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Small Business Financing

What We Don't Know About Small Business Lending

Small business lending remains down following two years of attempts by Washington to revive it. The latest remedy to surface is President Barack Obama's $30 billion plan to offer capital to small banks with incentives to loan it to small companies. That plan passed the U.S. House of Representatives on June 17, but it's not clear if it will manage better than previous efforts to increase the supply of credit by pumping money into banks.

Beneath the problem, say some economists, policymakers, and observers, is a lack of information: We don't have the data that's needed to understand why small business lending is down—and what a proper fix might look like.

Elizabeth Warren, the watchdog appointed by Congress to oversee the $700 billion Troubled Asset Relief Program, says in an interview with Bloomberg Businessweek that "policymakers are flying blind" because the data on small business lending is inadequate. She says there's no evidence that the government's attempts to bolster the supply of credit with capital infusions have worked.

The data shortfall makes it hard to determine if the decline in small business lending has been driven by the banks' unwillingness to lend—or by the companies' disinterest in borrowing or lack of creditworthy status. "The theory of the case is that if there's more money in banks, they'll lend it out," Warren says. "Actually, the data don't support that."

Small business portfolios at the largest bailed-out banks—those with over $100 billion in assets—shrank by 9 percent from June 2008 to June 2009, compared to a drop of 4 percent in their overall lending, according to a May report from the Congressional Oversight Panel, which Warren chairs.

Atlanta Fed's new quarterly survey

TARP's record prompts Warren and others to question whether the $30 billion Small Business Lending Fund will work. The plan would offer community banks government loans that become cheaper if they increase lending to small businesses. Raj Date, a former managing director at Deutsche Bank (DB) who now runs the Cambridge Winter Center research group, estimates that the plan would increase lending to small companies by 10 percent. He says banks would use most of the money to cover losses on existing assets such as commercial real estate loans. "Any time you offer subsidized capital to firms, the firms to whom it is most valuable are the firms with the most existing problems," Date says.

The Federal Reserve Bank of Atlanta recently started a quarterly survey to get a clearer picture of what's happening in the region's small business lending market. "We should now realize this is a gap," says Paula Tkac, an economist at the Atlanta Fed. "If there's good data, that means there might end up being more academic work, and that creates kind of a positive-feedback loop" that eventually helps craft more effective policies, she says.

The most comprehensive look at how small business owners finance their companies, the Survey of Small Business Finances, was last conducted by the Federal Reserve Board in 2003 and discontinued in 2007. After the bank bailout, the Treasury Dept. briefly required the 22 largest TARP recipients to report their monthly lending to small companies, starting in April 2009—six months after they began reporting other types of loans such as mortgages. Outstanding loans to small businesses dropped 4.6 percent, or $12.5 billion, between April and November 2009 at banks in that group, which includes commercial banks such as Citi (C) and Bank of America (BAC), plus such other lenders as American Express (AXP) and CIT (CIT). As banks repaid their government loans, however, they stopped reporting on their lending, making it difficult to judge the bailout's long-term effect.

How big is a "small business?"

A pair of surveys offers clues about how supply and demand may have driven the drop in lending. The Federal Reserve's quarterly Survey of Senior Loan Officers indicates that banks tightened standards for small companies during each quarter from the start of 2007 to 2010. Demand for credit from small businesses dropped in the same period. The National Federation of Independent Business' monthly member survey shows that while credit has tightened, few respondents—a mere 8 percent in May—say their credit needs are unmet. Most rank such problems as poor sales well ahead of difficulty borrowing.

Those figures can paint an incomplete picture, says Brian Headd, an economist at the Small Business Administration's Office of Advocacy. Most businesses do not plan to grow, Headd says, but if the minority that do are the ones that can't get loans, that would drag on the recovery and hiring. Researchers don't even agree on how to define a "small business," and some datasets lump solo contractors together with companies that have hundreds of employees, adding to the confusion. "We really need to break them out and find out what's going on," Headd says.

Scattered efforts are underway to produce better data. Regulators just started making banks report small business lending each quarter, rather than just once a year. The Treasury is considering using data from credit bureaus to get a better picture of small business lending conditions, spokesman Mark Paustenbach says via e-mail. And the Federal Reserve Board plans to hold a forum in Washington on July 12 to explore the dearth of data on small business finance.

These may be small steps in the right direction. The first recommendation in Warren's report to the Treasury Dept. is to collect better information, requiring banks that receive taxpayer money to report their lending activity in greater detail than under the TARP program. The panel writes: "Such poor data have made it far more difficult to pinpoint the causes of today's problems and, as a result, to find effective solutions."

Tozzi is a reporter for Bloomberg Businessweek in New York.

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