April 1, 2010

Small Banks Say They Can't Win in Small Lending

There was an article in USA Today yesterday about banks being unable to freely lend to small businesses because of increased pressure from government examiners. These examiners come from the FDIC and are deployed to make sure that banks are following newer, stricter guidelines in their lending practices in an effort to avoid another lending crisis. While these regulators don't deny or approve loans, they will downgrade the rating of performing loans, including when collateral, mainly commercial real estate, has fallen in value. I believe this is misguided policy because oftentimes, collateral value has no effect on a company's ability to repay a loan. Granted, the loan must be secured by a reasonably valued asset, but it would be wholly impractical to constantly revalue loans based on the current market value of the collateral, especially when the fundamental financials of the business who took out the loan hasn't changed. In trying to keep banks from overextending themselves, regulators in this situation are requiring banks to hold higher minimum capital reserves to make up for the loss in collateral value. In turn, this decreases the money banks have to lend.
It is well established that small businesses fuel growth in this country and are responsible for two thirds of new job growth by some estimates. Since small businesses are not able to utilize capital markets to get funding, the banks are a critical part in this process, and therefore, the recovery of the economy. This government intervention with the intent of making lending practices more sound in order to help bolster the economy has the effect of stifiling small businesses, the very thing that fuels growth. In light of this unexpected result, regulators have issued more guidance (3 times in the past 15 months) encouraging banks to lend to creditworthy borrowers, as well as now not to lower ratings simply because collateral value has fallen. However, the more "guidance" lenders have to wade through, the more cumbersome and restrictive the process will become. So maybe the answer is less, not more.

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