By Karen Lynch
The Fed raised its "policy" interest rate in March 2018, from a range of 1.25-1.5 percent to a 1.5-1.75 percent range. Fed officials also signaled at least two more increases this year and two more in each of the next two years, to a range of 3.25-3.5 percent.1 The downside for small and midsized enterprises (SMEs) is the corresponding rise in funding costs, since business loan interest rates track the benchmark set by the Fed. The upside is that small business loans will become more readily available as they become more profitable for banks, according to Fundera, a small business lending marketplace.2
Yet, observers say those implications may differ noticeably depending on the funding source, from big banks and community banks to online lenders and other financial technology companies (fintechs).
The Fed's interest rates, which apply only to short-term lending between banks, provide benchmarks that inform how banks set business loan rates. While there is no direct correlation, an indication of their impact is the prime rate that U.S. banks charge their "best" customers. Historically, that prime rate has been three percentage points higher than the Fed's rate, and it has exactly matched Fed rate changes in recent history.3,4
For small businesses, "if the Federal Reserve raises rates the anticipated three times this year, variable rate loan costs will respond immediately, although longer-term rates are not likely to reflect the full hike," according to the National Federation of Independent Business (NFIB), a trade association.5 A continuation of this trend over the next several years could eventually translate to increased cost across most forms of small business funding, Fundera says.6
"Counterintuitively, the Fed interest rate may actually have a net positive impact on business owners in the short term as banks slowly dip their toes back into the small business lending pool," Fundera says. Various figures bear this out, though the patterns are only beginning to emerge. Small business loans from big banks reached a record high in January 2018, according to the Biz2Credit Small Business Lending Index.7 That said, small enterprises were more likely to have difficulty getting business funding than midsized companies, according to a late 2017 survey by Pepperdine University's Graziadio School of Business and Management and Dun & Bradstreet Corp.8
Small business loan interest rates vary, depending on an SME's qualification as a borrower, the type of loan, and the lender. Average annual percentage rates (APRs) for conventional business loans at large national banks were 2.55 percent to 5.14 percent at the time this was written; at small national and regional banks, they were 2.48 percent to 5.40 percent; and online lenders were charging 13 percent to 71 percent, according to ValuePenguin, a finance website.9 Loans guaranteed by the Small Business Administration (SBA) average 6.30 percent to 10 percent. Other types of lending, such as lines of credit, merchant cash advances, and invoice factoring, generally have higher APRs.10
"Following the 2008 fiscal crisis, traditional banks all but completely shuttered their loan offerings to small business owners, citing high risk and low profit margins as a reason to avoid small business loans," Fundera reports.11 Post-crisis regulations, including oversight of banks' safety and soundness, anti-money laundering, and counter-terrorist financing measures, have made banks more risk-averse, according to Garnet Capital Advisors.12 And, "while community banks have traditionally worked with smaller organizations, there are fewer of them around that are active commercial lenders." Online lenders stepped in to fill the small business funding void, creating more choice but at higher cost.13
Rising interest rates could alter this equation, observers say.
"If traditional banks do take this cue to loosen the reins on their small business lending standards, the resulting uptick in the availability of bank loans could force down the rates from alternative lenders eager to maintain their market share," Fundera says.14
In Washington, meanwhile, the SBA is seeking to spur momentum. Its impetus comes in part from the fact that small businesses account for about half of all private sector employment, net job growth, and GDP, according to Florida Atlantic University Finance Professor Rebel Cole.15
"Regulators could use existing laws, such as the Community Reinvestment Act, to encourage more small-business lending by these very large banks," says a January 2018 report from the SBA. Other recommendations in the report include encouraging the launch of new community banks to work with small businesses and supporting the growth of small business loans by credit unions.
Meanwhile, demand for small business funding could increase, as the NFIB's Small Business Optimism Index reached a record high in January 2018. Nearly a third (32 percent) proclaimed the current economic environment ripe for them to expand, up 5 percent in a month.16
Although Fed rates are increasing, they are still near historic lows and are rising gradually – so far. While small business funding rates tend to rise in tandem, there is also potential upside for borrowers. As more banks and other lenders are projected to issue more small business loans, competition among business funding sources could put downward pressure on rates – even for fintech and other online lenders.17
Karen Lynch is a journalist who has covered global business, technology and policy in New York, Paris and Washington, DC, for more than 30 years. Karen also is a principal at Content Marketing Partners.
1. “Fed Raises Rates and Signals Faster Path Next Year,” Wall Street Journal; https://www.wsj.com/articles/fed-raises-rates-and-signals-faster-path-next-year-1521655316
2. “How Will the Fed Interest Rate Increase Affect Small Business Lending?” BusinessTown; https://businesstown.com/will-fed-interest-rate-increase-affect-small-business-lending/
3. “Q&A: How a Key Fed Interest Rate Affects the Economy,” Los Angeles Times; http://www.latimes.com/business/la-fi-fed-interest-rate-qa-20150615-story.html
4. “Here’s How the Fed’s Decision to Raise Interest Rates Could Impact Your Life,” Business Insider; http://www.businessinsider.com/federal-reserve-interest-rate-impact-consumers-businesses-2016-12/#the-feds-main-monetary-policy-tool-is-the-federal-funds-rate-1
5. “Record Number of Small Business Owners Say ‘Now is Good Time to Expand,’’ National Federation of Independent Business; https://www.nfib.com/surveys/small-business-economic-trends/
6. “How Will the Fed Interest Rate Increase Affect Small Business Lending?” BusinessTown; https://businesstown.com/will-fed-interest-rate-increase-affect-small-business-lending/
7. “Small Business Loan Approval Percentages Hit New High Mark at Big Banks in January 2018,” Biz2Credit; https://www.biz2credit.com/small-business-lending-index/january-2018
8. “Get Started: Small Businesses More Interested in Loans,” Chicago Tribune; http://www.chicagotribune.com/business/sns-bc-us--smallbiz-get-started-20171226-story.html
9. ““Average Small Business Loan Interest Rates in 2018: Comparing Top Lenders,” ValuePenguin, https://www.valuepenguin.com/average-small-business-loan-interest-rates
11. “How Will the Fed Interest Rate Increase Affect Small Business Lending?” BusinessTown; https://businesstown.com/will-fed-interest-rate-increase-affect-small-business-lending/
12. “Small Business Lending: Banks, FinTech, or SBA?” Garnet Capital Advisors; http://www.consumerbankers.com/sites/default/files/Garnet%20Capital%20Small%20Business%20Lending%20White%20Paper.pdf
13. “How Will the Fed Interest Rate Increase Affect Small Business Lending?” BusinessTown; https://businesstown.com/will-fed-interest-rate-increase-affect-small-business-lending/
15. “SBA Turns Attention to Credit Unions to Revive Small Biz Lending,” pymnts.com; https://www.pymnts.com/news/b2b-payments/2018/small-businesses-credit-gallup/
16. “Record Number of Small Business Owners Say ‘Now is Good Time to Expand,’’ National Federation of Independent Business; https://www.nfib.com/surveys/small-business-economic-trends/
17. “How Will the Fed Interest Rate Increase Affect Small Business Lending?” BusinessTown; https://businesstown.com/will-fed-interest-rate-increase-affect-small-business-lending/