Why are Banks Waging War on Small Business?
How Old Banks with New Rules are Killing our Job Creation Engine
Joe J. Wallace, Managing Director
Hadannah Business Solutions
Small and medium sized businesses have long relied on banks as a source of working capital that they have used to fuel the prosperity that has had a profound positive impact on the economy of the free world. The United States, as the de-facto leader of the free world, has been the locale of choice for visionaries and entrepreneurs to pursue their ambitions. The worlds best and brightest have enriched our nation with their energy and intellect and we are all better off for it. The personal relationships between banks and small enterprise have played a large role in our country’s attractiveness as a place for entrepreneurs to prosper and live.
These loans have typically been revolving credit lines that are renewable at defined times and have carried competitive interest rate charges that are a couple of percentage points higher than a traditional mortgage. Unfortunately, the partnership of prosperity that banks have forged with small business has been severely diminished by the events of recent years including, falling real estate prices, government bail-outs, and the new rules that have either been forced on banks or that big banks have exploited to increase their short term profits.
Importance of Small Business: The Kauffman Foundation in a recent publication titled “Where Will the Jobs Come From”, presents data supporting the fact that small business employs just over half of the entire American workforce. The study also concludes that excluding start-ups, in 2007 over two-thirds of all employment growth came from businesses that are less than five years old. It is safe to say that small businesses founded by entrepreneurs, as opposed to large companies or government are really the only mechanism through which the needed jobs will be added to our economy in a sustainable way. The last section of the Kauffman paper is simply titled “Entrepreneurs = Recovery”. It seems as though our very survival as a nation depends on stimulating and nurturing the entrepreneurial atmosphere that has lead us to become the de-facto leader of the free world.
A question worth asking in consideration of the importance of entrepreneurship and small business is, “Why are our financial institutions acting as though they have declared war on small business”? The following is a fairly detailed description of a classic military strategy to weaken and subjugate an enemy that bears much resemblance to what big banks are doing to small business today.
Scorched earth policy: A scorched earth policy is a military strategy which involves destroying anything that might be useful to the enemy while advancing through or withdrawing from an area. At one time this was simply the practice of burning crops to deny the enemy food sources, in modern times the term is not limited to food. It includes the destruction of infrastructure such as shelter, transportation, communications, and of course access to financing. Here are some recent headlines in business publications:
The SBA loan volume plunged 36% in 2009 as banks slammed their vaults shut to small businesses
Top banks cut small business lending by $8 billion
Want a loan for your business? Hit the plastic!
One of the most effective counter terrorism measures that the US has quietly taken has been to interrupt or eliminate funding sources to terrorist organizations such as Al Qaeda. An enemy that cannot eat cannot fight. Similarly, a business that cannot access cash, cannot survive.
When banks retreated into the safe, secure, and regulated new world of easy 3% margins on money that the bailout and expanded government borrowing provided, what followed for small business was nothing short of a scorched earth policy. The banking industry has instituted policies that essentially treat small businesses as enemy combatants. While the balance sheets of the banks were being propped up by taxes that came largely from small business, the small businesses and their owners were shut off from credit lines of working capital that ultimately has resulted in layoffs and shut-downs. Soon, a day of reckoning that the taxes collected from these small businesses won’t just decrease by 30% as our housing values have, they will disappear altogether. The vicious cycle is just beginning to unfold.
American small businesses have finally realized that they are being manipulated and attacked by the banking industry. Our government officials make many eloquent speeches on the value of small businesses. They seem to recognize the value and say the right words. When it comes to passing tangible legislation, they sit complacently on the sideline. Like Caesar at the Roman Coliseum, our government chooses winners and losers by a capricious thumbs-up or thumbs down signal, but real leadership in supporting entrepreneurship has not been forthcoming. America’s small businesses are angry and they have good reason to be.
Circle the City, Cut the Supply Lines, then Subjugate and Dominate:
Step one in the process is to cut off the traditional supply lines that small businesses use to fuel operations and growth. That source has traditionally been the Commercial Credit Line used to finance inventory, labor, and growth. The incidents of banks giving small businesses notice that their commercial credit lines will not be renewed are at staggering levels. There is hardly a week that goes by that I do not have a discussion with a business owner about a retracted credit line or one that will not be renewed. Estimates of the total amount of credit line reductions since early 2009 vary from $1.5 trillion to $2.0 trillion. That is 2 to 3 times the total size of the stimulus package that is rumored to have saved us from the brink of another great depression.
In a real example with a regional bank, a small business’s credit line was not renewed after many years of never missing a payment. There was approximately $50,000 on the line and the business had roughly $20,000 on deposit with the bank. On the day before payroll was to be paid, the bank confiscated the $20,000 and applied it to the $50,000 balance causing the entire payroll and the monthly expense checks to bounce. Of course the bank harvested nearly $1,000 in non-sufficient fund fees from the business. This action was not only usury, it was planned and callous. It was also completely legal.
