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June 27, 2011
Stimulating small business activity: Still a struggle
In testimony before Congress on June 22, U.S. Treasury Secretary Timothy Geithner laid out the disproportionate effect the financial crisis has had on small businesses and particularly their ability to raise funds:
"The banking and credit component of the economic crisis was especially damaging for small businesses, which are more dependent on bank loans for financing than are larger firms. Alternative forms of financing, through household credit via mortgages and credit cards, were also deeply compromised by the financial crisis. Mortgages and other loans account for four times the share of liabilities for non-corporate businesses as they do for corporate businesses. Total lending to non-financial businesses shrank for nine straight quarters starting in the fourth quarter of 2008, before turning slightly positive in the first quarter of 2011; on net, lending has declined by a cumulative $4.2 trillion since Fall 2008. Over the same period, larger businesses were able to raise $3.6 trillion by issuing debt securities."
Evidence from the Atlanta Fed's latest small business finance poll of approximately 182 firms in the Southeast confirms that many firms are still struggling with financing. Total financing received among repeat poll participants edged up only slightly in the first quarter of 2011 from the previous quarter. Further, 43 percent of participants overall reported that tighter lending practices are hindering access to credit. In addition, when offers of credit do occur, they often do not materialize into loans as a result of the unfavorable credit terms being offered. In fact, 41 percent of applications to community and regional banks and 57 percent of applications to large national banks were refused by the borrower, according to the first quarter poll.
In response to these ongoing problems, the Administration has created several programs to help small business obtain funding. One is the Small Business Lending Fund (SBLF). Created by the Small Business Jobs Act in September 2010, the fund began accepting applications in December 2010. The SBLF was set up to provide an incentive for financial institutions with less than $10 billion in assets (mostly community banks) to boost lending to small businesses.
Under the terms of the program, the more small business lending increases, the greater the benefit to the institution. In theory, shoring up the balance sheets of the banks in exchange for an increase in small business lending would result in an increase the amount of loanable capital. Further, there would be a greater opportunity cost for failing to bring loans to closure, and this cost could result in borrowers receiving more appealing credit terms. As a result, those small businesses currently rejecting loans based on the cost of funds could see credit terms ease, resulting in more acceptances and an expansion of small business loans. (You can read more about the details of the SBLF here.)
Unfortunately, the program, which closed out June 22, was not very popular. As of the morning of June 22, the Treasury had received 869 applications out of 7,700 eligible lenders. All together, they requested only $11.6 billion out of a possible $30 billion from the program.
Why was participation so low? One potential reason is lack of demand. According to Paul Merski, chief economist and executive vice president of the Independent Community Bankers of America, "You're not going to pull down capital unless you have loan demand."
If demand for small business loans is not expected to pick up, then what is restraining demand?
One possibility that we considered in a macroblog about a year ago is that demand is being restrained as a result of the perception of tight credit supply. Creditworthy borrowers could be assuming they will be denied so they are not applying. Another possibility is that demand is constrained because of economic weakness. To get a handle on the extent to which these factors are restraining demand, we turn back to our small business finance poll. In the poll, we ask those who did not seek credit in the previous three months why they didn't seek it. The chart below shows the responses to the question. (Note that survey participants can check more than one option.)
At first glimpse none of the reasons seem to dominate. However, if we categorize the responses into "I didn't need credit" and "I didn't think I'd able to get credit," the graph becomes a little more useful.
The graph below shows the responses placed into these two categories (where possible). Firms that only marked "sales/revenue did not warrant it," "sufficient cash on hand," or "existing financing meets needs" are put into the "I didn't need credit" category. Meanwhile, firms that only said "unfavorable credit terms" or "did not think lenders would approve" fall under "I didn't think I'd be able to get credit."
We do not claim that our survey is a statistically representative sample, and we of course can only reach existing businesses. The survey is silent on potential new businesses that were not formed because of credit issues that the SBLF could potentially address. With those caveats, we do find that the majority of firms (66 percent) did not borrow because they didn't need to or want to. Whatever the merits of the SBLF program, it appears that understanding why those businesses that are fully capable of expanding are not doing so is at least as important as understanding the slow pace of SBLF activity.
By Ellyn Terry, an analyst in the Atlanta Fed's research department
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