For nearly four years, small businesses have endured a rollercoaster economy that took them from the depths of the pandemic to the frenetic heights of a post-Covid consumption binge. Today, small businesses are earning higher revenue but managing even higher costs, leaving less in the bank at the end of each week. At the same time, small business access to capital continues to decline despite a seemingly strong economy and nearly full employment. Why is that and what does it mean for small businesses in 2024? The answers lie in the government’s response to the pandemic and its impact on nearly every aspect of the economy.
When the pandemic shut down the country in March 2020, small business owners braced for the worst. Many scaled back production, laid off employees, and pivoted to products that met the needs of a new remote world. For many, the crisis was averted thanks to the federal government’s ballooning balance sheet. The Paycheck Protection Program (PPP) and the Covid-19 Economic Injury Disaster Loan (EIDL) program collectively dropped over $1.2 trillion into the hands of small- and medium-sized businesses, according to the U.S. Small Business Administration. Most of those loans were subsequently forgiven. Displaced workers also received generous unemployment benefits which fueled consumer spending, the primary driver of small business revenue. The economy roared.
Several years later, small business owners are facing the aftermath of this extraordinary government stimulus and its many unintended consequences. Inflation, which had hovered around 2 percent for the past 20 years, suddenly spiked and peaked at around 9 percent in the spring of 2022. Fearing long-term damage to the economy, the Federal Reserve sprang into action in March 2022 and over the next 18 months raised interest rates from near zero to above 5 percent. This action brought inflation back under 4 percent but also slowed the economy and placed tremendous pressure on the banking system.
As interest rates rose, bank customers began cashing in their deposits in search of higher returns outside the banking system. Many customers moved bank deposits into money market funds available through their brokerage accounts, as money market yields rose rapidly relative to bank deposits. Others moved money into the bond market to capture rising short-term yields, or into other earning assets such as real estate or dividend-paying stocks.
At the same time, consumers were burning through the cash they had saved during the pandemic. As deposits declined, banks were forced to raise deposit rates and sell assets at a loss to generate the cash required to cover withdrawals. For Silicon Valley Bank (SIVBQ), Signature Bank (SBNY) and First Republic Bank, these losses proved too great, and they were forced into receivership by the FDIC.
While most banks managed to avoid receivership, deposit losses curtailed their ability to lend. As a result, over the past three and a half years, banks have barely grown their exposure to small businesses despite strong economic growth and recent significant inflation. At the end of 2019, banks held $645 billion in commercial loans under $1 million in size. By June 2023, that number had grown by only $11 billion, or 0.5 percent annually, according to the FDIC Quarterly Banking Profile, a quarterly summary published by the FDIC of financial results for all FDIC-insured institutions. This means small businesses have considerably less access to bank capital today than they did before the pandemic.
As we look ahead to 2024, the clouds of elevated inflation, interest rates at 15-year highs and slowing economic growth continue to darken the small business landscape. Many are struggling to navigate a tight labor market that continues to produce wage inflation, higher financing costs and more discerning customers who have burned through their pandemic savings, can no longer extract cash from their homes through refinancing, and begin to worry about job security.
As a result, 2024 will put small businesses to test as higher interest rates continue to slow the economy and drive up the cost of capital. Fortunately, small business owners are some of the most creative and resilient resources our economy has. They have navigated pandemics, natural disasters, supply chain disruptions, and wild swings in consumer behavior, and they will navigate these challenges as well.
Ben Johnston is the chief operating officer of Kapitus, a provider of loans and financing services to small- and medium-sized businesses. The company has provided over $4.5 billion to over 50,000 businesses since 2006.