Closed bank vault door.
US small businesses had access to capital and low interest rates for more than a decade before COVID hit. A combination of the economic shutdown during the pandemic and the inflation that accompanied the rapid recovery has led to a small business credit crunch with a double whammy. Firstly, banks are less willing to lend – especially after the collapse of both Silicon Valley Bank (SVB) and Signature Bank and problems at other medium-sized banks. Second, interest rates have risen to their highest level since 2007.
It is becoming increasingly difficult to access financing, and when business borrowers are approved, they pay a much higher cost of capital than in years past.
At the Federal Reserve Survey for senior loan advisors (SLOOS) of April 2023, which surveyed 65 domestic banks and 19 U.S. branches of foreign banks, reported “tighter standards and weaker demand for commercial and industrial (C&I) loans to large and mid-sized companies, as well as small businesses during the first quarter .”
Banks reported a tightening of credit policy for all categories of CRE loans in the past year. They often reported changes related to widening loan interest spreads over bank borrowing costs and lower loan-to-value ratios.
Many banks reported tighter credit standards or conditions citing a less favorable or more uncertain economic outlook, reduced risk appetite, exacerbation of sector-specific problems and deterioration in their current or expected liquidity position as reasons for reducing lending. Worryingly, banks have reported widely that they expect to tighten their lending standards in the remainder of this year.
The last Biz2Credit Lending Index™ for small businesses for April 2023, released on May 9, found that approval of small business loans percentages at large banks fell again from 13.8% in March to 13.5% in April. Furthermore, approval rates of business credit applications at small banks fell from the disappointing March figure of 19.1% to 18.7% in April. Small business credit union approval rates also fell last month, from 20.2% in March to 19.8% in April. The conclusion is that fewer than one in five companies were able to obtain financing from banks or credit unions by April 2023.
While small business lending at banks and credit unions continues to decline, approvals at non-traditional lenders rose in each of the categories monitored by the Biz2Credit Index. Alternative lenders rose to 28.7% in April from 28.4% in March. That is quite different from December 2013, when alternative lenders approved 67.3% of financing applications. In April 2023, institutional investors accepted 26.7% of applications, up from 26.5% in March. While that figure is slightly better than what banks report, the number is down significantly from its pre-pandemic high of 66.5% in February 2020.
The instability in the banking system goes far beyond the recent SVB and Signature Bank. Most recently, First Republic Bank, a bank much more responsibly managed than SVB, was acquired by the FDIC and its assets were sold to JPMorgan Chase. Other mid-sized and regional banks could also be in trouble as corporate accounts continue to withdraw their funds and transfer them to major banks or money market accounts.
Although we do not yet have a full bank run, these developments are detrimental to the banks’ ability to make money small business loans. The FDIC insures deposits up to $250,000, which is a relatively small amount for commercial accounts and leaves some deposits uninsured. The huge amount of uninsured deposits in the banking system increases the likelihood of bank runs in the future. This is bad not only for small businesses, but for the economy as a whole.
Federal Reserve Board Chairman Jerome Powell speaks at a press conference at the Federal Reserve … [+]
Small business financial woes are further complicated by the ever-rising cost of capital, as the Fed raised its key lending rate by another 25 basis points at its May FOMC meeting to a range of 5% to 5.25%. While the central bank is signaling that this may be the last hike this year, interest rates are currently at their highest level since 2007. Encouragingly, Fed Chair Jerome Powell suggested the central bank could pause its rate hikes and the impact of the rapid increases over the past 12 months.
Total nonfarm employment increased by 253,000 in April and the unemployment rate fell slightly to 3.4%, according to the Jobs report released by the Bureau of Labor Statistics on Friday, May 5, 2023. Meanwhile, the low unemployment rate is keeping pressure on wage inflation, which rose 4.4% in April from a year earlier. Employment continued to grow in several sectors, including professional and business services, healthcare, leisure and hospitality, and social assistance. Many of these jobs are created by small businesses.
While it is good news that people are in work, the tight labor market and resulting wage pressures are hurting small business results. Companies that need working capital to pay their bills pay a higher cost of capital to do so. This combination even puts pressure on small businesses that are thriving.
However, there are some positive signs. Inflation slowed in April to its lowest annual rate (4.9%) in two years. For comparison: in June 2022 it was 9.1%. If the Fed halts the trend of raising interest rates, it will be a welcome relief. Importantly, if stability returns to the market for medium-sized banks, the second half of 2023 could be better than the beginning of the year.
Janice has been with businesskinda for 5 years, writing copy for client websites, blog posts, EDMs and other mediums to engage readers and encourage action. By collaborating with clients, our SEO manager and the wider businesskinda team, Janice seeks to understand an audience before creating memorable, persuasive copy.