No. 230

June 2003

SMALL BUSINESS

RESEARCH

SUMMARY

Impact of Tight Money and/or Recessions on Small Business

by PM KeyPoint LLC,

2003 [56 pages] Emeryville, CA 94608.

under contract no. SBAHQ-01-C-0152

This Small Business Research Summary (ISSN 1076-8904) summarizes one of a series of research papers prepared under contracts

issued by the U.S. Small Business Administration’s Office of Advocacy. The opinions and recommendations of the authors of this study do

not necessarily reflect official policies of the SBA or other agencies of the U.S. government. For more information, write to the Office of

Advocacy at 409 Third Street S.W., Washington, DC 20416, or visit the office’s Internet site at www.sba.gov/advo.

Purpose

Small businesses may be particularly exposed to

recessions, banking conditions, and monetary policy.

Small firms typically rely more for their credit on

bank lending than larger firms do and may be more

adversely affected when tighter monetary policies or

a deterioration in bank health reduce the supply of

bank loans. During the 1990-1991 recession, for

example, smaller businesses were affected more than

larger businesses by banks' troubles. This study

addresses the relative effects on small businesses of

changes in various economic, monetary, and financial conditions. To do so, the study attempts to

answer these questions: 

(1) Do economic slowdowns, tighter monetary

policy, or adverse conditions in banking sector affect

small businesses more than larger businesses?

(2) During tight monetary periods or economic

slowdowns, what are the effects on real economic

activity at smaller businesses and in the overall economy of small, medium, and large-size bank capital

and SBA-guaranteed loan programs?

(3) How much are various effects changed during

economic slowdowns or when interest rates are high?

Overall Findings

The findings suggest that tighter monetary policy

and adverse conditions in the banking sector reduce

economic activity in businesses of all sizes. Using

banks' capital positions and delinquency rates as

proxy measures for conditions in banking, the study

found that capital pressures at small banks turned out

to be particularly detrimental to the performance of

small businesses.

Evidence was found that increased flows of SBAguaranteed loans raised output, employment, wages

and salaries, and nonfarm proprietors' incomes. To

the extent that they did, SBA-guaranteed lending

acted as an economic stabilizer.

The effects of various ameliorating or countercyclical policies may be significantly larger than

would be suggested by their average effects over the

whole period of observation. 

Highlights

• This study reaffirms the conventional wisdom

that higher federal funds interest rates reduce the

amount of bank lending. Lending also declined in

the face of adverse banking developments, such as

reduced bank equity capital and higher loan delinquency rates.

• Small bank capital had the largest effect on

employment. This suggests that capital at small

banks was "high-powered capital," in terms of stimulating employment. The effect on employment of

additional capital at small banks was about three

times the effect at large banks.

• Larger numbers and amounts of SBA-guaranteed

loans tended to raise employment and payroll at

firms of all sizes. 
• Generally, a decline in bank capital leads to a

reduction in the number of bank loans. However, a

reduction in bank capital at both small and large

banks was found to lead to an increase in the volume

of SBA-guaranteed loans, although the effect was

not statistically significant. This finding suggests that

the SBA program is countercyclical, providing a stabilizing influence on small business lending.

• Reduced bank capital and increased real estate

delinquencies at small banks were more associated

with business failures and bankruptcies than the

same deterioration at larger banks. 

• During periods of slow growth or of tight monetary policy, the effects of bank capital levels, loan

delinquencies, and SBA-guaranteed loans were both

much larger and more statistically significant than

during other periods. Thus, the effects of both

adverse changes and potential solutions were magnified during recessions.

Scope and Methodology

The study estimated how much and how differently

small businesses responded to banking sector difficulties and aggregate economic conditions over the

1991-2000 period. Annual data from a variety of

sources including banks' call reports, U.S. Bureau of

the Census data for business activities in firms of

different sizes, and reports on macroeconomic conditions from the Federal Reserve and the Bureau of

Economic Analysis were used in the statistical analysis. Most variables were adjusted for inflation and

population growth. In general, changes in various

measures of business activity relative to changes in

other variables were estimated. This specification has

the benefit of removing "fixed effects," which were

likely to differ considerably across states but not be

readily measured.

Ordinary least squares using annual data for each

state for each year from 1991 to 2000 were estimated. Data for some of the variables were not available

for the years before 1990 or after 2000, which precluded extending the sample period. Dependent variables in the models included employment, number of

firms, dollar payrolls, loans, gross state product

(GSP) growth rates, personal income and some of its

major components (wages and salaries and nonfarm

proprietors' incomes), SBA-guaranteed loans, business failures, and business bankruptcies. To the

extent possible, business activities were displayed by

firm size. The effects on employment, number of

firms, and payrolls were estimated both at the aggregate level and disaggregated into activities at firms

with either 1-19, 20-99, 100-499, or more than 499

employees. The effects on various categories of bank

loans (commercial, consumer, etc.) by bank size

were also estimated. Bank sizes were small, with less

than $1 billion in assets; medium-sized, with $1 to

$10 billion in assets; large, with $10 billion to $50

billion in assets; and megabanks, with more than $50

billion in assets. . 

Independent variables included bank capital, loan

delinquencies, SBA-guaranteed loans, and macroeconomic conditions. Bank capital measures for banks

of various sizes were used. Loan delinquencies were

separated by loan type (commercial and real estate)

and by bank size. To measure economic conditions,

the growth rates of gross state product, the federal

funds rate, and spreads of risky over safer short-term

and long-term interest rates were used.

Ordering Information

The full text of this report and summaries of other

studies performed under contract to the U.S. Small

Business Administration’s Office of Advocacy are

available on the Internet at www.sba.gov/advo/research.

Printed copies are available for purchase from:

National Technical Information Service

5285 Port Royal Road

Springfield, VA 22161

Tel. (800) 553-6847

TDD: (703) 487-4639

www.ntis.gov

Order number: PB2003-105490

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