Banking & Capital Markets

Finance Execs Report Illegal Bank Tying

A survey of 370 finance executives unearths widespread bank demands that credit be linked to the purchase of other services.
Tim ReasonJune 11, 2004

Imagine if banks refused to let customers open an account unless they also bought a toaster. That’s pretty much the way it works in the world of corporate credit.

Indeed, banks often force corporate customers to buy investment-banking services in exchange for loans, a survey of 370 financial executives released this week by the Bethesda, Maryland-based Association for Finance Professionals (AFP) suggests.

Fifty-three percent of the survey respondents working at companies with annual revenues of more than $1 billion said that in the past five years their companies were denied credit or had their borrowing terms changed after not awarding investment-banking services to a commercial lender. (The AFP’s survey report doesn’t say how many of the respondents come from companies of that size.)

Such “tying” of commercial and investment banking services is illegal, although there’s widespread confusion over the difference between illegal tying and permissible “relationship banking.” On a practical level, however, the problem with packaging different banking products together is that it becomes difficult to determine the price of credit.

Such difficulties appear to be widespread among corporate borrowers. Half of all the respondents and 63 percent of those from the bigger companies reported that a commercial bank has denied credited or shifted the terms of a loan over the last five years because the company failed to grant other business to the bank.

But key government players have been squabbling over the effectiveness of methods for gauging just how much of the bank tying is illegal. Last August, the Federal Reserve issued a proposed interpretation of what would and would not constitute illegal tying. The following month, the Office of the Comptroller of the Currency Control (OCC), concluded there was no empirical evidence of illegal tying activity.

But, as CFO magazine reported in December (“The Ties that Bind,” in Newswatch), the General Accounting Office criticized that study. While it agreed with OCC and Fed assertions that evidence was hard to come by, the GAO criticized both bank regulators for failing to talk to any corporate borrowers or do any empirical studies of loan pricing.

The current AFP survey, conducted in February, would seem to fill that data gap. AFP CEO James Kaitz, however, advises caution in how the data’s used: “Before one goes accusing anybody, the Fed needs to step up to the plate and clarify this regulation.” That’s particularly important because the survey results note that “specific examples of activity that the Federal Reserve has indicated would be prohibited,” he notes.

By far the most widespread violation suggested by the AFP survey seems to be the common bank practice of requiring that corporate customers generate a set amount of banking fees. According to the Fed’s August interpretation, such requirements are acceptable — as long as the company has a “meaningful option” of spending that money only on “traditional bank products.”

In fact, half of the companies surveyed said they couldn’t meet those spending requirements without awarding underwriting or strategic advisory services. In other words, the bank’s requirements effectively force companies to buy both commercial and investment-banking services, which constitutes tying.

In the same vein, the Fed interpretation said banks cannot bar their customers from using their competitors. Yet 21 percent of all companies and 28 percent of companies with revenues over $1 billion said banks have threatened to terminate their credit relationship if they were to use a competitor’s underwriting services.

The Fed has also said that making a corporate loan contingent on a company’s commitment to hire the bank’s investment arm to underwrite a bond offering would violate anti-tying laws. Yet 14 percent of finance executives said they had been explicitly required to do just that in the last five years.

Another key finding of the survey: The larger the company, the greater the tying pressures. That’s significant, because the Department of Justice has expressed little interest in enforcing anti-tying laws at the corporate level. A November letter to the Fed from assistant attorney general R. Hewitt Pate suggests that both the Fed’s interpretation and the underlying legislation are broader than current antitrust laws and may have outlived their usefulness. “At a minimum, the section should be limited to ties involving small businesses and individual consumers,” wrote Pate. “Borrowers in [the syndicated lending] market are large corporations with well-trained and sophisticated staff fully capable of negotiating favorable terms.”

“We see no evidence,” Pate continued, that such large borrowers “need additional assistance beyond the antitrust laws to protect themselves from anti-competitive tying.” But the conclusion that only small companies suffer from tying, says Kaitz, “is completely contrary to our data. It’s the companies with over a billion in sales where this linkage is happening.”