Small businesses continue to feel the credit crunch. As banks tighten their lending standards, it's harder for these companies to obtain financing. And as the recovery looks feebler and feebler, banks are becoming warier and warier about lending to small firms. Federal Reserve Chairman Ben Bernanke spoke on this problem today. Although he says the Fed will do what it can to ensure small businesses can get credit, how might he make good on that promise?

First, Bernanke explains the banks' perspective, via small businesses owners who he has heard from:

Business owners frequently noted that the declining value of real estate and other collateral securing their loans poses a particularly severe challenge. As one business owner at the Detroit meeting I attended put it, "If you thought housing had declined in value, take a look at what equipment is worth."

If you follow commercial real estate, then it's not surprising to see banks uncomfortable with those loans, but even other secured loans are looking risky these days. Consequently, Bernanke continues:

Business owners cited credit lines and working capital as their most critical financial needs, followed by refinancing products that would permit them to take advantage of low interest rates. Many reported having had to resort to borrowing through their personal credit cards or from their retirement accounts. Several mentioned the need for small-value loans in amounts less than $200,000 as well as the need for "patient capital" from investors willing to commit funds for 5 to 10 years without an expectation of immediate returns.

If Washington stays its current path, then this problem is likely to get worse before it gets better. As banks face more aggressive regulatory requirements, the amount of credit they provide will decline. The firms that will suffer most will be those on the margins, which mostly consist of small businesses. Community banks aren't as healthy as the big buys, and those large ones aren't as likely to care about small businesses.

So what can the Fed do? Now that all of its financial crisis-era programs have ended, Bernanke says:

We have heard the often-expressed concern that bank examiners have prevented banks from making good loans. We take this issue very seriously. The Federal Reserve has worked assiduously with the other banking regulators to develop interagency policy statements on this issue, aimed at both banks and examiners.

That likely won't be enough, however. Urgings from the Fed alone can't help alleviate the regulatory measures and pressures, like looming higher capital requirements, likely to prevent banks from making more loans. If the Fed really considers small business credit a major problem, it should renew and broaden a program to purchase small business loans from banks.

But just how big a problem is small business lending? Here's a chart showing credit conditions, according to the National Federation of Small Businesses' most recent report (.pdf):

NFIB credit 2010-06 cht1.PNG

Credit availability isn't great, but it does appear to be recovering a bit from its 2009 levels. In fact, another part of the report says that "Financing and Interest Rates" are the most important problem for just 3% of small businesses, putting eight other concerns ahead of it, including inflation -- which is virtually nonexistant.

So maybe the Fed isn't as worried about small business lending as Bernanke's speech indicates. If it is really concerned about credit availability for these firms, it has weapons in its arsenal that it can use to help. But just urging bank regulators to chill out won't do the trick.

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