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Undernews is the online report of the Progressive Review, edited by Sam Smith, who covered Washington during all or part of ten of America's presidencies and who has edited alternative journals since 1964. The Review, which has been on the web since 1995, is now published from Freeport, Maine. We get over 5 million article visits a year. See for full contents of our site

February 20, 2010


Stacy Mitchell, New Rules - Just before Thanksgiving last year, the U.S. Small Business Administration's flagship loan program, which provides banks with a government guarantee of up to 90 percent of the value of loans made to small businesses that fall just shy of qualifying for a standard bank loan, ran out of money.

SBA loan guarantees are arguably one of the most efficient uses of stimulus funds. The $325 million included in the Recovery Act of last February covered the cost of backing $16.5 billion in loans to small businesses. Yet, as loan volume spiked in the fall, reaching pre-recession levels, Congress let the pipeline run dry.

Within weeks, more than 1,000 small businesses found themselves in loan purgatory: their loans had been approved, but banks couldn't release the funds.

Such a turn of events seems unconscionable amid a recession. But it's about to happen again. An additional $125 million appropriated in December will run out toward the end of February unless the Senate moves quickly to approve legislation that would support SBA loan guarantees through the end of the year.

These days, all eyes are on small businesses, and for good reason. They've created the majority of new jobs over the last decade and, in past downturns, it's been small business growth that has pulled us out of recession.

The ability of small businesses to finance growth is, in turn, largely dependent on the capacity of local community banks to lend them money. Although small and mid-sized banks ($10 billion or less in assets) control only 22 percent of all bank assets, they account for 54 percent of small business lending. Big banks, meanwhile, allocate relatively little of their resources to small businesses. The largest 20 banks, which now command 57 percent of all bank assets, devote only 18 percent of their commercial loan portfolios to small business.

As big banks have consolidated the market, small businesses have had a harder time obtaining loans. In a study published in 2007 in the Journal of Banking and Finance, Steven G. Craig and Pauline Hardee examined different regions of the country and concluded, "Credit access in markets dominated by big banks tends to be lower for small businesses than in markets with a relatively larger share of small banks."

Other research has found that, all else being equal, regions with a robust network of small, local banks are home to significantly more small firms.

Why is it that community banks do so much more small business lending than their big competitors? One reason is that big banks rely on computer models to determine whether to make a loan. Because the local market conditions and the circumstances surrounding each borrower and his or her enterprise are so incredibly varied, this standardized approach does not work very well when it comes to understanding the nuances of risk associated with a particular small business.

By drawing on qualitative information - getting to know the borrower, learning about the business, and understanding the local market - small banks can better assess risk and successfully make loans to a wider group of small businesses. . .

Because big banks are run from afar, it's impossible, or at least very expensive, for them to obtain the kind of qualitative information about risk that local bankers pick up naturally by being part of the community and interacting with borrowers. As a result, there are no economies of scale in small business lending; just the opposite. Small banks are, on average, more efficient small business lenders and make a better return on their assets.

All of this makes plain the fallacy of thirty years of banking policy that has fueled mergers and consolidation on the grounds that bigger banks mean greater efficiency and more growth. Banking consolidation has in fact constricted the flow of credit to the very businesses most likely to create new jobs.

It's no surprise then that the money taxpayers have spent over the last 16 months shoring up big banks has done nothing to free up credit for small businesses. To do that, we need to focus on expanding the lending capacity of small banks.

The Obama Administration has finally grasped this, putting forward a flurry of proposals in recent weeks aimed at increasing the flow of loans from small banks to small businesses.

Although some community banks will benefit from Obama's plan to make $30 billion in low-cost capital available to them, for most small banks, the issue right now is not a lack of capital. Most small banks are in pretty good shape and have money to lend.

The problem is that loan demand is down and many of the small businesses that are seeking loans are not creditworthy by standard measures. Their cash flow has been battered by the recession. Many no longer have equity in their homes or businesses to borrow against. Through no fault of their own, small businesses are operating in an economy in which they are more likely to fail and thus constitute much riskier investments.

This is where SBA loan guarantees come in. They allow banks to absorb more risk. "For a bank, if more than one or two percent of your loans go bad, you're out of business," explained Kimball of Park Midway Bank. "The SBA guarantees allow you to get that into a range of 5-8 percent. It allows you a lot more leeway in terms of risk.". . .

In the 12 months before the credit crisis, some 2,500 banks, mostly small community banks, made over 69,000 loans under the 7(a) program. Three-quarters were for amounts under $150,000, one-third went to minorities, and nearly 40 percent funded start-ups. In good economic times, fees paid by borrowers cover the cost of the program, including defaults.

When the credit markets froze in the fall of 2008, the volume of SBA-backed bank loans plummeted to about half of normal. Big banks, especially, sharply cut back their lending. SBA loan volume at JP Morgan Chase, for example, fell 66 percent. . .

Yet, despite the fact that SBA loan guarantees effectively and inexpensively address one of the most debilitating aspects of this recession - reduced credit for small businesses - Congress has allowed the program to run dry once already and is on the verge of doing so again in the next few weeks.


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