The front cover of the May 17, 2009 issue of the New York Times Magazine asked “Are Small Banks the Future?“  As noted in the article, lending may have slowed at the largest banks, but at the other end of the financial system, there are 8,500 community banks, and most remain very strong.

In the midst of the worst banking crisis since the Great Depression, community banks have generally fared well. That’s because they typically shunned the lending practices that led to high default rates. They rarely participated in the securitization of loans, credit-default swaps and other overvalued financial products that put the global financial system in crisis. Instead, they stuck to the fundamentals. They considered the character and history of their borrowers. They required collateral. Without community banks, the current financial crisis would be a lot worse.

The focus of the mainstreet press, and the Treasury Department, continues to be on the largest institutions, whether it be the initial nine TARP Capital recipients, or the nineteen that underwent the stress test.  There is some rationality for this focus, the majority of assets, deposits and loans are held by these institutions.  But just like small businesses generally, community banks play a critical role in the American economy.

Community banks may have weathered the current crisis better than larger banks, but they remain an American oddity. Most other countries have 5 or 10 na­tional banks, and when they get in trouble, as they did in Iceland, it can be devastating. The balance in this country is tipped toward big institutions (the four largest control half the assets held by American banks and 40 percent of all deposits), but community banks still make 43 percent of all small business loans under $1 million. Since January 2008, fewer than 1 percent of all community banks have failed.

On March 16, 2009, the Treasury announced the terms of new program, Unlocking Credit for Small Businesses, aimed at helping jump start credit markets for small business loans.  The program includes the following significant provisions:

1. The Treasury will purchase up to $15 billion in securities backed by Small Business Administration (SBA) loans;
2. The SBA may guarantee up to 90% of Section 7(a) loans, which are loans to support the business operations of small businesses;
3. The SBA will temporarily eliminate loan fees for certain Section 7(a) loans and 504 Program loans, which provide long-term financing to directly support economic development within a community;
4. The largest Financial Stability Plan Assistance recipients must weekly report their SBA lending activities, and all financial institutions may have to monthly report their SBA lending activities; and
5. The Treasury will issue guidance for the tax-related provisions, aimed at providing liquidity to small businesses and encouraging investments in small businesses.

Together, these provisions are aimed at increasing small business lending, which is extremely important in these flagging economic times because small businesses have generated approximately 70% of net new jobs annually over the past decade.  These provisions should also provide a liquidity boost for community banks, credit unions, and small lenders, who together account for approximately 40% of all SBA-backed loans, by allowing these institutions to sell existing SBA loans and then to extend more credit to other borrowers.

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