As the dust starts to settle following the collapse of Silicon Valley Bank and Signature Bank in March, economists are warning of cracks in the system that started spreading even before the failures. Under conditions of banking turmoil, some are worried credit tightening will become a credit crunch crisis.
No. 1: What is a credit crunch? And why does it matter?
A credit crunch is a decline in lending activity driven by a shortage of funds. Access to capital fuels growth in the U.S. economy and a credit crunch significantly slows expansion.
Loan activity has been trending down due to the central bank’s aggressive actions to tame inflation. Over the last 12 months, the Fed raised its benchmark interest rate from near 0% to nearly 5%.
No. 2: Bank credit is the ‘lifeblood’ of small businesses, which employ most Americans
Banks were already reporting tighter credit conditions even before the banking turmoil that began in March. But smaller banks are now getting hit twice as hard as customers move deposits away from regional institutions, which could put some small businesses in further peril.
Small and medium-sized businesses are disproportionately impacted by this. According to UBS research, smaller and regional banks hold 40% of these companies’ loans and debt. Pantheon Macroeconomics’ research shows that small and medium-sized companies employ 58% of private workforce in the U.S.
No. 3: Small businesses were already feeling the crunch, with bankruptcy filings on the rise pre-banking crisis
This year, research shows private companies are filing for bankruptcy at rates that exceed what was seen at the height of the pandemic. According to UBS, a lot of bankruptcies are at smaller firms for now, so the impact on assets and employees is not as egregious as the sheer number of filings.
The banking crisis is just injecting more uncertainty into an economy that was already tightening credit. The latest Fed survey found roughly 44% of banks reported tightening standards for business loans in the first quarter of 2023. With the exception of the COVID-19 pandemic, it’s the highest share to say that since 2009 in the wake of the Great Recession.
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