As Fed examines banking woes, small businesses already feel the crunch

Janna Rodriguez has big goals for her home-based child-care center. She wants to grow Innovative Daycare to serve more low-income families in Freeport, N.Y., but first, she needs a bank to loan her between $2 million and $4 million to help her move into a larger space and expand her hours.

So far, she keeps hearing “no.” Midsize banks near her in Long Island don’t want to take bets on the child-care industry, which has been hit hard by the pandemic, Rodriguez said. She’s felt lenders pull back even more since the March shock to the banking system. If she can’t expand, she’ll have to consider shutting the business down because otherwise, she just can’t see getting by.

“It was a concern in 2020, but now it’s even more of a concern,” Rodriguez said. “What does that do for us in the field?”

All over the country, small-business owners like Rodriguez are feeling the early consequences of this spring’s banking crisis, which spanned two chaotic weeks in March and is still ricocheting through the economy. Two midsize banks failed that month—Silicon Valley Bank, based in California, and Signature Bank, in New York. A third bank, California-based First Republic, was taken over by regulators and sold early Monday morning to JPMorgan Chase after a chaotic weekend scramble. Officials and experts expect the chaos to slow the economy, as other banks grow more cautious and get pickier with loans, leaving businesses with less ability to grow and invest.

But policymakers from the Federal Reserve who set interest rates don’t yet know how much the banking tumult will affect the broader economy. They’re set to discuss the potential fallout when they convene on Tuesday and Wednesday and prepare to raise rates yet again. Analysts expect the Fed to announce another 0.25-percentage-point step-up this week.

Already, businesses are having a tougher time borrowing money.

A Fed survey released April 19 said more businesses were contending with tighter lending standards and growing uncertainty about liquidity. Those fears weren’t overwhelming, and loan demand also fell for all kinds of consumer and business lending. But the report known as the “beige book,” which collects anecdotes from the Federal Reserve system’s 12 districts, showed fears bubbling up.

In Boston, several respondents predicted that lending to the commercial real estate sector would pull back, and one worried the credit contraction could be large enough to spill over to other parts of the economy. In Cleveland, an auto dealer cautioned that higher credit standards had already become an issue for potential buyers, on top of rising rates, high prices for new cars and supply chain issues.

For the Fed, that complicates the economic picture as officials try to decide if they’ve done enough to slow inflation—or done too much, bringing on a recession. At this week’s meeting, Fed officials will also look at additional data on bank lending and demand for loans before the closely watched central bank survey is published next week.

“It’s a really fast-moving situation,” said Derek Tang, an economist at research firm LH Meyer/Monetary Policy Analytics. “How does this translate into the broader economy though? That is the biggest question.”

If the Fed board does raise rates by another quarter of a percentage point, the central bank’s baseline rate would sit between 5 and 5.25 percent. Analysts think they might then pause on rate hikes and let the 10 increases they will have made since March 2022 sink in.

As with the Fed’s last meeting, which came days after SVB and Signature crashed, the banking troubles will loom over this week’s rate decision. Chair Jerome H. Powell will need to figure out—and then explain to the public—how much the sudden caution in the financial sector will aid the fight against inflation. If banks get more reluctant to loan money, that will curb demand in a way that mimics an interest rate hike.

“It is too soon to determine the extent of these effects and therefore too soon to tell how monetary policy should respond,” Powell said at that March meeting.

Other economic hazards are also in the background. House Republicans last week approved a bill that would raise the debt ceiling but only while also slashing federal spending. That move defied congressional Democrats and the White House and inched the United States closer to financial disaster if the parties can’t agree on how to proceed. On Monday, the Treasury Department warned that the United States could default as early as June 1 if the limit isn’t raised by then.

Inflation, too, is still far too high, and the economy slowed much more than expected in the first quarter, renewing fears of a recession. At the Fed’s last policy meeting, the central bank’s economists also warned of a “mild” recession later this year.

Only time will tell how much the banking issues will hamper the economy. But a recent survey of banking conditions from the Dallas Fed was bleak. Results collected between March 21-29, just after the SVB meltdown, pointed to “waning consumer confidence from recent financial instability as a concern.”

“Credit standards and terms continued tightened sharply, and marked increases in loan pricing were noted,” the survey results read. “Banking outlooks continued to deteriorate, with contacts expecting a contraction in loan demand and business activity and an increase in nonperforming loans over the next six months.”

Stephen Martin feels some of that sense of gloom.

When he started ACESA Cleaning Services in December 2019, he was told that banks rarely lent out to new companies, and to come back after the first few years. But that timeline keeps getting longer, and lately, banks are turning him down for not having an established line of credit or enough sources of income.

A loan of $20,000 to $50,000 would help him buy new equipment and build a cushion for leaner months. He’s got about 20 employees and is afraid to grow his business in Duluth, Ga., in such an uncertain environment. But he knows that without a loan, the current situation isn’t tenable for much longer either.

“It’s not an environment meant for small businesses to survive,” Martin said.

For John Marcella, the failures of SVB and Signature were alarming in other ways. When depositors with those banks panicked, they took their anxiety online. In SVB’s case, the social media frenzy turbocharged the run to the point where $100 billion in withdrawals were headed out the door the day the bank collapsed.

Marcella feels confident that his maintenance business, Apex One-51, is on good footing, and that his $2 million line of credit with a midsize bank is safe. But he worries that some fresh wave of panic could spill over and contaminate his otherwise-stable situation.

“Humans are composed of a bunch of different emotions,” Marcella said. “It’s based on the way they feel, so they react to that. It creates a story in their head. And then that spreads.”

Even business owners who aren’t having trouble getting loans are realizing that the environment has changed.

Alex Cates co-founded Orion Managed Services, an environmental health and safety consulting firm, in November 2020. The company was issued a $2 million line of credit that renews every Dec. 31. The timing was lucky: Cates’s banker said that if Orion had needed to reestablish its line of credit in March or April, the answer would have been no, even with Cates’s years of experience in the industry. The company just would have been seen as too new and too small.

“I thought, holy cow—it’s not anything personal, it’s just a risk modeling effect,” Cates said, “where they have to make sure their portfolios are solvent and present the least risk possible.”