Posted: February 12, 2010

By Michael Schwartz

michael.schwartz@insidebiz.com

A few months after sending down guidance to banks on how best to handle troubled commercial real estate loans, federal regulators last week advised financial institutions about meeting the credit needs of credit-worthy small businesses in light of reports that small businesses are having trouble obtaining the loans they need to operate.

Between June 30, 2008, and June 30, 2009, loans outstanding to small businesses declined by $14 billion nationwide, according to a joint statement released by the Federal Deposit Insurance Corporation, the Office of the Comptroller of the Currency, the Federal Reserve System, the Office of Thrift Supervision and the National Credit Union Administration.

They found that small business lending declined more than 4 percent at institutions with total assets greater than $100 billion. That same category of lending increased only slightly at institutions with less than $1 billion in assets.

The Federal Reserve found in a study that the percentage of banks that tightened their credit standards and terms for small businesses had reached a 20-year high.

In defense of lenders, the decline is partly attributed to a decrease in loan demand and higher levels of delinquencies caused by the recession. And indeed, some financial institutions were forced by regulators to reduce their business-lending levels to shore up their balance sheets.

But the regulators warn that some institutions "may at times react to a significant economic downturn by becoming overly cautious with respect to small business lending."

And they worry that inadvertently cutting off sound small business borrowers may further weaken the economy.

So as they did in their commercial real estate guidance, the regulators assured lenders that they would not be subject to extra regulatory scrutiny on sensible small business lending as long as a comprehensive review of the borrower's financial condition was performed.

"Examiners will not discourage prudent small business lending by financial institutions, nor will they criticize institutions for working in a prudent and constructive manner with small business borrowers."

The regulators suggested institutions should pay special attention to local market conditions that would affect the small business borrower so as not to base lending decisions on national market trends that may not necessarily correlate locally. Nor should they refuse credit to sound borrowers based solely on their particular industry or geographic location.

Lenders should also not analyze a small business borrower's ability to repay the loans only in the context of a downturn in the economy. They should also look at how a business plan would operate in a strong economy.nib