Despite months of worry that small businesses would fold underneath the weight of government-backed PPP loan repayments, it turns out that the market was worried about the wrong risk.
The real “time bomb” is possible bank credit contraction in 2021 that could not only destroy the companies lucky enough to survive last year’s crisis, but would also create a new and larger class of corporate failures.
“Even if pandemic loans come due, business failures remain modest, and so do policy costs,” says a report issued by the National Bureau of Economic Research last week. “By contrast, we find significant exposure to the risk of a credit contraction.”
The report, written by researchers from the Federal Reserve Bank of Atlanta, Bank of Canada and University of California at Berkeley, says that it’s U.S. small and medium sized enterprises (SMEs) that would suffer the most in any credit contraction.
SMEs get a majority of their operating credit from private banks, as opposed to larger corporates than can tap capital markets.
According to the research, if the US banking sector limited access to credit and prevented the rollover of pre-pandemic maturing debts, small and medium sized business failure rates would “spike” by as much as 9.84 percent over a prior, non-pandemic year.
Even more alarming, nearly half of the SME failures would arise from firms that did not even need support to survive to the end of 2020, meaning even somewhat healthy business would implode.
“The analysis clearly illustrates that the main danger for 2021 resides in impaired access to credit markets,” the report states.
For months policymakers have been warning the real threat to the US economy were loans coming due made through the Paycheck Protection Program (PPP). The loans, which were created through the Coronavirus Aid, Relief, and Economic Security (CARES) Act, required repayment if certain hurdles were not met
However, the researchers discovered that SME failure rates increase only “modestly” relative to a normal year for those companies that accepted PPP, most often because they were able to be “forgiven” for the loans.
“Policies implemented in 2020, on their own, do not create a 2021 “time-bomb” for SMEs. Rather, business failures and policy costs remain modest,” the report says. “By contrast, credit contraction poses a significant risk. Such a contraction would disproportionately impact firms that could survive COVID-19 in 2020 without any fiscal support. Even in that scenario, most business failures would not arise from excessively generous 2020 policies, but rather from the contraction of credit to the corporate sector.”