On March 2, the Cambridge Winter Center’s Executive Director, Raj Date, testified before the Senate Banking Committee’s Economic Policy Subcommittee regarding proposals to stimulate small business credit. 

Cambridge Winter’s testimony suggests that the small business credit marketplace is reaching a transition point:  the point at which credit contraction becomes less driven by a rational decline in the demand for small business credit; and the point at which credit becomes constrained by a structural shortfall of supply.

The crisis has triggered a simultaneous and dramatic reduction in the availability of important nationally marketed lending products (high-line credit cards, cash-out home equity loans), as well as in the credit capacity of large national finance companies (like GE Capital, or CIT).  As a result, small business lending is, by default, reverting back to regional and community banks.  But, by and large, banks’ capital positions will not be sufficient to accommodate incremental demand. 

In that light, proposals to stimulate regional and community banks’ small business lending do seem logical.  To evaluate such proposals, including the Administration’s proposal for a Small Business Lending Fund, the testimony suggests three principles:  (1) recognize the limits of direct government credit-decisioning; (2) do not disproportionately reward poor performers; and (3) create an explicit link to desired behavior.