The Small Business Lending Experience Amidst ‘Trouble’

The latest “banking crisis” was different from past experiences. Historically, bank problems arise from borrowers defaulting, loans becoming uncollectible. This time the problem is due to poor risk management. Deposits are “loans” to the bank with maturities of up to 24 hours – depositors can withdraw at any time (thus developing certificates of deposit with longer maturities, with penalties for loss of interest for early withdrawal). The government handed out huge sums of money to consumers during Covid, this money was immediately deposited into bank accounts while depositors decided how much and when to spend. These excess reserves earned almost nothing at the Federal Reserve, so the banks invested the funds in longer-term government bonds, fully protected against default. All of these bonds carried low interest rates. The Federal Reserve then quickly raised interest rates by 475 basis points, and depositors found better ways to use their money and began withdrawing. Silicon Valley Bank (SVB), the most notable recent bank failure, had to liquidate their safe (but low-yielding) investments, generating large losses that had to be covered by their capital (which was not enough). All the bonds were safe, but depositors didn’t want to wait 10 years to get their money while earning only a small return. New Treasuries pay twice as much, making it a more attractive investment for depositors. SVB was caught in this squeeze failed. But it seems that most banks did not make these mistakes and most depositors did not feel the need to move their deposits.

Credit conditions have been quite favorable for small businesses since the Federal Reserve introduced the Zero Interest Rate Policy (ZIRP), a policy that is not good for savers but a real boon for borrowers. From 2009 to 2015, borrower satisfaction improved, with the percentage reporting unmet credit needs falling from a high of 11% in 2010 to 2% this year (March) (Chart 1). Owners are asked to compare the difficulties encountered in obtaining their current loan with those they had with the last loan. Complaints peaked at 16% in May 2009, falling rapidly to 1% in August 2019, stabilizing between 1% and 4% until July 2022, when it began to rise, reaching 9% in March 2023, reflecting the Fed’s drive to raise interest rates and tighten credit standards.

Overall, rising interest rates don’t seem to have deterred creditworthy small business owners. Yes, interest rates are higher and more small business owners report that their loans are harder to get than the last time they borrowed, but the percentage who report that their credit needs have not been met remains close to 0%. The average interest rate on owner-reported loans rose from a low of 4.1% in July 2020 to 7.9% in February this year. So far, higher interest rates do not seem to have significantly reduced demand for credit. In small business financing, the availability of credit is the primary concern for small business owners, not the cost of credit. The return expected from the use of borrowed funds far exceeds the cost of the loan. In 1980, homeowners reported an average mortgage interest rate of 19% and were borrowing! Current vacancies and hiring plans show that many owners still see opportunities to make money and grow their businesses and are willing to borrow to pursue them. As the economy slows down, lenders will be more cautious in lending because a slowing economy usually results in lower expected sales and profits from business ventures.

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