Why Banks Aren’t Lending

Recently I came across an explanation by Scott Shane in The American as to why banks are not lending to small businesses, and it sounded quite familiar. For background, Shane is the A. Malachi Mixon III Professor of Entrepreneurial Studies at Case Western Reserve University. In other words, he knows of which he speaks.

In a nutshell, Shane puts a large portion of the responsibility for the decline in small business lending at the feet of the Federal Reserve. As he points out, when the Fed instructed banks to tighten up lending the lending practices that gave rise to the housing collapse (which were pushed onto the banks by politicians, but another time on that) the banks responded by tightening up across the board. That meant that not only mortgages but small business loans were affected.

On top of that, because so many small business owners use the equity in their homes to help finance their businesses (28 percent at the height of the bubble, according to Shane) the new standards hit them double. As an example, according to FDIC statistics, loans under $1 million fell 13 percent between June 2007 and June 2011. If we adjust that for inflation, it works out to a 19 percent decline over the four years.

Now this has not all been bad, in that some businesses that received loans during the heyday had no business getting them. But on the other hand, now many small companies that were more than worthy back then - and are still quite viable now - are having problems simply because of the effects of the Recession. So the good are being punished along with the bad.

Shane does not necessarily advocate for loosened standards, and I do not want to see us go back to the days when simply being able to sign on the line seemed enough of a qualification for a loan. What Shane would like to see - and what I doubt we will, politics being what they are - is for the Fed to at least acknowledge its role in the current lending morass. While that may be in line with what Shane says is the Fed’s “new strategy of greater transparency,” expecting that sort of candor from an institution like the Fed is probably unrealistic.

However, even if the Fed does “fess up” to its role, that will not change the fact that small businesses are still hurting in this economy, and the prospects for improvement seem to be dimming again. Business owners need a measure of certainty and stability, and the only certainty lately is that there is none.