The Vicious Cycle in Small Business Lending
There is a vicious cycle going in small business lending. It goes something like this:
- Small business gets battered by the economy. The business is still profitable but less so than before.
- The business sees its lending facility pared back or eliminated by their bank.
- Small business cuts jobs, moves to a smaller building or stops future equipment orders so that their expenses reflect the reality of their new lower revenues.
- Small business owner takes their austerity program to their lender in hopes of restoring some of their lost borrowing capabilities. The lender looks at the lower revenues, layoffs and downsizing as a further deterioration of the business. The lender lowers the business’s line of credit even further.
- The business now has to run on even less cash and is not able to replenish inventory at the levels needed to grow its business.
- Go back to step 1 and repeat until the business becomes truly uncreditworthy and eventually becomes insolvent.
So what can be done to break this vicious cycle? First the Federal government must pass the small business bill which will give $30 billion to community banks to lend to small businesses. Community banks are primarily focused on lending to small businesses. Next, underwriters at banks lending to small businesses need to look at their lending criteria. Credit benchmarks must be adjusted to take into consideration the current status of the economy. This means that bank underwriters should take a longer view of the performance of the small business. This should enable the lender to possibly provide a larger credit line than would be warranted by strict adherence to traditional underwriting guidelines. These additional funds will enable businesses to invest in growing their businesses again and start the process of reversing the cycle and hiring will follow. The proposed small business legislation makes some guarantees around the funds that the Federal government is providing to community banks so the banks will not be taking the additional risk of lending to small business without the federal government providing a backstop. While this creates some exposure for taxpayers, I think this is an instance of taxpayers making an investment in their personal financial well being.