The second step is for banks that have retracted a commercial credit line to transfer the balance to a Credit Card in the businesses name with a credit limit of just over the amount that was on the commercial line. This takes a fixed rate loan with a 7% interest rate and converts it to a 20%+ variable rate loan. This triples the banks interest charges while denying access to additional cash for operation of the business. It also will increase the payments that the business must make – further weakening the prospects for prosperity. Just so you know, business credit cards are exempted from the supposed credit card protection reform laws that became effective in on February 22nd.
It is a little known fact that credit scores are reduced based on the ratio of available credit to utilized credit. The transfer of commercial balances to credit cards with no margin to borrow against reduces the credit score of a business which can cause a cascade of increases in interest rates and reduction of limits from other financing sources. CNN Business recently reported that, credit cards now represent the largest source of small business financing – 59 percent of small businesses now use credit cards. That number is up from 49 percent reported just five months ago. CNN went on to report that the loss or severe reduction of credit lines was probably the number one problem hurting small businesses in need of capital, and that lenders were doing it even when borrowers had never missed a payment.
Recognize that these first two assaults on small businesses have come without provocation, cut off the businesses supply lines, increased the burden of operation, and done so in a way that triples the banks revenue stream from the same account. Small businesses do not have a reasonable chance of predicting when an army of MBA’s in a banks war room will choose to launch a sneak attack. Small business owners are too busy creating jobs and wealth to spend time playing chess with an institution that is miles from home with predatory policies and a set of new rules to enforce.
Of course the final coup de grace (the blow that kills) is the banks insistence on the Personal Guarantee of the business owner. This is the move that enables the bank to confiscate personal property should the business fail. In some instances this series of classic military maneuvers has left business owners who never missed a payment, yet are unable to perform to the “NEW RULES”, destitute and homeless. Of course the entire workforce is laid off when this happens. The sick truth though is that many businesses that become the subject of such attacks were thriving under the “OLD RULES”. Perfectly good businesses with a history of playing by the rules are routinely forced into a death spiral through no action of their own.
When your deliberate actions cause another person to die, it is called first degree murder. When a financial institution’s deliberate actions cause a business to cease to exist it is called a change of policy. To the business owners and their employees it is more like willful homicide.
When banking institutions with the strength of free government financing reduce relationship banking to a war game it is time for small businesses to learn to play the game and to make counter moves to protect themselves and to improve their prospects for a positive outcome. Game theory in its simplest form is usually represented by a matrix which shows the players, strategies, and payoffs. The first rule of any game is that when the opponent changes the rules in the middle of the game, or cheats, then one has but three choices. One may continue to play and be guaranteed of losing, cheat like the opponent did equalizing the odds, or simply quit. Game theory is a good metaphor for how a small business should react when a bank changes the rules in the middle of the game. Let’s be very open with the fact that this is precisely what has happened to small business in America over the last few years. In fairness to the banking industry many of their actions were responses to the “New Rules” that were thrust upon them by government regulators.
What is the best first move to make when a credit line in slashed or an interest rate is jacked? A proportional aggressive response is the most preferred move. This could take the form of a letter to the bank explaining that the action is not acceptable accompanied by suspending payments until an acceptable resolution is met. It could also include a cash flow statement with a clear explanation as to how the banks actions were unprovoked and put the company’s survival in jeopardy. A business owner can expect many phone calls from collection call centers when payments are suspended. One should be prepared for condescending language and a carefully crafted script from a boiler room in Bangalore, to attack ones integrity in an attempt to collect a debt that was created by changing the rules in the middle of the game. Make no mistake though, the banks do not want the businesses that they have loaned money to defaulting, and when faced with that prospect they frequently change their behavior.
I am getting reports from the field that after several of months with no payments coupled with the prospect of regulations that require a loan to be placed in the non-performing category that banks and credit card issuers are much more receptive to going back to the old rules. After all, they do not have the inclination or the desire to run any business other than a bank.
Do you remember what your parents taught you about bullies? The only way to counter a bully is to hit the bully right back. Like Pavlov’s dog, banks that jack rates and cut limits while continuing to be paid to do so, will continue to jack rates, cut limits, and attempt to access personal property until they are met with a resounding NO. In times like these, small businesses need to draw a line in the sand, and position themselves at strategic points that leverage their strengths.
Big banks started a war on small business in America. As mentioned previously there are only three choices when the rules are changed in the middle of the game. Lose, quit, or break some rules too. If a couple of million small businesses realize this and act according, I suspect that the Old Rules will be re-established. Banks need small business just as much as small business needs banks. The American dream cannot be attained without both. When the banking industry along with our government get their heads out of the sand and realize this, the unemployment rate and the default rates may just reverse the death spiral that started when the New Rules were enacted.