Why small businesses aren't getting credit, even when it's available

Fed Chairman Ben Berkanke urged lenders and Congress to take steps towards easing credit to small businesses. Here are some of the obstacles lenders face.

Federal Reserve Chairman Ben Bernanke put pressure on lenders Monday, imploring them to ease credit to small businesses.

Lending to small business has dropped by some $40 billion since the second quarter of 2008 – going from more than $710 billion to less than $670 billion in the first quarter of 2010.

The lag has kept small businesses – which Mr. Bernanke said, employ “roughly one-half of all Americans and account for about 60 percent of gross job creation” – and the economy, from expanding.

So why have small community banks, which do the majority of the lending to businesses, stopped doing so?

• Lack of demand.

It’s not because they don’t want to, says Paul Merski, senior vice president and chief economist of the Independent Community Bankers of America, an advocacy group.

“Lending is the way banks make money,” he says. “Banks have plenty of liquidity, plenty of money to lend – it’s matter of getting quality demand back.”

It’s the credit-worthy business borrowers who are missing, says Merski. “Consumers aren’t spending. As a business owner, you’re not going to take on more debt if uncertain about your business prospects going forward.”

In fact, 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.

• Lack of collateral and credit-worthy borrowers.

Because of the 30 to 40 percent drop in real estate values seen since the start of the recession, many small business owners that do want to borrow to expand (or even just to keep their heads above water) have no equity to borrow against. As Bernanke acknowledged, the same is true for the value of equipment and machinery, which small businesses typically rely on heavily as collateral.

The depth and length of the recession has also wreaked havoc on many small business owners' credit, making banks uneasy to lend.

• Stricter regulatory standards.

Banks have also been restricted by tightened lending standards, says Bob Seiwart, a senior vice president at the American Bankers Association, who manages the group’s Center for Commercial Banking and Business Lending.

“Money is available to viable small businesses,” says Mr. Seiwart. “But the terms will be different than in the past, as they should be reflecting the added risk of lending in today’s economy: rates will be higher and loan terms will be shorter.”

Regulators have also started to require that banks maintain a higher level of capital in order to lend. In the current economic climate, the new standards have been difficult to sustain, said Seiwart.

“If they can’t sell stocks, they’ll shrink the size of the bank,” he says. “If banks are making less capital, they’re also making fewer loans.”

• Diminishing government aid.

Funding for the Small Business Administration’s flagship lending program ran out in May, leading to a precipitous drop in lending last month. Banks made about $400 million in loans backed by the administration in June, compared to $1.5 billion in May.

An extension of the program, which offers banks a 90 percent guarantee for certain small business loans, is pending in Congress, as is a proposed $30 billion small business lending fund, which would be administered by the Treasury.

Ultimately though, even an infusion of capital and guarantees from the federal government might not be enough.

"Until consumers feel confident that the recession is over and things are getting better and start expressing that confidence through spending and making purchases -- that’s the only way we’re going to climb back," said Seiwart.