Elizabeth A Duke: Small business credit - next steps
Speech by Ms Elizabeth A Duke, Member of the Board of Governors of the Federal Reserve,
at the Federal Reserve Meeting Series: "Addressing the Financing Needs of Small Businesses",
Washington DC, 12 July 2010.
* * *
Good afternoon. I want to thank all of you for participating in today's discussion about the
financing needs of small businesses. I particularly want to thank Karen Mills, the Small
Business Administration (SBA) Administrator, for her remarks and our distinguished panelists
for helping us to better understand the dynamics of small business lending in these difficult
economic times. I would also like to thank everyone who participated in the more than
40 regional meetings that led up to today's conference and to thank the Reserve Banks for
their sponsorship and organization of those meetings. They brought together small
businesses, lenders, technical assistance providers, bank examiners and others involved in
small business credit to help identify barriers to small business credit access and to suggest
potential solutions.
As many of you know, I came to the Federal Reserve after many years as a community
banker. Quite a number of those years were spent lending to the small businesses that were
the backbone of my local economy. That experience gives me a deep appreciation for the
importance of credit to economic growth and the particular importance of small business
lending to job creation in local communities. So, as you might imagine, the recent decline in
availability of credit to small businesses concerns me. It also concerns my colleagues across
the Federal Reserve System.
When the mortgage crisis first broke a few years ago, we were able to build a body of data
and an understanding of relevant issues through a series of meetings convened by the
Federal Reserve Banks across the country on topics such as foreclosure or neighborhood
stabilization. As we started hearing more about problems encountered by small businesses
in accessing credit, we again tapped the broad footprint of the Reserve Bank system and the
web of local contacts they have developed to help us better understand the issues
surrounding loans to small business. I attended one of the regional meetings in June and
was pleased to see firsthand the quality of the conversation that took place. Today we have
seen evidence that the conversations were equally rich across the country. The information
gathered through this kind of outreach is invaluable as we consider our policy options, and I
hope that you have found it similarly helpful.
Today's agenda was organized around the common issues identified in those regional
meetings. We looked at small business credit issues from the perspective of the private,
public, and nonprofit sectors. We also looked at the implications of data and information gaps
on our understanding of the dynamics of small business lending. And, perhaps most
important, we identified some promising next steps to ensure that creditworthy small
businesses have the access to capital that they need.
Today's meeting has been referred to as a capstone because it summarized the information
we gathered. But our conversation today makes it clear that this is just the beginning. There
is no single step that can be taken to cure what is ailing the small business lending market.
As we have heard, the causes for credit tightening are many and complex. Equally numerous
are the challenges facing small businesses and limiting their demand for credit. These issues
have evolved over time, and it only makes sense that implementing solutions will be equally
difficult and will take time. This has been a full day and I want to commend you for your
stamina, your insights, and your commitment to helping us identify those next steps that all of
us - public policymakers, small business lenders, nonprofits, and small business owners -
can take to facilitate small businesses' access to credit. I hope we can also count on you to
continue the effort, for it will take all of us working together to fully restore a healthy credit
environment for the small businesses that are so important to our economy.
As we think about taking the next steps, I would like to especially note the success of the
Federal Reserve's small business meeting series in fostering collaboration among numerous
federal agencies, including the other financial regulatory agencies, the Treasury's
Community Development Financial Institution (CDFI) Fund, and the Small Business
Administration. Collaboration will continue to be the key to crafting solutions to small
business financing issues, both in Washington and in the field. Today we identified several
areas where we can work together to improve the lending conditions for small businesses.
Before we adjourn, let me briefly review what we heard today.
Private sector solutions
We consistently heard about the impact of credit tightening and banks' ability and willingness
to lend to small businesses. If we assume, as I do, that bankers are predisposed to lending,
because without lending there can be no profit, then it is important to understand what stands
in the way of lending to small businesses. Some banks are limited in their ability to lend due
to weaknesses in their balance sheet, such as low capital or liquidity. Others might have the
balance sheet capacity to lend but are restricted in some loan categories due to problems or
concentrations in their own loan portfolios. Because small business lending relationships are
built through repeated interactions over time, customers of weakened institutions may find
their available credit under existing relationships reduced and have trouble replicating those
relationships with a new bank. In addition, a number of small businesses are feeling the
effects of tightened credit because the value of their collateral has dropped. Businesses that
have maintained strong cash flows through the recession are particularly concerned about
the potential for devalued collateral to reduce their credit access and, in some cases, to
create an additional strain on balance sheets as cash and other assets are required to shore
up collateral positions that no longer meet underwriting standards. In addition, small
businesses and banks alike attribute a significant portion of the tightened credit environment
to regulatory uncertainty and, in particular, to concern about the classification of assets by
bank examiners.
