostly by the opportunity to use the borrowed money for expansion and higher profits. Now this offset is missing.
Surveys by the National Federation of Independent Business show that borrowing by its 600,000 members, mostly small companies, is at a 20-year low.
"The reason is that their mood is sour; I cannot think of a better word," said William Dennis, the federation's director of research.
And Kenneth Guenther, the executive director of the Independent Bankers Association, representing the country's thousands of smaller banks, added, "When I go to bankers' meetings, the major problem on the table is that good loan demand is not there."
The prime rate's stickiness came to public attention in mid-September when several small banks lowered their prime to 5.75 percent, and no one else followed suit.
"We went down early because we felt that the prime will go down eventually, and we have made the decision to be the price leader in Virginia," said Peggy Cummings, the director of investor relations at Central Fidelity Bank in Richmond, one of those banks.
Being the price leader has brought Central Fidelity dozens of inquiries since mid-September from potential new borrowers, but far no measurable increase in new loans pegged to the prime. Such loans now total $750 million at Central Fidelity, or 18 percent of the bank's loan portfolio.
What has improved -- by accident -- is mortgage lending. "People have been calling our branches and saying, 'I hear your mortgage rates are down,' Our employees explain that our mortgage rates have not dropped, our prime has," Ms. Cummings said. "But the calls opened up conversations and we were able to do new business on mortgages."
Beyond lack of demand, bankers say cutting the prime below 6 percent would be impractical for them. As Richard J. Boyle, the vice chairman of Chase Manhattan Bank, and others explain it, a bank's present costs make a 6 percent prime a base for profitable loans.
But a lower prime would mean that a bank could earn similar income with less risk and cost by investing in Treasury notes that pay interest of 4.5 percent to 5 percent annually.
Or banks that already devote huge sums to consumer lending, might devote even more, at a time when consumers have been borrowing more, particularly through their credit cards and through other short-term credit. Most rates charged to consumers are still above 10 percent.
The Federal Reserve, of course, could change the equation by acting to lower interest rates again. That would in turn give banks even more room than they already have to reduce the prime rate, by reducing what they pay in interest on deposits and on other funds the banks then lend at the prime rate.