The Diminishing Role of Big Banks in Small Business Lending

The banking landscape for small businesses has undergone significant changes. In recent years, big banks, traditionally defined as those with assets over $10 billion, have been reducing their involvement in lending to small enterprises. Their declining loan approval rates, juxtaposed with the rising percentages of community banks, credit unions, and non-bank lenders, paint a concerning picture for small business owners seeking funds.

A Continuous Drop in Approval Rates

According to the recent Biz2Credit Small Business Lending Index™, loan approval percentages at big banks have been consistently dipping. In August 2022, their figures stood at 15.1% and by August 2023, they had dropped by nearly 2% to settle at 13.2%. This reduction in lending is not an isolated event of a single month; rather, it's a concerning trend that has been ongoing since June 2022.

This continuous decline poses a severe challenge for small businesses. Historically, large banks have been a dependable reservoir of funds, with an ample amount of deposit money often regarded as a perpetual source of inexpensive capital. But as the financial landscape evolved, especially post-COVID, increased interest rates and the expensive maintenance costs of physical branches have impacted the banks' lending tendencies.

The Saving Grace: Community Banks and Alternative Lenders

Amidst the gloom of declining approval rates at big banks, regional and community banks provide a silver lining. Their loan approval percentages have shown growth, increasing from 18.9% in July to 19.1% in August 2023. One critical aspect of their consistency in lending is their inclination toward processing government-backed SBA loans. These loans inherently reduce the lenders’ risk, offering guarantees that foster financial aid to small businesses. With a variety of purposes, ranging from acquiring real estate to refinancing current business debt, these loans have been pivotal for many enterprises.

Despite their consistent performance, community banks face challenges in the commercial real estate sector. Many of them expanded their portfolios in this domain only to face the unpredicted downturn in the market. The high exposure to commercial real estate could potentially disrupt their lending capabilities in the future.

There's also been a surge in institutional investors and alternative lenders. These non-bank entities have become significant sources of capital for small businesses. Their loan approval rates rose slightly from July to August 2023, albeit at a typically higher interest rate than banks. This slight increase in approval rates may appear marginal, but in the broader context of dwindling bank loans, they become invaluable lifelines for businesses desperate for funds.

The Current Financial Landscape: A Bigger Picture

The U.S. economy is witnessing a multifaceted challenge. While the low unemployment rate, as indicated by the U.S. Bureau of Labor Statistics, is usually celebrated, it currently indicates a tight labor market. For businesses, this means increased wage expenses. Couple this with inflationary pressures, and it leads to reduced profits for small businesses. Additionally, the Federal Reserve's continuous interest rate hikes have increased capital costs. These complexities contribute significantly to the ongoing business credit crunch.

Moreover, as the CEO of Biz2Credit, Rohit Arora, opined, the ongoing credit squeeze on entrepreneurs might not see a resolution until the Federal Reserve considers lowering interest rates. The shift in lending tendencies of big banks has led many entrepreneurs to lean on alternative funding sources. Despite these non-traditional sources proving beneficial, their typically higher interest rates might not be the ideal solution for every business.

Conclusion

The evolving dynamics of the banking sector, especially regarding small business lending, underscore the need for adaptability on both the lenders' and borrowers' parts. While big banks recede, alternative funding avenues are emerging as the new hope. However, for a sustainable financial ecosystem, a balance between traditional banks and non-traditional lenders is imperative.

Sources:

Forbes

Inc.