Be wary of 'tying' arrangements.

Has your banker discussed your overall business relationship lately? Was there an implicit suggestion that you had better buy all of your banking products from that source or credit might not be made available? The threat of withholding access to credit affects everyone, as loans are the lifeblood of a corporation.

Because of low profitability on loans to large companies, banks are demanding that credit and non-credit activities be linked--that is, credit will not be provided without receiving most or all of a corporate customer's other business. In an Association of Finance Professionals (AFP) survey of senior managers at nearly 700 companies, half of the respondees claimed to have been denied credit or seen changes to lending terms because they did not purchase other services from their bankers.

As a result, companies are consolidating all of their business in one or two banks, are working with their bankers to make the arrangement profitable and are searching for backup credit sources in case the bank says "adios."

What is a Tying Arrangement?

Linking credit to any other bank product--you must buy this (cash management services) to get that (credit)--is known as a "tying" arrangement, and is illegal under general antitrust laws, the Sherman and Clayton Acts and the Bank Holding Company Act Amendments of 1970 (BHCA).

The general antitrust approach by the courts has been to apply a "rule of reason" that considers the power and control of the market by the seller. The BCHA makes such ties illegal per se, that is, without regard to the economic impact of the seller or other rule of reason balancing.

The General Accounting Office (GAO) is expected to report this month on the situation, although the Office of the Comptroller of the Currency has been claiming that there have not been any illegalities. The Federal Reserve has recently proposed new rules that will make banks guilty of tying if corporate credit and non-credit business must be purchased to meet a preset minimum revenue level. Bank attorneys tell account officers to avoid explicit demands that clients purchase "linked" products, although there have been numerous instances where bank officers clearly indicate their expectations.

Some observers have become overly emotional on the subject. For example, a Wall Street Journal lead editorial (Apr. 21, 2003) worried over cut-rate loans offered to win fee-based business. Concerns were expressed over eroding credit quality, taxpayers who would have to bail out failing banks and the general evils of tying arrangements.

However, consider that the remedies in the BHCA were created at a time when a provincial U.S. banking structure did not permit banks to engage in all types of financial services and prohibited interstate banking. An established local financial institution could deny credit to a company if a tied product was not also purchased, justifying protection for businesses from unfair banking practices.

What Should be Done?

The issue to be examined is what is appropriate policy, given the changes in financial regulation and industry structure since Congress passed the BHCA.

* Changed Economics. The definition of a banking market is no longer a single state (or combinations of states in those situations where exceptions to the old McFadden Act were permitted). With recently enacted deregulation, banks can and do enter any appealing market and depart unattractive markets, and any concern for control and intimidation by one bank is minimized.

* Inadequate Remedies. Under BHCA, the Department of Justice and the federal banking agencies monitor bank behaviors, and private parties can sue for injunctive relief. Although there are substantial civil penalties, legal action requires the expenditure of considerable time, effort and money, and will not provide much comfort to injured borrowers that are starved for credit. In fact, the complainant could be in dire financial straits or out of business by the time the case is heard and decided.

* Uneven Market Access. Deregulation seeks to increase competition and market efficiency. However, the remnants of such legislation as BHCA make banking subject to greater limitations than investment banks and insurance companies, which are subject to lesser tying standards under the general antitrust laws. This is not a level playing field with equal rules fairly applied to all participants.

Deregulation is often messy, and in the short term, may result in anti-competitive behavior. In the long run, inefficiencies and the sub-optimal allocation of capital will be replaced by lower prices, better service and higher profits. The next appropriate step for Congress may be to eliminate the BHCA penalties on bank tying arrangements, allowing the same legislative approach and judicial remedies as applied to other industries.

James S. Sagner is a principal of treasury advisory firm Sagner/Marks and author of several finance books, including The Real World of Finance (John Wiley & Sons Inc., 2002). He can be reached at 914.686.2732.