Personal Loans And Bank Ethics

Correspondent relations?

Though it may touch their lives in several ways, most Americans had never heard of correspondent banking until the troubles of Budget Boss Bert Lance hit the headlines. One suspicion that was raised about Lance was that he used his position as head of the relatively small National Bank of Georgia to get personal loans from bigger banks with which the NBG had correspondent relationships. Although Comptroller of the Currency John Heimann last week found that Lance had done nothing to warrant criminal prosecution, he added that the whole affair "raises unresolved questions about what constitutes acceptable banking practice" (see THE NATION). It does indeed--but to understand why, it is necessary first to know what correspondent banks are and do.

Correspondent banking essentially is a relationship among banks that enables each to offer its customers more, better and faster services than it could acting on its own. Says Special Assistant to the Comptroller of the Currency Robert Baer: "There probably isn't a single bank in the country that doesn't have a correspondent account with another bank." Typically, a small local bank will be a correspondent of a regional bank, which will be a correspondent of the smaller one and of a bank in the money centers of New York, Chicago and Los Angeles.

At each step up the ladder, the smaller bank seeks the help of a big brother to provide services that it cannot offer, or offer so well, on its own. Examples:

Check Clearing A New Yorker, say, buys a suit of clothes in Atlanta and pays with a check drawn on a Manhattan bank. The clothing store deposits the check in an Atlanta bank. The bank bundles the check with other checks drawn on New York-area banks, and sends them by air to its New York correspondent bank, which gives the checks to a bank clearinghouse in Manhattan. The Atlanta bank receives a credit to its correspondent account within a day.

Investment Advice An Atlanta bank hears that Mexican securities are a good investment, but it has no one who knows anything about Mexico. It asks its correspondent in New York--which in turn may consult the officers of its correspondent in Mexico City.

"Overlines" A Wisconsin bank is asked by a customer for a loan $1.5 million larger than it can handle. If the bank has a larger correspondent bank, for instance Harris Trust & Savings Bank in Chicago, it can ask Harris to participate in the loan. The arrangement benefits not only the Wisconsin bank, which keeps its local customer happy, but also Harris, which has no branch offices of its own in Wisconsin and would otherwise probably never have learned about the loan opportunity.

In return for such services, the smaller bank compensates its big brother by putting an interest-free deposit in the larger bank. These deposits benefit the larger bank because it can lend out the money to its own loan customers without having to pay interest to get the funds. It is an extremely profitable business for larger banks, and competition for correspondent deposits is fierce.

So far, no ethical problems--but how about the case in which a banker, like Lance, asks a bigger bank of which his own bank is a correspondent for a personal loan? Lance would be quite correct in saying that it is nonetheless common practice. A startling 93% of bankers replying to a 1976 survey by the American Bankers Association said that they routinely offer personal loans to the officers of correspondent banks.

Such loans can become illegal if it can be demonstrated that the amount of the deposit was too large for the correspondent services rendered, or if its size enabled the borrower to get more favorable terms for his personal loan than are normally offered to routine customers. At issue is the question of intent, but proving what goes on in the minds of borrowers and loan officers is difficult. Since 1971, the Comptroller has referred 400 cases to the Department of Justice; only a handful have been prosecuted.

The ethical question remains: Can a bank loan officer really judge a personal loan to an officer of a correspondent bank entirely on its own merits? Even if no one ever mentions the fact, the loan officer cannot avoid knowing that the correspondent bank's interest-free deposit can be withdrawn and switched to an other bank at any time.

In Lance's case, the question is compounded by the fact that his loans--$5.3 million between 1975 and January 1977--were granted for the express purpose of enabling Lance to buy, with two partners, a majority share of the stock in his own bank. Federal law forbids banks to make such loans to their own officers, lest unscrupulous bankers use depositors' money to enrich themselves; but the law is silent about stock-purchase loans to correspondent bankers. Yet if a banker cannot borrow money from his own bank to buy its stock, why should he be allowed to borrow from a correspondent bank for the same purpose? It is clearly time for a new law that would shift the burden of proof, and forbid big banks to make personal loans to officers of cor respondent banks unless both parties can prove that the transaction is an "arm's length" deal.

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