Editor's note: This article is excerpted from a speech
given by Gary H. Stern, president of the Federal Reserve Bank of
Minneapolis, at last year's Nation Building Conference: Building
Tribal Infrastructure for Economic Prosperity. The conference, held
April 1316 in Missoula, Mont., was cohosted by the Montana-Wyoming
Tribal Leaders Council, the University of Montana Law School and
the Federal Reserve Banks of Minneapolis and Kansas City. Among
the conference's other highlights were discussions by nationally
recognized speakers, interactive workshops on understanding tribal
and bank cultures and presentations on the effective use of sovereignty.
I am pleased to have the opportunity to discuss economic and community
development issues on tribal lands. Usually, I am asked to comment
on monetary policy, so it is refreshing to be talking about a somewhat
different topic. However, I say only a somewhat different topic
because Federal Reserve monetary policy and opportunities for economic
prosperity on reservations are more closely related than they might
at first appear. The Fed is well known for the strategies it uses
to promote a low-inflation environment, particularly those of the
Federal Open Market Committee, which makes decisions that affect
interest rates. However, the use of these tools to keep inflation
in check should not overshadow the larger goal of the Federal Reserve,
which is to improve standards of living nationwide.
While I believe a low-inflation environment provides the best
climate for improving living standards, it is clear that some areas
have been left behind in this time of sustained economic expansion.
Isolated rural areas, core central cities and many tribal lands
have not shared in the benefits of economic growth, and therefore
may well require extra attention to ensure that they too benefit
as the overall economy progresses. One of the important limitations
in these communities has been access to capitalaccess that
is critical to starting and growing businesses.
Equity capital: A scarce resource for new businesses
First, I'd like to discuss what capital is, where it can be obtained
and why it is important. As most of you know, there are two types
of capital: equity and debt. Equity capital is the money put in
the business by the owners and not financed through a lender. The
more equity capital invested in a business, the less money the owners
need to borrow, other things equal. This results in lower payments
for a new business that often operates on slim margins.
While some amount of equity almost always comes from the savings
of the business owner, outside investors can also provide it in
exchange for an ownership interest in the business. Outside equity
capital can be difficult to attract, especially in rural areas where
the investor is located at a distance and cannot keep an eye on
the business. Also, many new businesses do not survive. Because
of this, outside equity investors want a relatively high rate of
return to compensate for the risk of losing their investment if
the business fails. Equity capital can, and often does, come from
friends or family members who are not as concerned about a high
rate of return. However, family money is likely to be much less
available on reservations, where many people have not been able
to accumulate savings. If resources from friends and family are
not available, there are few other sources of equity capital for
most new businesses.
Debt capital: The engine of business development
It seems clear that outside equity capital cannot by itself be
the driving force behind significant and sustained economic development.
Therefore, most new businesses will need access to debt capital.
Debt capital is expensive in the sense that the business owner will
need cash every month to make loan payments, but it is also much
more widely available than equity. Debt financing also allows the
borrower to retain full ownership of the business and to use his
or her cash to invest in facilities and equipment to get the business
Although it may not seem clear at first, debt financing is one
of the primary ways to build savings to be used as equity. For example,
consider a rancher who wants to expand her herd, but is not making
enough money to buy more cattle outright. Using her existing assets
of the current herd as collateral, she can get a loan for more cattle
that will allow her to earn more profit. The profits from the larger
herd are used to pay off her loan, and she now has greater assets
and profit potential. This process of using debt to enable an entrepreneur
to expand a business with a relatively small amount of business
equity is called leverage. The debt is used as a lever to increase
the size of the business.
This may be a good time to make a distinction between using debt
financing as a lever to build assets and simply "being in debt,"
which frequently has a negative connotation. In the example I just
used, the rancher is making a rational decision about taking on
debt based on her belief that the returns from a larger herd will
be greater than the costs of paying for the loan. Taking out a business
loan is often a logical financial choice, and should not be viewed
as a sign of poor financial management, but rather as making use
of an effective business growth tool.
There is another benefit from the use of debt capital that should
not be overlooked. The loan to the rancher resulted in a profit
for the lender, who can now loan out more money to other businesses
in the community to continue the cycle of lending and reinvestment.
Local banks: Providing services and capital to borrowers
Bank loans are the primary source of debt capital for small businesses.
Banks traditionally have made money by making loans to businesses
and consumers, so they have both the resources and expertise to
finance business creation and expansion. Bringing bankers into the
economic development partnership adds another level of expertise
and imposes another level of discipline to the business plan or
project. Bankers review and evaluate loan requests, and weigh the
risks and prospects for success. In other words, they review whether
the business will likely stay in operation and whether the borrower
will likely make the loan payments.
This risk evaluation can be viewed as technical assistance from
the banker to the potential borrower. It prevents an entrepreneur
with a good idea but a not-so-great business plan from receiving
a loan that could possibly result in personal financial hardship
if the business fails. Lenders are protecting their assets when
they say no to some loans, and they are also providing valuable
advice to the potential borrower about the weaknesses of his or
her business proposal. Many bankers also offer advice to potential
borrowers about other sources of funding or assistance, for example
education about business planning that may be tied to a revolving
loan fund. In summary, a local banker can be a valuable resource
to an entrepreneur, even if the loan request is not granted immediately.
Other business financing resources: Important but limited
Banks are the most significantbut not the onlyproviders
of debt capital financing to businesses. Another source of debt
capital is revolving loan funds, which are most often operated by
nonprofit organizations. Access to these funds is frequently contingent
on completing a business planning and education process with the
nonprofit organization. Such resources provide access to capital
for entrepreneurs who are not able to qualify for bank financing.
