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Friday, January 18, 2013

Economic Factors Affecting Small Business Lending and Loan Guarantees

N. Eric Weiss
Specialist in Financial Economics

Small businesses (usually defined as companies with 500 or fewer employees) are an important part of the nation’s economy. At various times during the business cycle, concern is voiced about the difficulties that small businesses have obtaining loans. There can be many reasons for periodic declines in small business lending over the business cycle: loan standards change, the quality of projects to be financed changes, and small businesses’ demand for loans fluctuates with anticipated customer demand.

Congress created the Small Business Administration (SBA) to assist small businesses in many ways, including by guaranteeing loans made by the private sector. This guarantee reduces a lender’s potential loss on a small business loan and should make lenders look more favorably on small business loan requests. Nevertheless, there are several reasons why the volume of small business loans varies over time despite the availability of the SBA’s guarantee.

The business cycle’s impact on the volume of SBA guarantees is not clear. When the economy is growing, demand for SBA loan guarantees can increase as small business expands to take advantage of opportunities or small businesses might reduce their demand because they can obtain loans without the SBA’s guarantee. In an expanding ecomomy, lenders are more willing to make loans on more favorable terms.

In slowdowns, concern over potential losses leads lenders to tighten all loan standards, perhaps affecting small businesses disproportionately. The demand for SBA loan guarantees can increase as small businesses are unable to obtain loans without the government’s backing or interest in SBA loan guarantees can fall because there are fewer reasons to borrow. Even with an SBA guarantee, small business owners frequently pledge their personal residences as collateral for business loans. During the 2007-2009 recession, the widespread decline in home prices reduced owners’ abilities to provide such credit enhancement. The ultimate impact of these factors on SBA loan volume, which work in opposite directions, cannot, however, be predicted with confidence.

This report analyzes reasons used to justify government intervention in small business lending and discusses how making the proper analysis of problems improves the policy outcome. For program information on SBA loan guarantees, see CRS Report R41146, Small Business Administration 7(a) Loan Guaranty Program, by Robert Jay Dilger and CRS Report R41184, Small Business Administration 504/CDC Loan Guaranty Program, by Robert Jay Dilger. This report also identifies some sources of information about the condition of the small business loan market.

Date of Report: January 8, 2013
Number of Pages: 11
Order Number: RL34400
Price: $29.95

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