Rising Interest Rates Will Hurt Small Businesses, But Not As Much As You Might Think Just Yet
By Rohit Arora
Inflation is hitting small businesses hard right now, and data from MetLife and the U.S. Chamber of Commerce found that 85% of small business owners surveyed expressed concern about inflation. Research finds that one-in-three business owners list inflation as their No. 1 business concern.
The reality is that inflation is always happening, so small-business owners need to be prepared. It’s important to understand how inflation affects your business and to produce solutions to manage it.
Yesterday, Chairman Jerome Powell and the Federal Reserve raised its benchmark interest rate by 75 basis points as the central bank continues its rate hikes intended to curb inflation.
Recent indicators of spending and production have softened. Nonetheless, job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated, reflecting supply and demand imbalances related to the pandemic, higher food and energy prices, and broader price pressures.
Russia’s war against Ukraine is causing tremendous human and economic hardship. The war and related events are creating additional upward pressure on inflation and are weighing on global economic activity. The Committee is highly attentive to inflation risks.
The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 2-1/4 to 2-1/2 percent and anticipates that ongoing increases in the target range will be appropriate. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in the Plans for Reducing the Size of the Federal Reserve’s Balance Sheet that were issued in May. The Committee is strongly committed to returning inflation to its 2 percent objective. – Federal Reserve FOMC Statement of July 27, 2022.
However, interest rate hikes impact small business owners significant, as the cost of capital will go up from all types of lenders, including big banks and the regional and community banks that make a large percentage of the SBA’s 7(a) loan program.
It is an interesting economic time. While inflation keeps rising, there is also concern about a recession that could be lurking around the corner. Some sectors are driving because of pent-up demand that resulted from the COVID shutdown of the economy. Travel, tourism, and the hospitality industry have all rebounded, while the real estate market has cooled from its white-hot peak during the pandemic.
The question is: Are business owners themselves going to be willing to take on debt capital at variable rates while the Fed keeps signaling that it plans to keep raising interest rates?
Borrowers can absorb the 75 basis points and still make their debt payments. However, if rates go up another 250 points, then the monthly debt payment will start to become an issue. Right now, small businesses are being hurt most by the ever-increasing cost of labor, along with the lack of workers to fill jobs.
Rrising interest rates and increasing cost structures are hurting small businesses, particularly minority-owned and women-owned business owners. These companies were hit particularly hard by the pandemic, and they were already at a cashflow disadvantage in trying to secure capital. Typically, minority-owned and women-owned businesses are smaller, younger, and often have little or no credit history and/or banking relationships. It is harder for them to secure small business loans and often they pay higher interest rates when they do borrow.
We are in a much different place than we were during the 2008 economy. Businesses that were flush with PPP money have been able to clear debts and reinvest. If they borrow money to grow their businesses, they have to be ready to incur higher interest rates. The near-zero cost of capital that the U.S. economy enjoyed for more than a decade has passed.
Small businesses cannot keep raising wages for employees and have higher inventory costs, even during a period of high demand. Margins are shrinking for a lot of industries, and business owners are passing along their increased costs to their customers.
The Fed’s mission is to keep the target inflation rate to about 2%. Thus, it was time for the Federal Reserve to act. The Fed is unlikely to cut rates again until the economy slows. There is no way to sugarcoat this medicine.
A continuing issue in small business lending is the relatively low approval percentages at banks. The latest Biz2Credit Small Business Lending Index found that in June 2022, only 15.4% of loan applications at big banks were approved. That number is higher for smaller banks at 21.1%. But these figures are in stark contrast to pre-pandemic lending figures of February 2020 when big bank approval rates hit an all-time Index high of 28.3% at big banks and when lending percentages were greater than half (50.3%) for small banks.
Further, at non-bank lenders institutional lenders approved 25.6% of business loan requests in June 2022, compared to the pre-pandemic high of 66.5% in February 2020. Banks and institutional lenders are much more cautious than they were a little more than two years ago. Many of them have put stricter credit requirements into place.
So how do small businesses survive in these challenging economic times?
According to the U.S. Chamber survey, small businesses are raising prices to cope with spiraling inflation. In fact, more than two-thirds (67%) of small businesses reported having to raise their prices over the past year. More than four in ten (41%) report having decreased staff. Some have taken out loans in the past year (39%) in response to growing inflation pressures. However, if the Fed continues to raise rates consistently by 75 basis points or more, small businesses are less likely to borrow once rates hit a certain threshold. Two more increases like the one announced yesterday could indeed be the breaking point.