The great recession has had a profound effect on how banks view small business. Business lending is changing, and it is changing most rapidly for small businesses. However, there isn’t one particular aspect that is to blame for the decline of small business credit, therefore, focusing on factor alone when addressing the situation would be an exercise in futility. Let’s take a deeper look at how business lending for smaller firms is evolving the factors behind these changes.
While small businesses employ about half of the private sector and contribute almost as much to the nation’s GDP, each business is by definition small. Big businesses have the track record and cash flow to prove to lenders that they can repay their loans. Small businesses, on the other hand, may not be generating much of a profit yet and rarely have the numbers or history of the big firms. Some banks stopped lending to small businesses during the Great Recession completely and have only slowly returned to the lending market; all banks have tighter lending rules than before the recession and lend less than they did before the recession. They’ve even retained their tighter standards for small business as they’ve started to loosen them for big businesses.
Small businesses are seen as less creditworthy now than they were since the Great Recession started, something we’re only now pulling out of. Small businesses did take a major hit; between 2007 and 2017, the average self-employed person saw income drop by 19% according to the Federal Reserve Survey of Consumer Finances. Before you say that was just one survey, the Census says over the same time period, the average self-employed household had a 17% drop in real earnings. This reduced income reduced the creditworthiness of every affected business person, whether or not they went further into debt, went bankrupt or missed payments. However, average creditworthiness for small business did fall during this time. The average PAYDEX score for small businesses rated by the Federal Reserve was 53.4 in 20013. In 2011, it was 44.7.
Shifts in Lending Practices
Businesses still need to borrow money at times. The solution for scared lenders is collateral. In 2007, a Federal Reserve study found that 84% of loans under a hundred thousand dollars were secured by collateral. In 2013, that rate was 90%. One example of this trend is buying inventory secured by the inventory itself instead of a line of credit with a bank. Another example would be buying industrial equipment to expand your plant and having the loan secured at least in part by the equipment itself. This trend has even been hitting mid-sized businesses, since the rate of loans up to one million dollars secured by collateral hit 80% in 2013, up from 76% in 2007.
Small businesses face an increasingly restricted lending market and fewer conventional lenders. Many small businesses faced a cash crunch during the Great Recession, hurting their creditworthiness. This has driven growth in collateralized loans secured by business real estate, inventory, equipment and even the business owner’s own home.
Unfortunately, there isn’t any reason to believe that the situation will turn around anytime soon without policy. However, policymakers will have to take all these factors into consideration if they eventually want to turn the tide.