What Business Leaders Need To Know About The Credit Crunch

Carolina Martinez is CEO of CAMEO, a California micro-business network, and an expert on small business and CDFIs.

After years of a post-pandemic boom in new business creation, we’re now seeing a worrying new trend: Small business bankruptcies are rising at the fastest rate since the early pandemic. One possible explanation? Marked by sky-high interest rates and banks collapsing, many small businesses faced a dramatic downturn in lending in 2023, leading to a credit crunch. Unsurprisingly, entrepreneurs of color, who face challenges accessing funding in the best of markets, have been disproportionately affected.

The small-business credit crunch and ongoing inequities in capital access could be alleviated through legislative action to increase fairness and transparency in lending. Unfortunately, this year Congress missed out again on opportunities to protect small businesses from predatory lenders and create a more equitable small-business financing system. Federal courts also failed to support fairness and transparency in lending.

The good news? Despite these disappointing results from the federal government, business leaders and advocates in California made significant progress in successfully urging legislators protecting small businesses from predatory lenders—securing the passage of laws to mandate disclosure of annual percentage rates (APR) and ban junk fees in small-business lending. Their successes in California offer a road map for small-business advocates who want to take meaningful action to help entrepreneurs access affordable and trustworthy access to capital, in the face of congressional inaction.

Truth In Lending Legislation: Fails, Again

Small-business advocates have pushed Congress to pass the Small Business Lending Disclosure Act, which would require small-business lenders to clearly disclose APRs and protect small businesses from predatory lenders. This legislation was needed urgently last year, as the 2023 lending downturn sparked an uptick in unregulated alternative lending, much of which is predatory, hiding exorbitant interest rates, some as high as 358%, behind promises of fast cash.

Unfortunately, while the Small Business Lending Disclosure Act was introduced in June of 2023, lawmakers failed to move it forward—meaning that small-business owners in most of the country continue to wait for common sense protection from predatory lenders.

Setbacks For Rule Aimed At Reducing Discrimination In Lending

Earlier in 2023, after 13 years of delay, the Consumer Financial Protection Bureau (CFPB) released a long-awaited rule to promote fairness and transparency in small-business lending. The rule, which was finalized under Section 1071 of the Dodd-Frank Act, requires lenders to collect and report demographic data for small-business borrowers. The goal is to identify any patterns of discrimination in small-business lending and ensure equal opportunities for minority-owned businesses.

The banking industry, however, met this rule with opposition, suggesting they do not care to address their own shortcomings. They successfully lobbied Congress to pass legislation overturning the rule, sending it to the president (who vetoed the legislation).

Further, a lawsuit brought by the American Bankers Association and Texas Bankers Association resulted in an appeals court’s decision to halt implementation of the CFPB’s data-collection rule. Even more concerning, the legal reasoning cited by the court calls into question the very existence of the CFPB, referencing a ruling from the U.S. 5th Circuit Court of Appeals. If the U.S. Supreme Court upholds that the CFPB’s funding structure is unconstitutional, it would be a major setback for fairness and transparency in lending—opening the door to a resurgence in predatory and discriminatory lending practices, such as payday lending and redlining, for small businesses and consumers.

Bankers should recognize that transparency in lending is good for the economy and drives competitiveness. Opposing the CFPB and the disclosure of demographics in small-business lending will only slow economic growth.

California: A Beacon Of Hope

In contrast to federal failures and inaction, California took significant steps in 2023 to support small businesses looking for affordable, trustworthy capital—passing three landmark laws thanks to the persistent work of small-business advocates:

• SB 33 makes permanent a requirement that small-business financers disclose APRs upfront, giving small-business owners a clear picture of the full cost of a loan product so they can comparison shop.

• SB 666 bans junk fees in small-business financing, meaning lenders can no longer charge unreasonable and unnecessary fees for processes such as documentation, loan origination or payment processing.

• SB 54 requires venture capital firms to disclose demographic data of who they fund, which will help measure and address any inequities in VC funding.

Each of these bills will help California’s small businesses access affordable capital and root out discrimination in small-business funding, lowering barriers to entrepreneurship and giving all small businesses the capital they need to grow and power a strong economy.

Equally important, California’s first round of grants from the California Investment and Innovation Program (Cal IIP)—new funding to support community development financial institutions and mission-driven lenders serving underbanked small businesses—was released on February 1, 2024. CDFIs have a mission and a mandate to lend to unserved entrepreneurs, making them one of the best options for small-business owners who are turned down by banks. Additionally, CDFIs can offer free business advice to set entrepreneurs up for success.

Transparency in lending, funding for CDFIs and a robust CFPB are all critical to creating a strong economy that offers equal and fair opportunity for all. Business leaders who care about economic competitiveness should invest in advocating for equity in small-business lending on a larger scale. With so much of small-business owners’ success lying in the hands of lawmakers, each of us has a role to play in advocating for equal opportunity in small-business lending.

The information provided here is not investment, tax or financial advice. You should consult with a licensed professional for advice concerning your specific situation.

Forbes Finance Council is an invitation-only organization for executives in successful accounting, financial planning and wealth management firms. Do I qualify?