Has lending to small business declined so sharply in the US because banks are unwilling or unable to make loans, or do businesses simply have less need for them in an economy with a shortage of demand?
This is a surprisingly difficult question to answer, and having looked into it, FT Alphaville isn’t really sure. But we’ll present both sides and then put forward a suggestion that seems a good idea either way.
THE INABILITY OR UNWILLINGNESS OF BANKS IS TO BLAME
—Two finance professors from Harvard recently published a study concluding that when larger companies switch from bank loans to bond issuance, it’s because banks are no longer willing to extend the credit, at least not without imposing more stringent terms than would normally be expected. When this happens, it also predicts accurately what’s happening at small businesses, which can’t access the bond market. So if overall bank lending has declined and large firms are increasingly tapping the bond market, it’s reasonable to assume that it’s a supply problem. And if these two stories from Bloomberg and Real Time Economics are any indication, that seems to be happening now.
—A similar dynamic as the one just described actually is happening at small businesses, but instead of switching to bond markets, they are increasingly using credit cards for financing needs. That’s according to this Washington Post story, which cited a couple of studies.
—Banks continue to fail at a record pace and their balance sheets remain constrained by regulatory capital requirements, and perhaps they remain uneasy over the prospect of additional non-performing loans, especially in commercial real estate. This has been a worry since earlier this year, as we said at the time.
—Stimulus provisions that made it easier to offer certain loans to small businesses ended two months ago, and such lending promptly cratered.
BUSINESSES JUST DON’T NEED CREDIT
—From Elizabeth Warren’s May oversight report (emphasis ours):
In the fourth quarter of 2008, net 57.7 percent of the respondents to the Federal Reserve Board’s Survey of Senior Loan Officers reported that demand had fallen for small business loans – a figure that rose to 63.5 percent the following quarter. Even now, net 9.3 percent of the survey respondents continue to report falling demand, suggesting that some of the reduction in small business lending may be the result of a lack of demand.
—A report in the Christian Science Monitor notes that “only about 30 percent of small business owners surveyed by Barlow Research Associates Inc., a financial services market research firm, applied for credit in the last year.”
—The National Federation of Independent Business surveyed small businesses (pdf) and asked them why they weren’t investing more, and a slight majority said it was because of slow or declining sales (HT Ezra Klein).
That’s what we were able to come up with, and obviously there could be strong forces from both the demand and supply sides pushing the same trend. And there probably are. But the whole thing is very tough to quantify, and it turns out that our difficulty in answering this question puts us in pretty good company. Guess who said this:
An important but difficult-to-answer question is, How much of this reduction has been driven by weaker demand for loans from small businesses, how much by a deterioration in the financial condition of small businesses during the economic downturn, and how much by restricted credit availability?
That’s Ben Bernanke two months ago.
Which brings us to our recommendation, which isn’t really our recommendation at all. It belongs to Elizabeth Warren, found in the same link as above, and which to us seems entirely reasonable:
The debate over whether small business lending is constrained by supply or demand is a reminder of the absence of high-quality data about current lending practices. Such poor data have made it far more difficult to pinpoint the causes of today’s problems and, as a result, to find effective solutions. Treasury should take active steps to gather more detailed and dependable data about small business lending, and put data-reporting requirements in place so that in the future policymakers will not be forced to make decisions with too little information about what is actually happening.
Small business lending: the squeeze goes on – Bloomberg Businessweek
Bernanke and the small business lending drought – FT money supply
Why small businesses aren’t getting credit, even when it’s available – CSR
On those ‘epic’ declines in bank lending – FT Alphaville