Small-Business Banking

Small Business BankingWith big banks extending fewer loans to small businesses, community banks are emerging as the best hope for these businesses as they seek credit to help them grow and expand. Acknowledging the importance of small businesses in supporting his strategy for economic recovery plans, President Obama in February proposed to Congress a Small Business Lending Fund that would divert $30 billion from the big-bank bailout program to community banks (those with $10 billion and less in assets) for small-business loans.?

?These days, all eyes are on small businesses, and for good reason. They?ve created the majority of new jobs over the last decade and, in past downturns, it?s been small-business growth that has pulled us out of recession,? Stacy Mitchell, senior researcher for the New Rules Project – Community Banking Initiative, says in a Feb. 9 article in The Huffington Post on restoring the flow of credit to small businesses. ?The ability of small businesses to finance growth is?largely dependent on the capacity of local community banks to lend them money. Although small and midsized banks control only? twenty-two percent of all bank assets, they account for fifty-four percent of small business lending. Big banks, meanwhile, allocate relatively little of their resources to small businesses,? Mitchell says. The largest 20 banks now command 57 percent of all bank assets, but devote only 18 percent of their commercial loan portfolios to small business, she says.

The New Rules Project, a program of the Institute for Local Self-Reliance,?? launched the Community Banking Initiative to provide the underpinnings for a ?community-scaled? financial system.?

?You provide savings and credit products to previously unbanked and underbanked customers and offer financial services to help people purchase homes and start or expand their businesses,? John G. Walsh, chief of staff and public affairs in the Office of the Comptroller of the Currency, told community bank representatives attending the National Community Investment Fund?s Annual Development Banking Conference in Chicago last November.

The National Community Investment Fund, a nonprofit dedicated to driving ?socially responsible? capital to community banks, says these banks differ from their large money-center counterparts in that they are focused on providing the traditional banking products and services most needed in the economically disadvantaged areas they serve, ?rather than on constructing the ever more exotic derivative products that contributed to the current economic downturn.?

According to the American Bankers Association, with $13.3 trillion in assets and more than $1 trillion in capital, the banking industry as a whole has the capital and commitment to support the financial needs of individuals, businesses and all levels of government. But figures from federal and state financial regulatory agencies show that small businesses today are finding it hard to obtain or renew credit. Between June 30, 2008, and June 30, 2009, for example, loans outstanding to small businesses and farms declined 1.8 percent, by almost $14 billion, and the bigger the bank, the steeper the decline. While the number of loans to small businesses increased slightly at institutions with total assets of less than $1 billion, it fell more than 4 percent at institutions with total assets greater $100 billion in the period, they say in a joint statement on Feb. 5.

Moreover, responses to the Federal Reserve Board?s latest survey of senior loan officers indicate that the number of banks that tightened credit standards and terms on commercial and industrial loans to small businesses was high enough in 2009 to exceed previous highs in the past 20 years.

The regulatory agencies ? the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Board of Governors of the Federal Reserve System, the Office of Thrift Supervision, the National Credit Union Administration and the Conference of State Bank Supervisors ? attribute the decline in small-business lending to, among other factors, weakness in the broader economy, decreasing loan demand and higher levels of credit risk and delinquency. At the same time, their statement ?Meeting the Credit Needs of Creditworthy Small Business Borrowers? acknowledges that financial institutions may at times react to a significant economic downturn by becoming overly cautious with respect to small-business lending.

?Regulators are mindful of the harmful economic effects of an excessive tightening of credit availability in a downturn and are working through outreach and communication with the industry and supervisory staff to ensure that supervisory policies and actions do not inadvertently curtail the availability of credit to sound small-business borrowers,? the statement says.

In a surprising move that again emphasizes the critical role of small businesses in supporting economic recovery, the regulators urge banks to put aside their standardized models and adopt new models of assessing the creditworthiness of small businesses in light of the economic downturn. Banks should, for example, understand the long-term viability of the borrower?s business and focus on the strength of the borrower?s business plan, including its plan for the use and repayment of loan.

They also should have an understanding of the competition and local market conditions affecting the borrower?s business and should not base lending decisions solely on national market trends when local conditions may be more favorable. While they expect banks to effectively monitor and manage concentrations of credit, the regulators emphasize that banks should not automatically refuse credit to sound borrowers because of the borrowers? particular industry or geographic location. The regulators recommend a slew of other new approaches, including:

? The analysis of the business?s cash flow should cover current and expected cash flows and reflect expectations for the business performance over a reasonable range of future conditions, rather than overly optimistic or pessimistic cases;

? The borrower?s credit history and financial strength, including credit score, should be viewed as components of assessing willingness and ability to repay, and should be considered in conjunction with other judgmental factors, such as the strength of management;

? The loan structure should be appropriate for meeting the funding needs of the borrower given the type of credit and expected timing of the business?s cash flow;

? Banks should analyze the secondary sources of repayment, such as the strength of any guarantor or collateral support, and the ability of the borrower to provide additional capital;

? Banks should not place excessive reliance on cyclical factors, such as appreciating or depreciating collateral values.?
Small-business advocates are cheering the regulators? stance. ?I?m encouraged,? says one. ?Let?s hope the big banks act on those recommendations and soon.?