Evaluating the Small Business Lending Fund

On May 19, the House Financial Services Committee agreed to a $30 billion program called the Small Business Lending Fund (“SBLF”), which closely follows a proposal made by the Obama Administration in February.  Although the proposed bill is intended to help solve what will become a very real problem in the supply of small business credit, its design is likely to fail for the same principal reasons as the Bush Administration’s original TARP Capital Purchase Program.

This presentation, which builds on analysis presented during Cambridge Winter’s testimony before the Senate Banking Committee in March, explains the SBLF’s key structural problems.

Small business credit will become supply-constrained in 2010 and 2011.  To this point, declining small business loan volumes have been mostly driven by a natural reduction in loan demand by credit-worthy small businesses, given the severity of the financial crisis and ensuing recession.  As the real economy continues to recover, small business credit demand will recover as well, but the supply of such credit will continue to be impaired.  Capital market-funded finance companies are retrenching; high-line consumer products appear uneconomic; small and mid-sized banks remain pressured by commercial real estate credit.

The 2008 bank bailout did little to enable small business lending.  For better or worse, the major financial rescue programs (e.g. the CPP, TALF, and TLGP) were focused, in effect, on supporting capital and liquidity at the largest banks and shadow banks.  They were not especially suited to aiding the small banks that focus disproportionately on small business credit.

Unfortunately, the SBLF will mostly support legacy assets, not new lending.  To its credit, the SBLF creates incentives for small banks to accept capital infusions, and to use that capital to extend prudent small business loans.  But as the program is structured in the House bill, most small banks would likely gravitate towards increasing small business lending by only 10%, which would mean that more than 80% of the taxpayer-supplied capital under SBLF would support existing asset portfolios, rather than new small business credit.