Are small businesses being locked out of commercial lending?

Small business in the spotlight as de-regulation hits the headlines

Small businesses are the lifeblood of any economy, creating wealth and employment opportunities – and supporting economic growth at grass-roots level. This type of entrepreneurship has always been valued in the United States, where the founders of startups can aspire to become leaders of Fortune 500 companies if they hit on a successful niche.

But are small business owners being unfairly hampered by the raft of regulations introduced following the financial crisis of 2008? It’s an issue that’s hitting the headlines at the moment as ‎President Trump reaffirms his pre-election promises to de-regulate the financial services industry.

Lending restrictions throttling growth

Trump believes that restrictions brought in post-2008 in a bid to discourage the risk-taking behaviours that led to financial meltdown are crushing smaller (<500 employees) companies. To this end, the president has ordered a full-scale review of the Dodd-Frank Act (2010) which tightened lending restrictions on banks and instituted reforms to mitigate risk.

If the president’s rhetoric is to be believed, it would appear to be near-impossible to start a new business or expand an existing one in the US because banks ‘don’t loan you money’. But is this true and – if it is – could it be entirely attributable to the lack of availability of business funding?

Is Dodd-Frank damaging small businesses?

In fairness, Dodd-Frank restrictions were introduced to limit the scope of larger banks and financial service providers and to prevent similar problems arising in the future. But complaints about the impact of the law on smaller lenders have also accused Dodd-Frank of creating an impediment to small business growth.

The main stumbling block, according to the US Chamber of Commerce, is the ‘arbitrary’ threshold for capital requirements and regulations which, in practice, means that smaller local lenders make it a policy to stay below these limits by reducing lending. If, for instance, a bank passes the $10 billion threshold, it immediately has to comply with a swathe of regulatory hurdles which often carry a hefty price tag.

The only way smaller banks can underwrite these costs is to grow through a process of mergers and acquisitions. And it seems that if banks take the decision to pass the threshold, they aim for aggressive targets that will help them more easily swallow the added regulatory costs.

So, what’s the impact on credit availability?

The upshot of which seems to be that small businesses are paying a disproportionate price for increased regulation.

In a 2014 report, Goldman Sachs researchers found that small and medium-sized businesses were looking at funding costs of that had increased 175 basis points (bp) more than their larger competitors compared to the pre-crisis period, potentially damaging their ability to compete on a level playing field.

The report concluded that ‘low-income consumers and small businesses — which generally have fewer or less effective alternatives to bank credit — have paid the largest price for increased bank regulation’.

Credit parameters narrowing

Certainly, when it comes to commercial lending, there is a troubling gap between large corporations that are able to access alternative forms of funding at attractive rates and small businesses that are heavily reliant on traditional lending streams and are facing higher borrowing costs.

That said, it would be a stretch to pin the credit squeeze entirely on Dodd-Frank which wasn’t enacted till mid-2010, with many of its provisions coming into force long after.

An upturn in business lending

In any case, the tide may well be turning. A recent survey by the Federal Reserve found that around half of small businesses looking for credit in 2015 were successful (up from just over a third the previous year) and that under a fifth were turned down (a big drop from 46 percent in 2014).

Moreover, Census Bureau figures show that the number of small businesses in the US has risen year-on-year since 2010 following four years of decline. In 2013, the last year for which data is available, the number of small businesses grew by almost 45,000 to top 5.5 million – this excluding self-employed individuals.

Making the US a great place to do business

Ironically – according to World Bank figures – getting credit in the US is easier, by some distance, than assembling the required permits, licenses and employee verifications necessary to start a new business.

It remains to be seen how much financial regulatory reform will be rolled back and – importantly – whether any or all of the planned changes will have a positive impact on small business lending.

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