The Impact of Shrinking Financial Policy

In regular days, while banks are not open to bad credit business loan, there are financial institutions that are ready to extend this service to businesses with bad credit. However, during an economic downturn, extending these types of loans even from specialized lending services could be a challenge. This results in many businesses facing the possibility of taking drastic measures like retrenchment and cost-cutting.

People in the business face an economic downturn in many ways.

  • First, as unemployment and household income decrease, consumer spending decreases and employers’ sales decrease.
  • Second, banks have begun to tighten credit policies and offer small businesses with small loans and credit lines.

Changes in bank policy are common and can have a systematic impact on the economy. During the recession, cash demand is high, which can widen the bank’s impact on businesses.

Regulations in Banking

As a result of the Great Depression, Congress ratified a comprehensive law, the Dodd-Frank Act in 2010. This is aimed at overhauling the financial services industry. This sudden reform is fairly common following an economic downturn. For example, the “Grass-Steagall Act” (another financial reform law) was enacted in 1933, soon after the Great Depression. However, some believe laws like Dodd-Frank and Glass-Steagall will bring uncertainty to banks, allowing very few loans to small businesses.

There are two reasons for this.

  • First, new laws create uncertainty about how courts interpret the language.
  • Second, reform laws reduce the freedom of banks to take risks and make big profits.

Thus, banks can only offer loans to companies with the least risk, and that these companies can repay them.

Availability of Credit

The mixture of an economic downturn and new monetary laws has reduced overall loan availability. Like individuals, banks lose money whenever the market falls. As the market worsens, bank lending decreases. In addition, worsening market conditions could possibly require banks to demand more cash reserves to secure enough money to repay their debts. The more reserves held, the less money can be loaned to companies and the harder credit supply gets.

Rates of Interest

The rates of interests are one more part of banking policy that makes an impact on small to medium companies. The Federal Reserve takes on a key role in bank lending and small business lending rate decisions. The Fed decides on the nominal funding rate, which is the interest rate that banks receive when they make short-term loans.

The set rate determines what the bank should pay to provide additional funds to its customers, thus affecting the interest rates offered to consumers. As a result, the Fed encourages banks to lend to small businesses and individuals by lowering interest rates and reducing the cost of obtaining additional funds.

A low-interest rate often allows companies to obtain bigger loans at a lower cost. This indicates that the growth rate for SMEs should be expected when the interest rate is high.

The Amount of Risk Involved

The amount of risk likewise plays an important role in bank policy and affects small business loans. When banks determine that market risk is increasing (usually during recessions), they tend to spend their funds for safer investments. For example, in high-risk markets, US Treasuries are becoming more attractive.

When banks invest money in low-risk assets, they reduce the finances offered for small business and consumer loans. This trend can have a big impact on your potential to grow your business.