Here's What Happens to Small Businesses When Banks Stop Lending

When large corporations need to raise money to fuel their own growth, they can issue stock or bonds to procure the capital they need. Because small businesses generally don't have that option, they tend to be more reliant on loans to expand their services, product lines, and physical footprint.

But new data shows that banks have been hesitant to give out small business loans. And that's problematic on several fronts.

Lenders are holding back

In the wake of the recent banking crisis, it's not surprising that some banks are being more judicious with their lending practices. But data reveals that even before the banking industry started to melt down earlier this year, lenders were still being more conservative in the context of small business loans.

The Biz2Credit Small Business Lending Index released in February revealed that approval rates of small business loan requests at big banks had fallen for nine consecutive months. Larger banks approved only 14.2% of loan applications that February, down from 28.3% in February of 2020. And smaller banks approved just 20% of small business loan applications in February of 2023, compared to around 50% of applications in February 2020.

A problem for small businesses and communities alike

Lenders on a whole have been tightening their standards, and it's not just small businesses that are feeling the impact. Consumers in search of personal loans, for example, might struggle to borrow in the coming months due to stricter lending practices.

But when small businesses fail to get the funding they need, they can't grow. And if they can't grow, they can't create more jobs and hire new employees. That, in turn, has the potential to impact the broad economy.

On a more local level, though, if small businesses can't expand, it has the potential to hurt communities and limit the extent to which they can thrive. Small businesses commonly give back to their communities in many ways, and it's not just a matter of job creation. Rather, these businesses tend to support one another, sponsor local sports teams, and do other good things for the neighborhoods they serve. So all told, when banks stop lending, not only do small businesses suffer, but everyday people suffer.

Now a general tightening of credit is necessary to cool inflation, which has been a problem for the economy since the latter part of 2021. But if banks don't ease up and small businesses continue to struggle to get loans, it has the potential to cause a real economic slowdown in time.

Furthermore, there have been continued rumblings about the U.S. economy entering a recession during the latter part of 2023. Unfortunately, that might result in even tighter lending practices, forcing many small businesses into standstill mode until things take a turn for the better.

Some small business owners may have the option to get the funding they need by tapping their home equity. But for many small operations, that route isn't feasible or desirable. So right now, a lot of small businesses are, unfortunately, trapped in a holding pattern.