Although this is an important resource, especially for the first-time
business owner, it is not a permanent solution. Resources tend to
be limited, and the number of businesses that can receive loans
is quite small. The goal of most of these organizations is to "graduate"
their borrowers to conventional bank financing when they have had
some success with their businesses. Revolving loan funds are an
important tool, but they lack the resources to sustain long-term,
significant economic development.
Another source of business financing comes through enhancements,
which are resources or services that improve the financial soundness
of the project. These resources offer an opportunity to make a project
stronger by filling gaps in finances or management experience in
a proposed business plan. One example of an enhancement is a guaranteed
loan program available through a government agency for lending on
tribal lands. Many banks offer these programs to their customers
since they promote access to capital and result in significantly
reduced risk for lenders. Other enhancements, such as grants or
loan subsidies from outside sources, can improve the cash flow of
new businesses to make the loan more attractive to conventional
lenders. Enhancements will not make every deal work, but they can
be an important tool for strong business prospects that need some
assistance to get started. However, resources for enhancements are
usually quite limited and are often used to complement bank financing.
Building banking relationships: The key to accessing capital
I have been discussing why access to debt capital is important
to economic development. The next step is identifying how tribal
members can access debt capital so business and economic development
can begin. First, tribal members must build banking relationships.
Building relationships with lenders offers tribal members two important
benefits. One benefit is access to basic banking services, such
as checking and savings accounts and the ability to apply for loans.
These services are valuable because they make doing everyday business
easier: for example, paying a bill with a check instead of a more
costly money order. Car and home loans allow people to obtain reliable
transportation and improve their living conditions without having
to save enough money to cover the entire expense at the time of
The second important benefit is for those tribal members who are
interested in starting a business. For these people, banking relationships
offer a way to begin developing the credit history that is vital
to accessing debt financing. Creditworthiness is first established
by obtaining consumer loans, such as for cars or homes. When borrowers
prove they are good risks for consumer loans, banks are more likely
to provide them with business loans.
There are a number of reasons why many tribal members currently
do not have banking relationships, and it is probably fair to say
that both lenders and tribal members can do more to make these relationships
work. There are several ways bankers and tribal members can work
together to develop such relationships. As just one example, bankers
could offer basic banking education in partnership with tribes or
tribal colleges. This is beneficial to all parties since bankers
can reach new markets and potential customers are better prepared
to use available banking services. Two challenges must be addressed
to improve access to capital: getting more bankers to lend to tribal
borrowers and preparing more tribal borrowers for good banking relationships.
Taking the next step: Promoting entrepreneurship
Let's assume that tribal members and bankers work together to
build relationships and that in the future, increased numbers of
tribal members will have access to banking services and to at least
some business debt financing. An equally important step on the path
to economic development is getting people interested in and prepared
for starting a new business. Entrepreneurs, who are the people who
develop the creative ideas and take the chance on starting new businesses,
are vital to a healthy and innovative economic climate. Unfortunately,
entrepreneurship on tribal lands has been limited by a lack of role
models and limited access to capital. This problem is not unique
to reservations. It exists in many communities, especially in low-income
and rural areas.
Promoting an entrepreneurial mindset is an important challenge
on reservations that must be addressed through creative education
and training programs. It is important because simply making bank
financing more accessible has little value if no one wants to borrow
the money. Developing a climate that fosters and encourages entrepreneurship
takes time, but it can happen and is critical to building a diverse
Understanding different motives: Working together for mutual
I'd like to suggest to you the value of all of you pulling together
to make economic development happen on reservations. This can be
challenging since each of you may operate under a different constraint
and may have a different goal. My earlier example of a lender who
seeks to protect the assets of the bank but also offers valuable
assistance to the potential borrower suggests that participants
in economic development often have multiple and sometimes competing
The intentions and motives of others may also be more complex
than they initially appear. For example, banks must operate within
certain regulatory rules to protect the assets of all bank customers.
This means that they are sometimes unable to make loans which they
think may be good for their communities, but which simply aren't
sufficiently strong financially to uphold the standards of safe
and sound banking.
Although the motives of business owners, tribes and bankers may
be different, they are legitimate for their business. The key is
for each party to respect the motives and constraints of the others
and to work within those boundaries to make the business or project
as strong as possible.
We all share the common goal of making economic development on
reservations a reality. The key is to use each others' strengths
to work together and form a partnership for this shared goal.
Tribes have human and natural resources and the ability to create
a positive climate for economic development.
Lawyers bring the skills to assist in the creation of a legal
structure that promotes business development and respects the values
of the tribe.
Entrepreneurs and business owners bring new ideas, job opportunities,
needed services and the "spark" for change.
Bankers provide the capital that is essential to the long-term
growth of most businesses. They lend the money that entrepreneurs
can use to create jobs and new opportunities and to build wealth
in the community.
Finally, organizations such as government, foundations and nonprofit
organizations provide critical resources that can often make a project
Economic development will not happen consistently without all
partners working together. I don't want to minimize the challenges
of this kind of partnership; however, the opportunities and rewards
can also be substantial. Economic vitality on tribal lands can and
should be beneficial for all. I encourage you to think and act creatively
to make economic opportunity on reservations a reality.
As president of the Federal Reserve Bank of Minneapolis, Gary
Stern is a member of the Federal Open Market Committee, the Federal
Reserve System's principal body for establishing national money
and credit policies. Stern serves on the board of trustees of the
National Council on Economic Education and the boards of directors
of the Minneapolis College of Art and Design, the Northwest Area
Foundation and the Carlson School of Management at the University
of Minnesota. He is a Wisconsin native.