I do not believe it is appropriate or even possible for regulators to urge banks to make loans
that are outside their risk tolerance or that would be unsafe or unsound. But we can and
should be sure that supervisory policies do not impede the flow of credit to all eligible
borrowers. That's why the Federal Reserve and other regulatory agencies have worked so
hard during the past few years to ensure that while banks appropriately recognize loan
problems they also can continue to make loans that are safe and sound.
The financial regulators have issued guidance to provide clarity and consistency regarding
the supervisory treatment of new loans, problem loans, and different loan workout
approaches because we understand how important regulatory certainty is to bankers, who
must make decisions about whether and to whom they should lend. The interagency
guidance stressed the importance of continuing to make prudent loans to creditworthy
customers;1 clarified standards for commercial real estate (CRE) loans and workouts;2 and,
most recently, restated supervisory views on lending to small businesses.3
At the Federal Reserve, we have complemented the guidance with training programs for
examiners and outreach to the banking industry that underscores the importance of sound
lending practices. In January, Federal Reserve staff instituted a Systemwide examiner
training initiative that is reaching Federal Reserve and state examiners all across the United
States. In addition, in May more than 1,400 bankers and state bank commissioners from
across the country participated in an "Ask the Fed" conference call to discuss CRE-related
issues, such as credit workouts and troubled debt restructurings. The session was an
effective way to help clarify the guidance and allowed us to hear more about concerns of
people in the industry.
But we are not finished. The Federal Reserve is also working to develop better ways to
measure the effectiveness of the lending guidance we have issued. After all, if these sorts of
issuances don't work, we need to know that so we can figure out a better way to get our
messages across. For example, before issuing the CRE guidance last year, Federal Reserve
staff surveyed examiners to gain a better understanding of the banks' workout practices.
That information is serving as a baseline for assessing the impact of the supervisory
guidance. We are asking examiners to capture, where possible, information on troubled debt
restructurings and other types of loan workouts and dispositions as part of the ongoing
examination process. We are also exploring the feasibility of more-formal statistical
approaches for measuring and evaluating the effectiveness of the CRE workout and
restructuring policy statement.
An encouraging sign of banks' responsiveness to borrowers' concerns was the discussion in
several meetings about the importance of second look programs. Some lenders have robust
second look programs to ensure that applications for small business credit receive
appropriate consideration. These programs are particularly helpful at a time when traditional
underwriting standards, such as reviewing three years' worth of financial statements, may not
be as reliable an indicator as they were before the recession. Similarly, in the meeting I
attended in Tampa, there was a lively give and take between borrowers and lenders about
permitting borrowers to talk directly to underwriters so borrowers can understand the
reasoning behind credit decisions and perhaps offer additional information or explanation.
Public and nonprofit sector solutions
Part of the ongoing debate about whether we have a supply or demand problem with small
business lending is based on the fact that bankers and small business owners have different
ideas about what a creditworthy small business looks like. We heard a lot of discussion from
bankers and small business owners about the need for technical assistance to help
businesses understand and prepare the documentation necessary to obtain credit. Business
owners might require technical assistance to help them repair their credit, rethink their cash
flow structures, develop business plans, or just present their information in a more organized
way. In addition, many technical assistance providers, such as small business development
centers, can help businesses tap into non-bank sources of credit or better utilize available
trade credit. We found that many banks and small businesses were unaware of the
assistance that nonprofit technical assistance providers could offer in such cases. The
demand for technical assistance is most acute among start-up businesses, but it continues to
be important for businesses that are trying to grow.
