Obstacles To Small Business Lending

On January 13th I attended the FDIC Small Business Forum titled Overcoming Obstacles to Small Business Lending and got an extraordinary glimpse into why many small businesses are missing the recovery.

Even though the forum panelists agreed that "what's good for small business is good for America", they had few ideas about how to energize the financial system to help Main Street.

While I have a lot of respect for several of the forum participants, including Ben Bernanke and Shelia Bair, I left with an unsettled feeling that the panel wasn't in touch with what makes Main Street tick. The consensus plan is to wait until the economic recovery gets down to Main Street and then hope everything will be OK. Unfortunately, it's going to be a long wait.

About 30 minutes into the forum, Senator Mark Warner said that to generate employment gains America needs to nurture small business "gazelles". He pointed out that fast moving companies often turn into big employers. The other panelists agreed and said that export growth was also key to fixing unemployment.

Once everyone agreed on the importance of gazelles and exporters, one by one, the panelists pledged their allegiance to community bankers. They were certain that community banks would be the primary small business lender of the future. FDIC Chairwoman Bair supported this thesis by pointing out that community banks own almost 40% of small business loans held by banks.

As I listened to Chairwoman Bair's articulate and enthusiastic comments, I was reminded of the movie It's A Wonderful Life. Unfortunately, it's not credible that America's Bailey Building and Loan Associations are suddenly going to become the primary resource for rapid growth manufacturers who are active in international markets.

Maybe a review of practical reality and facts would help.

According to Treasury, in 2007 less than 50% of all small business loans were owned by banks (the rest were owned by non-bank lenders). Small banks owned about 40% of the bank loans, meaning that small banks only owned about 20% of all small business loans, which isn't an overwhelming market share. Moreover, over the past 30 years community banks have been shrinking in numbers and losing market share.

Market share and capacity problems continue. Currently, the FDIC has classified around 1,300 small banks as "troubled" which means that community banks, as a class, are shrinking and under capital stress.

Put simply, community banks lack the capital and operational capacity to finance a resurgence of Main Street's fast growth companies and exporters. Interestingly, Senator Warner articulated his doubts about community bank capabilities but didn't receive any agreement or support from other panelists.

Even healthy community banks have major structural handicaps that prevent them from meeting the needs of many fast growth companies and exporters; namely their small legal lending limits and limited products and geographic operational capabilities.

Small banks have a small capital base and therefore a small legal lending limit. Fast growing international businesses need their banks to have large legal lending limits that they won't quickly outgrow. Community banks have local operational capabilities. Companies that buy and sell goods and services throughout the U.S. and around the globe need broader transaction processing product offerings and the ability to finance international procurement and sales. Community banks, more or less by definition, don't typically have such capabilities.

I was surprised when for much of the second hour of the forum, the panel stopped talking about financing small business and turned to issues that everyone on the stage agreed had nothing to do with why they were there.

Suddenly, everyone had something to say about Dodd Frank rulemaking, BASEL III regulation, healthcare reform, tax cut legislation and the foreclosure mess.

When the conversation got more or less back on point, most speakers whined about how declining asset values are hurting small business. Of course, not a single speaker mentioned that the largest asset class owned by most small businesses, i.e., accounts receivables, didn't at all drop in value. Inventory, typically the second largest asset class for manufacturing companies, was mentioned once or twice in passing and not in the context of lending or banking.

It wasn't until late in the day that anyone spoke of equipment finance, inventory finance, trade finance or any other type of loan or service that a fast growing manufacturing or service company would be interested in. No one talked about how to finance imports through the supply chain. I'm pretty sure that most of the speakers had no idea that something called supply chain finance exists or why it is important to small business.

Karen Mills, SBA administrator, was the most articulate and relevant speaker, but she was last to talk and only had 15 minutes allotted to her. While everyone had agreed with Senator Warner at around 1:30 PM that export gazelles were the key to growing small business employment, it wasn't until 3:57 PM, with 3 minutes of time remaining, that Ms. Mills mentioned trade finance. She was the only person to say anything remotely useful on the topic. Her two sentence reference to trade finance secured my vote for the "most relevant speaker of the day" award.

With the exception of the SBA, it's clear that Washington's economic power elite is almost totally out of touch with the needs of Main Street. The FDIC Forum highlighted that perhaps the biggest obstacle to small business lending is the disconnect between well intentioned policy makers and the reality of Main Street U.S.A. Until policy makers provide initiatives that are relevant and practical, we have a long wait before small business restores its status as the U.S. employment growth engine.