Regulators Encourage “Prudent” Practices to Spur Lending to Small Businesses

The federal financial institutions’ regulatory agencies and the Conference of State Bank Supervisors issued a statement that reiterates and elaborates their supervisory views on prudent lending to creditworthy small business borrowers, noting a concern that the economic downturn may be making lenders overly cautious.

The Interagency Statement on Meeting the Credit Needs of Creditworthy Small Business Borrowers notes that between June 30, 2008, and June 30, 2009, loans outstanding to small businesses and farms, as defined in the Consolidated Report of Condition (Call Report), declined 1.8% or almost $14 billion. The agencies attributed the drop to a 4% decline in lending to small businesses by institutions with more than $100 billion in assets. This category of lending actually increased at institutions with less than $1 billion in assets.

The FDIC, the Federal Reserve, the Office of the Comptroller of the Currency, the Office of Thrift Supervision, and the National Credit Union Administration are the federal agencies that joined in the report.

The statement said that financial institutions that engage in prudent small business lending after performing a comprehensive review of a borrower’s financial condition will not be subject to criticism for loans made on that basis. The regulators say institutions should consider a borrower’s credit history and financial strength, including credit score, and the strength of management. The loan structure should be appropriate for meeting the funding needs of the borrower given the type of credit and expected timing of the business’ cash flow. The report also encourages institutions to gain an understanding of the competition and local market conditions affecting borrowers’ businesses and not to base lending decisions solely on national market trends when local conditions may be more favorable and to not automatically refuse credit to sound borrowers because of a borrower’s particular industry or geographic location.

The regulators continue to emphasize the importance of maintaining robust risk management practices to identify, measure, monitor and control credit risk in lending activities. Examiners will expect institutions to employ sound underwriting and risk management practices, maintain adequate loan-loss reserves and capital, and take appropriate charge-offs when warranted. But, as a general principle, examiners will not adversely classify loans solely due to a decline in the collateral value below the loan balance, provided the borrower has the willingness and ability to repay the loan according to reasonable terms.

The statement builds upon principles in existing guidance, including the Interagency Statement on Meeting the Needs of Creditworthy Borrowers issued in November 2008 and the Policy Statement on Prudent Commercial Real Estate Loan Workouts issued in October 2009.