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March 31, 2023
The collapse of Silicon Valley Bank and Signature bank, plus the stumbling of other major banks around the world, has many small business owners concerned about the long-term impact of rising interest rates, spiking inflation and tighter banking regulations.
As the United States’ top banking and financial regulators meet to discuss the state of American banks, there is a strong possibility that they’ll recommend greater scrutiny for both large, corporate banks and small, local banks across the country. And those restrictive policies could have a significant impact on how small businesses access capital, starting as soon as late 2023.
Banks across the country, and around the world, have been growing exceptionally fast over the past few years as businesses increase their deposits and more startups enter the market. Those growing banks typically use their depositors’ money to purchase government bonds as a way to earn steady interest on a relatively low-risk investment. But as interest rates rise and the value of bonds falls, banks can quickly find themselves in a losing position.
Over-leveraged and mismanaged banks run into a significant problem when too much of their capital is tied up in bonds that are currently selling at a loss. When depositors pull their money back out, the bank is forced to sell its investments for less than it purchased them. And when the public realizes the bank’s tenuous position and rushes to withdraw their cash while the bank still has some, the resulting bank run can almost instantly collapse the institution.
Properly managed banks are better insulated from interest rate fluctuations. But for everyday small business owners, it can be difficult to tell the difference between a safe, reliable bank and one taking high-risk positions. And with the Federal Reserve raising rates again in March, for the ninth time in a row, banks are facing increasingly high pressure.
According to Treasury Secretary Janet Yellen, major withdrawals by small businesses and individuals with significant assets have leveled off, and the threat of a national bank run seems small. But a proposed rule by the Consumer Financial Protection Bureau could change the way banks, and particularly small financial institutions, lend to small businesses.
The provision, called the Small Business Lending Data Collection Rule, will require banks to collect more information about the businesses they lend to, in order to monitor lending discrimination, lending laws, and the credit needs of small businesses. While this rule has been a part of lending law for nearly a decade, it had been largely ignored until 2019, when a consumer advocacy group sued the bureau for failing to enforce it.
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If the rule goes into effect, it will have a major impact on the cost, data collection and paperwork required to complete a small business loan. Today, these small institutions aren’t required to collect or report any demographic information about the businesses they serve. But starting in July 2024, if the rule is enforced, these institutions will be required to collect and publicly report data on the size, revenue and demographics of the small businesses they support.
Local financial institutions where long-standing relationships play a big role in lending practices say the new rule will make it more expensive to lend to small businesses, and may result in fewer loans issued if businesses don’t wish to share their sensitive information. But those in favor of the regulations say greater transparency about which small businesses receive credit will help women- and minority-owned businesses have greater access to the capital they need.
Banks are watching the same headlines as small business owners. They see a potential recession on the horizon, major layoffs across many industries, rising inflation and skyrocketing costs. They see businesses having to work harder and think smarter just to maintain their performance. And it’s likely this caution will lead to tighter lending practices that limit what some small businesses can qualify for.
As lending slows, business growth slows. And slower business growth can bring the whole economy to a halt. That course reversal has the potential to correct inflation, but it can also trigger an economic downturn that takes years to recover from.
Whether the latest banking disruptions and increased regulations trigger a recession, or just result in a little extra paperwork, there’s no question — small businesses should be prepared for the potential for tougher lending practices and reduced access to capital. There’s hope for these growing businesses, but it may take extra effort to secure the loans and lines of credit you need to keep your company running.
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