The recent bank failures in the U.S., the takeover of Credit Suisse by UBS and the bank-led capital (deposit) infusion into First Republic Bank, may seem disconnected to the millions of small businesses across the country and Western economies. However, the direct and indirect connections to business owners are nonetheless sitting right below the surface.
First, if you were a depositor at SVB, Signature or the other banks that have featured prominently in western headlines the last few weeks, this situation has been both frightening and a wakeup call to the limitations of the banking system and your deposits. Events have brought back fears of the 2008 Global Financial Crisis and even 1930’s era global banking issues.
Those issues have, for the moment, seem to have been abated by quick and decisive direct regulatory intervention, but what does this mean for the future? First, the mainstay of commercial small business lending in the United States (depending on how you define small business), has been local and community banks up to some smaller mid-size financial institution. According to the Independent Community Bankers of America Association, these banks make 60% of all small business loans. The number of these institutions has been declining for some time. Sadly, we do not expect these trends to change.
These banks have generally been encouraged to invest deposits in a combination of loans and ‘safe securities’ such as U.S. treasury obligations. The very simple math is that the yield on these investments will generate excess cash for the banks over the seemingly paltry returns offered depositors for their accounts, Certificates of Deposits, etc. Since interest rates have been so low for so long, Banks have invested in securities with longer and longer maturities. The not so simple math is that when the Federal Reserve raises interest rates repeatedly as it has done over the last year, the yields on these securities remain the same, but the price declines as new U.S. Securities offer a higher yield. This is generally not an issue for banks who tend to hold these securities until maturity and get 100% of their capital back.
This is all well and good until depositors get nervous and start demanding more and more of their deposits back. No bank of any size can individually withstand a so-called ‘run on the bank’. In steps the regulators, both state and federal.
One of the first spillover effects of this is all banks start to tighten their belts to increase capital which results in less lending; less renewal of loans; more collateral, etc. This is where it starts to directly affect small businesses. Simply put, the access to capital starts to decline, which has the greatest aspects on the smallest businesses. Less access to credit, more loan defaults, slower growth and that is why this week’s headlines are replete with the banking system’s issues and the caution over how they could be accelerating or tipping the U.S. and other western economies towards a recession. The federal reserve might now have to increase interest rates from here. The banking system may have done the job (and too good a job) for them.
Our next discussion on this topic will be: What Alternatives are there for Small Business Financing? As you might imagine the options are less diverse and more expensive (if available) for small businesses across almost all sectors.