Insights & Advice

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Why Banks Will Not Lend

Waiting for a loan

“Then we’d own those banks of marble,
With a guard at every door;
And we’d share those vaults of silver,
That we have sweated for”
“Banks are made of Marble” by Pete Seeger

Over the last few years, the Federal Reserve has practically given money away to any entity that calls itself a bank. Individual states have also tried, but so far the banks have just been hoarding this growing pile of cash instead of loaning it out. Why?

Two reasons come to mind: Banks are afraid of taking on lending risk after the financial crisis and want to be sure that the economic recovery is here to stay before lending, especially to lesser-quality customers. Two, interest rates are at historical lows. If rates start to rise, loans made today could turn to losses fairly quickly.
However, to hear the banks tell it, they are more than willing to lend to small businesses as long as they qualify as a good credit risk. The problem, according to them, is that small businesses aren’t interested in borrowing because the economy is so bad.

On paper it makes a lot of sense to increase lending to this entrepreneurial group, since small businesses employ the vast majority of workers in this country and pay the most taxes. They are the backbone of this country’s economy. And as such, small businesses lending under the Obama Administration has become a focal point.

Last year, in an effort to jump start lending to this group, the State Small Business Credit Initiative was launched by the U.S. Treasury with $1.5 billion earmarked to increase the availability of credit for small business and generate jobs. The money can be lent directly to a business in partnership with a financial institution or to insure the loan through the Capital Access Program (CAPs). It is a game of leverage where states must show that a minimum of $10 in new private lending will result from every $1 in federal funding. So far Connecticut plans to use $13.3 million in SSBCI funding and the Federal government just approved a similar amount ($13.2 million) for Vermont. Massachusetts has their own plan, The Small Business Banking Partnership, which will loan $100 million to community banks for the same purpose.

However, given that small business has suddenly become a political football, I take many of these statistics with a grain of salt. For example, in Massachusetts, as in other states, community banks account for as much as 80% of small business lending and that trend has increased through the recession, according to the state’s banking association. The lending rates have also almost doubled in the last six years.

What they don’t mention is a lot of that recent growth was in picking up old loans that out of state and money center banks had dumped or would not renew due to the recession. A recent survey of members of the International Franchise Association contradicts some of the data coming out of the financial lending sector. The survey revealed that 39% of the franchisors report that more than half of their franchisees and prospects are unable to obtain needed financing, which is up 33% from a survey taken last year.

Yet, according to recent news reports, bankers in our area don’t really see a need for additional funding from the state. They claim that they have the cash but their problem is finding small businesses that want to borrow.

“There are several businessmen right here in this region who want to open franchises with me but can’t get loans from local banks,” says a successful fast-food chain entrepreneur who is expanding into several states. “The banks sent them packing to the SBA for help.”

The argument that businesses are not growing and aren’t applying for new loans is in some dispute, according to some small business owners I talk to.

“What they aren’t telling you is the hoops a small business owner has to jump through in order to get that new loan,” says the head of a large excavating company in the region.

“They want collateral and a lot of it. They want you to sign your life away, and none of that matters unless you are making tons of income as well. And once I pass all their risk criteria, I get the privilege of borrowing short term from them at 8-9% when the prime rate is 3.25%.”

Given that most banks are paying under 1% for money to loan, one would think that a 7-8% spread should bring in plenty of profits. One of the reasons that the Federal Reserve has been keeping interest rates at historical lows is to entice banks to lend and make those profits. So far it hasn’t worked.

And speaking of the Fed and QE II, most everyone including the banks are expecting interest rates to rise in the second half of this year. Few bankers have the appetite to lend money to you or me when they expect rates to rise. And if they do, they don’t want to lend for a long period of time.

“That’s also difficult for a small business to handle,” explains the excavator,” if I have to go back to the bank in three years, I can’t do long range planning. I can’t even be sure I’ll get a new loan, and if so at what price. It makes being a small business owner that much more uncertain.”

Posted in A Few Dollars More, Macroeconomics