Small business loans are getting more expensive and harder to get

Banks rejected more than 8 in 10 business loan applications in May.

Small business loan approval percentages at major banks fell from 13.5% in April to 13.4% in May, according to the latest Biz2Credit Small Business Lending Index™. Meanwhile, small bank approval rates remained at 18.7%. Essentially, bank lending to businesses has come to a standstill.

Banks struggle to get new deposits, and when they do, they have to pay higher interest rates to get deposits. The banks are hit on both sides of the equation, so they don’t lend. They began tightening credit parameters last year, and when the collapses of Silicon Valley Bank, Signature Bank, and First Republic Bank earlier this year raised concerns about industry-wide liquidity. Small and medium-sized banks are losing deposits to large banks in the aftermath of many bank failures.

Related: The collapse of the SVB can also cause big problems for small businesses

A recent study by the Federal Reserve reported that lending policies for commercial and industrial (C&I) loans to large, medium and small businesses were tightened in the first quarter of 2023. Meanwhile, banks reported weaker demand for all types of commercial real estate (CRE) loans, according to the opinion poll of the Fed’s senior loan officers (SLOOS) on bank lending practices.

Why have the banks become stingier?

According to the Fed, they cited uncertain economic prospects, reduced risk tolerance, deterioration in collateral values ​​and concerns about banks’ funding costs and liquidity positions. The banks also reported concerns about funding costs, liquidity positions and deposit outflows as reasons for tightening credit standards for the remainder of 2023.

In addition, the Fed’s Small Business Employer Survey, released in May, found that small businesses reported needing credit to expand, cover operating expenses, make repairs or replace assets, and refinance or pay off debt. Employer companies typically secure funding through major banks, small banks, online lenders, the Fed survey said.

Meanwhile, as the central bank’s Federal Open Market Committee (FOMC) has often raised interest rates, banks must pay depositors more to avoid moving money into higher-yielding investments, such as government bonds. As this happens, banks worry about declining asset values ​​and deteriorating credit quality. So they have a reduced tolerance for risk, which has limited their ability to make new loans.

Acceptance rates at nontraditional lenders increased slightly in May, the Biz2Credit Small Business Loan Index released on June 6, 2023. Institutional investor approval rates rose from 26.7% in April to 26.9% last month, while alternative lenders improved from 28.7% in April to 28.9% in May. Credit unions stagnated at 18.9%. Approval rates at these non-bank lenders are about half what they were in February 2020, just before the pandemic hit.

At present, SBA loans are the best choice of banks. However, rates for 7(a) loans are currently around 12% and take up to two months to process. Businesses in need of quick cash are searching online and turning to alternative lenders, offering capital at even higher interest rates than the banks. Borrowers pay for the speed of the transaction and the increased risk the lenders take in turbulent times.

With high employment, rising oil prices and continued inflation, there is a good chance that the Fed will raise rates again by 25 basis points in June or perhaps wait until July. While the timing is an issue, it is almost certain that we can expect the cost of capital to rise for small business borrowers as the Federal Reserve continues its efforts to curb inflation. With full employment, high labor costs and rising oil prices, the Fed is unlikely to shy away from rate hikes anytime soon.

In short, it’s a tough time for companies looking for capital right now, and it may take some time for this credit crunch to improve.