The Small Business Credit Experience Amid “Issues”

The most recent “banking crisis” was different from past experiences. Historically, bank problems rose from borrower defaults, loans becoming uncollectable. This time, the problem was due to poor risk management. Deposits are “loans” to the bank with a maturity as short as 24 hours – depositors can withdraw any time (thus the development of longer maturity Certificates of Deposit, with interest lost penalties for early withdrawal). The government distributed massive sums of money to consumers during Covid, this money was immediately deposited in bank accounts until depositors decided how much and when to spend. These excess reserves earned virtually nothing at the Federal Reserve, so banks invested the funds in longer term Treasury bonds, perfectly safe from default. These bonds all carried low interest rates. Then the Fed quickly raised rates 475 basis points and depositors discovered better uses for their money and started withdrawing funds. Silicon Valley Bank (SVB), the most notable recent bank failure, had to liquidate their safe (but low yield) investments, generating large losses that had to be covered with their capital (which was not sufficient). The bonds were all safe, but depositors did not want to wait 10 years to get their money while only earning a small return. New Treasury bonds paid twice the rate, a more attractive investment for depositors. SVB was caught in this squeeze failed. But it appears that most banks didn’t make these mistakes and most depositors didn’t feel the need to move their deposits.

Credit conditions have been quite favorable for small firms since the Fed instituted Zero Interest-Rate Policy (ZIRP), a policy not good for savers but a real boon to borrowers. From 2009 to 2015, borrower satisfaction improved, with the percent reporting credit needs not satisfied falling from highs of 11% in 2010 to 2% this year (March) (Chart 1). Owners are asked to compare the difficulty encountered getting their current loan to that experienced with their last loan. Complaints peaked at 16% in May 2009, falling rapidly to 1% in August 2019, stabilizing in a range between 1% and 4% until July 2022, when it began to rise, reaching 9% in March 2023, reflecting the Fed’s push to raise interest rates and tighten credit standards.

Overall, it appears that rising interest rates have not discouraged credit-worthy small business owners. Yes, rates are higher and more small business owners report loans harder to get than the last time they borrowed, but the percent reporting that their credit needs were not met has stayed close to 0%. The average interest rate on loans reported by owners has risen from a low of 4.1% in July 2020 to 7.9% in February of this year. So far, the higher interest rates don’t appear to have dampened credit demand significantly. In small business financing, credit availability is the primary concern for small business owners, not the cost of credit. The returns expected from the use of borrowed funds far exceed credit costs. In 1980, owners reported an average loan rate of 19% and were borrowing! Current job openings and hiring plans indicate that many owners still see opportunities to make money and grow their businesses and are willing to borrow to pursue them. As the economy slows, lenders will exercise more caution making loans, as a slowing economy generally results in lower expected sales and profits from business projects.

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