Small businesses voiced their concern over the dearth of products suited to their specific
credit needs, particularly small-dollar loans. We heard that many financial institutions have
reduced or curtailed small-dollar loans altogether because of the time and resources required
to make them. CDFIs and some community banks and credit unions are uniquely situated to
provide small-dollar loans and other products tailored to small business customers, but
funding, capacity, and certain regulatory constraints have hindered their ability to fully meet
the demand for these loans. Several ideas to help CDFIs, community banks, and credit
unions meet the increased demand for small business loans were discussed today, and we
are committed to following up on them.
CDFIs are especially useful to small businesses for loans that many traditional creditors view
as too risky or too small to be profitable. Moreover, CDFIs complement their lending products
with training and technical assistance for their customers, either directly or through
partnerships with nonprofit organizations. This combination enhances a borrower's capacity
and mitigates the risks of default. Successful borrowers often graduate to conventional
financing as their needs grow, freeing up resources to help new businesses.
Much of our outreach at the Federal Reserve has focused on the particular needs of minority
small businesses. While all small businesses are vulnerable to economic downturns, this
recession has hit minority small businesses particularly hard. At our meetings, we heard a
number of comments citing a comparative lack of capitalization, weaker collateral values,
and lower credit scores for many minority small businesses, which leave these firms with less
ability to absorb economic shocks. For example, in Los Angeles, we heard that the decline in
residential property values has had a significantly adverse impact on businesses owned by
Asian Pacific Islanders who relied heavily on home equity for financing. We heard about the
same issue with respect to many African American- and Hispanic-owned businesses around
the country. In other cases where efforts such as government procurement programs were
instituted to help minority small businesses, we heard that the inability to secure credit to
fulfill contracts makes these programs out of reach for many potential participants. It is also
clear that minority-owned businesses would benefit from improved access to technical
assistance and resources such as training in financial management, mentoring, and
assistance with loan documentation that may not be in a business owner's native language.
But there are also hopeful examples of successful collaboration to address these issues.
While in Minneapolis, I toured the Midtown Global Market, a multicultural marketplace that
serves as an inspirational reminder of what can be accomplished when public and private
resources combine to support minority businesses.
Research and data improvements
Finally, we spent some time today discussing the need for better data and analysis to
monitor and understand small business credit flows. As a research institution, the Federal
Reserve is always looking for opportunities to improve data, and we already have taken a
number of steps in this direction. First, while banks do not report loans to small businesses
separately, they do report information on business loans less than $1 million and farm loans
less than $500,000. The history of this data can be used as a proxy for small business
lending. So in order to monitor lending to small business more closely, beginning with the
first quarter of 2010, we have increased the frequency of this Call Report requirement from
an annual to a quarterly basis. Second, researchers from around the Federal Reserve
System will gather at the Federal Reserve Bank of Minneapolis later this summer to compare
notes on the research currently being conducted in the area of small business financing,
identify any gaps, and develop ideas for future areas of inquiry. In addition, the Federal
Reserve Banks of Atlanta and Dallas have partnered with the Ewing Marion Kauffman
Foundation to co-host a research conference, Small Business, Entrepreneurship, and
Economic Recovery: A Focus on Job Creation and Economic
Stabilization, which will take
place October 26 and 27 in Atlanta. Through paper presentations and policy roundtables, the
conference will help us gain a better understanding of the implications of various existing,
new, and proposed policies related to small business and entrepreneurship, including new
and expanded SBA and CDFI programs. Lastly, it is important to note that this meeting today
and the regional meetings that led to it have introduced us to potential partners for furthering
our research efforts in this area, and we look forward to expanding our horizons in this
respect.
Conclusion
I wish I could conclude this wrap-up with a list of the three or four things we could do to
immediately unlock small business lending. But the problems are numerous and complex
and they will require creativity and persistence to solve. Just because the solutions are hard
to find does not mean that we shouldn't keep trying. Finding solutions to small business
financing issues is not only an important component of the economic recovery, it is also
important to the restoration of communities that have been hard-hit by foreclosures and job
losses. What we have accomplished is a good beginning. We have identified some specific
credit gaps and generated some ideas to tackle them. We have brought together a network
of people with different perspectives and resources but a shared commitment to improving
credit conditions. And we have sparked numerous research projects to further understanding
of the current and ongoing credit needs of small businesses. If we continue to work together,
I am sure that we can alleviate some of the problems that small businesses face. The more
we do now, the better prepared our small businesses and lending institutions will be when
economic growth and consumer demand pick up. Thank you, again, for your participation
today.