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When banks pull back sharply, it can have serious consequences for small and midsize businesses.
Banks in multiple countries are tightening their lending standards, making it harder for companies to qualify for loans and lines of credit. Some market observers say we could even be facing a credit crunch, a sharp and sudden contraction in lending. If that is occurring, it could make staying in business more challenging — especially for smaller businesses.
A year ago, 77% of surveyed small business owners said they felt confident about their access to credit, according to a recent Goldman Sachs report. Today, 77% say they’re concerned about getting funding when they need it.
And that makes sense. After all, credit is one of the most important “fuel sources” for companies, allowing them to meet payroll and restock inventory when they’re running low on cash. Loans also fund major initiatives such as investment in new equipment, larger facilities and product development. Lock down credit, and all of that grinds to a halt.
A credit crunch can affect consumers, too, making it harder for them to purchase homes and vehicles, further limiting economic growth. The retail sector, for example, is also showing signs of less consumer spending.
The good news is that, while a credit crunch is a significant obstacle, there are ways that businesses can adapt to this challenge and continue to thrive.
A credit crunch occurs when banks and other lenders quickly raise their standards for loan requests, often by requiring more collateral or higher credit scores. The institutions do this because they’re worried about the larger economic environment and want to protect themselves.
Specifically, in our current circumstances, lenders know that high inflation continues to be a problem. Inflation began soaring partly because central banks printed massive sums of new money to prevent a depression during the global pandemic.
Underlying conditions have changed, but that excess cash is still in the market, which helps sustain high inflation. To remove some of the excess and restore a sense of equilibrium, policymakers have raised benchmark interest rates and stopped buying government bonds.
The result is a reduction in liquidity in the larger economy. It’s harder to borrow money, which has a braking effect on growth. Businesses can’t invest; consumers can’t buy. At scale, it could signal a sharp slowdown, with declining revenue, higher unemployment and other setbacks.
Smaller companies, which tend to depend on floating-rate loans more than larger businesses do, will feel the consequences first. Bigger businesses are more insulated because they usually have more cash and access to capital markets at fixed rates.
Many larger companies saw a recession on the horizon months ago, which is why they conducted layoffs and otherwise pulled back. The impact on unemployment has been somewhat masked by hiring from small and midsize firms, which quickly picked up those unemployed, but there are cracks in small business hiring and employment as small business layoffs had a large uptick this spring.
Lenders look at all this and predict a storm is coming on top of the 100% increase in the cost of debt for floating-rate loans. That’s why they’re conserving their resources and curtailing risk where possible.
Several regions are experiencing tighter credit, though at different levels. A recent series of highly publicized bank failures may have had an impact on lenders pulling back, but in the US at least, banks had been raising their standards in the months before those failures.
Even though standards are tightening, some observers — including Citibank and Swiss Re — have expressed skepticism that a sharp credit crunch will occur. Credit hasn’t pulled back enough to justify that classification.
A credit crunch doesn’t mean that no loans are being made. It’s just that lending may only be available to larger borrowers with excellent credit because financial institutions are trying to avoid risk as much as possible — what’s called a flight to quality.
Of course, large companies aren’t limited to banks for funding. As The Wall Street Journal notes, larger businesses also have the option of raising money by selling bonds.
Generally speaking, small businesses can’t do that. They are much more likely to depend on banks. Unfortunately, the interest rate on a typical SBA-backed loan — which is one of the more affordable bank loans — is now in the double digits.
There is one silver lining to tighter credit in the current economy. Central bankers are trying to fight inflation by cooling economic growth, and tougher lending standards can help with that goal. Swiss Re says that credit tightening could be equivalent to a rate hike of 25 to 100 basis points.
Historically, a typical credit crunch lasts about 2.5 years, according to the International Money Fund, which investigated credit crises in 21 countries between 1960 and 2007. Credit usually declines by 20%.
Though credit crunches are associated with recessions, they tend to last slightly longer than recessions, which were usually about two years long, the IMF found in its 2008 study. This is because lending is backward-looking, so it takes a few quarters for the contraction to work its way through the system and then companies’ financial statements.
Therefore, tighter standards are likely to be in place for the next couple of years. According to the Fed’s survey, most US senior loan officers said they plan to tighten standards for all loan products for the rest of 2023.
Keep enough cash on hand to pay for the essentials of your business, such as payroll, inventory and other core operational expenses. This is important, especially if your lender won’t be able to provide working capital when you need it.
Keep a close eye on your key metrics, and make sure you have a clear view of how much cash you have coming in, where it’s going and whether you have enough.
Sharpening your invoice management can help, too. It’s hard for accounts to become delinquent if you’re monitoring them and actively communicating with your clients.
Another way to boost cash is by offering a discount for early payment on your accounts receivable. This is an area where C2FO can help. Our platform lets suppliers offer a relatively small discount to their enterprise customers in exchange for being paid weeks or months ahead of schedule.
The best part about C2FO’s system? It removes risk from the equation. You’re not subject to an extensive credit check, and the discount you pay is controlled by you. You’re basically negotiating for faster payment of money you’ve already earned and that your clients — in the vast majority of cases — already have on hand.
If none of your customers are using C2FO’s platform, we also offer lending options that can be secured by your outstanding invoices.
Review your spending to identify costs that can be either delayed or cut entirely.
For example, you might drop your current video conferencing software and replace it with the app that’s already bundled with your other productivity software. You may have to delay your plan to grow into a new market.
Your review should also identify areas where spending more would ultimately generate more revenue or greater savings.
That could include increasing your inventory order to claim a bulk discount, stocking up on materials before costs increase, investing in a targeted marketing campaign or purchasing analytics software that reveals your best opportunities for business growth.
A good rule of thumb is to avoid cuts that directly impact your ability to generate revenue (like firing most of your sales team) unless they are absolutely unavoidable.
It’s getting tougher to qualify for a loan, but it’s not impossible. You may be able to win approval by presenting a better case to your lender. That could mean checking your credit history for errors, which could be unfairly hurting your credit score, or developing a “downside plan” that shows the lender how you would pay your loan if business conditions deteriorate.
Even if a full credit crunch doesn’t emerge, stricter lending standards could complicate life for many businesses in the coming months.
Companies should adapt by building up their cash on hand, potentially through the use of dynamic discounting; rethinking spending; and working with their lender to make the best possible case for a loan.
If your business needs help accessing cash when necessary, C2FO offers a suite of working capital solutions for businesses of all sizes. Learn more here.
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