Even before the COVID-19 pandemic struck, the small business lending situation was beginning to look like something straight out of a Joseph Heller novel. Following deregulation in 1999, commercial banks shifted to the higher profit investment banking that they had been barred from since 1932. Investment banks have little interest in Main Street small businesses.
Banks are reluctant to lend to small businesses due to the high administrative cost and the simple fact that the deregulation allows them to make more money elsewhere. Companies are at greater risk of failing due to the difficulty in accessing capital.
That’s some catch, that Catch-22.
Capital is a national resource. The recovery projections from the pandemic recession are long and dismal. Small businesses employ approximately half of the U.S. workforce. They are arguably the foundation of the U.S. economy, and certainly the innovation proving ground. Some form of regulation is necessary to slow and stop the erosion.
Much of this lender reticence stems from the higher perceived risk associated with small businesses. Is it the risk or the fact that the banks can make more money in other markets in high-risk, high-reward investments allowed since deregulation? These fledgling companies usually seek financing when they have only a short history of sales or other information to present to lenders. Yet even when a company has been in business for years, the risk stigma persists; data from the Bureau of Labor Statistics shows that half of small businesses collapse by their fifth year, with 70 percent going belly-up within a decade.
The common thread is lack of capital.
Banks have tightened their small business lending standards during economic crises, since newly established companies are considered more vulnerable to the loss of sales and other financial stressors these periods create. Unfortunately, the United States has experienced a double whammy of economic downturns in recent decades, first with the 2008 Great Recession and then with the 2020 COVID-19 pandemic recession.
Community banks have historically offered greater support to entrepreneurs in getting their ventures off the ground. However, they have also been more difficult to access as these institutions shut down branches or vanish through mergers with larger institutions. The small business commercial loan approval rate hovers between an estimated 13 to 19 percent.
This is not encouraging. Among developed nations, the U.S. is in last place for the ability to rise economically. There is little doubt that this puts stress on small businesses and their employees.
Small businesses have also been squeezed out by lenders’ profit calculations. Banks may be less likely to take on the work of processing a small business loan since it takes the same amount of time and effort to process a larger loan, which will yield greater profits for the lender.
The result: lenders have largely become entrenched in their support for more established, lower risk enterprises and gravitated away from small business loans. The value of small business loans and small commercial mortgages held by banks fell from $721 billion in 2007 to $680 billion in 2019. During the same period, lending to larger institutions doubled.
The U.S. Small Business Administration was created in 1953 to provide more support to small businesses, but the organization has gravitated toward providing larger loans to established companies since the Great Recession. This became apparent during the COVID-19 pandemic, when the SBA-administered Paycheck Protection Program largely catered to larger companies in its early funding rounds (though public outcry resulted in the program’s scope being narrowed to smaller companies in a final funding round).
The challenge of accessing capital has become particularly pressing in the aftermath of the COVID-19 pandemic. Small businesses that survived the dire economic conditions brought on by shutdowns and other restrictions will face ongoing financial hardships due to prolonged revenue losses and depleted emergency funds.
Even as vaccination efforts put the worst days of the pandemic in the past, small business owners worry about their ability to survive. Unless capital access improves, small businesses will struggle to maintain their workforces and the jobs recovery in the U.S. will be severely affected.
