Lending Relations

Lending empowers banks in their relations with nonfinancial firms in several ways. First, the ability to advance or deny loans and credit to nonfinancial firms enables banks to elicit major stock options and representation on recipients' boards of directors (Hilferding 1910; Lenin 1917; Menshikov 1969; Fitch and Oppenheimer 1970). More specifically, lending relations in and of themselves represent potential bank power. For example, bonds can be a source of bank power because financial institutions are the major holders and administrators. Bonds differ from stocks in that bonds are typically longer-term loans (over ten or fifteen years). As such, bondholding by banks produces long-standing capital relations between banks and nonfinancial firms. The significance of these relations is that "even large corporations which sell bonds sign agreements stipulating their dependence upon the creditors" (Menshikov 1969, 173). Furthermore, banks usually hold bonds, whereas individuals usually own stocks (Rochester 1936). Unlike stocks, bonds carry no voting rights and therefore do not entitle their holders to participate directly in decisions affecting the internal affairs of the firm. But they still represent a source of power, particularly during periods of corporate crisis. For example, when a firm goes bankrupt, bondholders' claims take precedence over stockholders' claims.

The short-term loan, which matures faster than bonds, is also a source of bank power. Most nonfinancial firms (including the largest corporations) depend on external sources of investment capital to meet their immediate needs. These large borrowing needs require lending consortia composed of several commercial banks and insurance companies, because banking laws restrict a single bank's exposure to one client to 10 percent of the bank's assets. By spreading the risks of large loans over many banks, lending consortia also minimize the competition between individual banks (Menshikov 1969, 175–176).

The popular belief in competition between creditors is greatly exaggerated. Financial institutions acknowledge and respect one another's role as main organizing or lead bank for a particular corporation or group of corporations. For example, "a banker will not begin to negotiate a loan with an industrial corporation if it is known to be the client of another banker without the latter's consent. Attempts to break this rule lead to joint disciplinary measures against the transgressor" (Menshikov 1969, 180). The development of long-standing relations between investment banks and specific firms is a key element in bank power. These relations "magnif[y] the influence that investment banks can exert" (Kotz 1978, 21). Furthermore, common participation in lending consortia reduces the number of nonparticipating competitors and fuses the interests of the participants.

The manager clause, often included as a term-loan stipulation (or condition of the loan), positions banks at the heart of a business. This clause stipulates banks' rights "to demand either the appointment of executives at their discretion or the placing of the firm's controlling block of stock under bank trusteeship" (Menshikov 1969, 176). Thus banks reserve the right to intrude into executive and personnel decisions should the current management displease them.

These lending arrangements produce structural bases of bank power in capital flow relations. Banks have held this powerful structural position for more than fifty years because of nonfinancial corporations' reliance on external sources of financing for investment capital (Lintner 1966; Sweezy and Magdoff 1975; Gogel 1977). Moreover, the largest firms are often the most dependent on outside sources of investment capital, for several reasons. Participation in mergers, acquisitions, and new ventures is increasingly expensive. So are high dividend payout rates, defensive strategies against hostile takeover attempts, and responses to economic and accounting constraints. For example, a reliance on loans contributes to the illusion of huge corporate profits:

In trying to maintain a false image of prosperity, U.S. corporations are literally throwing away money that they sorely need not only to pay current bills but also to bankroll future investment. As a result, they are forced to lean more heavily on external sources of funds. (Business Week , 19 Mar. 1979, 108)

Inflation also stimulates corporate borrowing because borrowers will eventually pay off the debt in depreciated dollars. Further, "many managers contend that debt can be . . . a cheaper source of capital than equity, because of depressed stock prices" (Business Week , 9 Apr. 1979, 108). Similarly, recession forces corporations to rely more on external capital. Cash flows are difficult to maintain during economic downturns because corporate profits decline (Business Week , 31 Dec. 1979, 153–155). But even the bull market of 1987 did not reduce corporations' need for loans because it was fueled partly by "merger mania." This reliance on external investment capital places banks at the center of the business community.

Some observers regard lending as a mutually beneficial and reciprocal relation between banks and nonfinancial corporations. They argue that the constraining influence of banks is counterbalanced by the power of nonfinancials, which have large deposits in the banks (Herman 1973, 1981; Stearns 1982). If banks interfere in the operations of their borrowers, the alienated nonfinancials might withdraw their deposits. The nonfinancials might also refuse to deal with the offending banks in the future. But such an analysis overlooks the way large organized lending consortia tip the balance of power in favor of the banks. When the major lenders take a concerted, aggressive position against a corporate borrower, they severely restrict the target firm's sources of loans. Furthermore, that banks recognize and respect each other's lead bank status prevents nonfinancials from exploiting competition between banks.