Impact of Macroeconomic Factors on Business Lending

1. The Interplay Between Economy and Business Lending
2. The Impact of Recessions on Business Loans
   • Credit Crunches During Recessions
3. How Inflation Affects Business Lending
4. Relationship Between Government Policies and Business Loans
   • Government Loan Guarantees
5. Strategies for Business Lending During an Economic Downturn

One of the biggest mistakes entrepreneurs make when seeking capital is failing to consider the role of macroeconomics. Sure, it goes without saying that factors like interest rates impact
business lending. However, too few consider how periods of recession, inflation, and fiscal policy also shape business loan terms and availability.

For entrepreneurs looking to secure favorable loans, staying ahead of the curve is key. Small and medium business owners aren’t just expected to have a solid overview of their company’s internal finances but are also expected to be able to see the bigger picture with equal clarity.

In this guide, we’ll break down the impact various macroeconomic factors have on business lending and offer strategies for entrepreneurs to navigate them with ease.

The Interplay Between Economy and Business Lending

There’s an intricate relationship between economy and lending.

During periods of economic growth, lenders are more willing to offer higher lines of credit, and businesses are more capable of repaying loans. Conversely, during a downturn, lenders grow more risk averse, and less likely to extend credit. Borrowers suffering from cash flow issues will also likely see a dip in credit scores.

This is, of course, an oversimplification. In reality, several economic trends influence loan availability and loan conditions, with each variable having its own unique impact on broader economic cycles.

As financial intermediaries, banks also have a major role to play in shaping the lending landscape. They connect lenders to borrowers, decide on the appropriate allocation of capital, and ensure the overall stability of the financial system.

The Impact of Recessions on Business Loans

“Recession” is one of the scariest words a small business owner can hear. Periods of economic downturn often mean lower sales and revenue for extended periods.

No one is more aware of this than lenders. During a recession, businesses that don’t have significant cash reserves, or assets to offer as collateral, are unlikely to see much luck when seeking funding, due to a lack of confidence among lenders. This leads to a credit crunch, which is a devastating outcome for the economy.

Credit Crunches During Recessions

Credit crunches are associated with higher unemployment levels, decreased investment, and a loss of confidence in the financial system. They often follow a period of easy credit availability. When financial institutions overextend credit, rising default rates and accumulating bad debt lead to stricter loan terms, further deepening a recession.

Consider the impact of the last major credit crunch — the Great Recession of 2007-08. This major financial crisis was caused by the easy availability of credit and lax lending standards, among other factors.

After the crisis hit, loan growth remained negative for several years, and bad debt was so high that many banks had to declare insolvency, or rely on government bailouts. Business owners, meanwhile, were left with no resources to grow operations. Those that survived had to severely trim operations, leading to high unemployment rates.

For an idea of how devastating a credit crunch can be, consider the stats: In a 2023 survey, Goldman Sachs found that a crunch had left only 29% of small businesses able to afford a loan. Nearly 80% said the lack of capital was a matter of concern.

How Inflation Affects Business Lending

Inflation rates have a significant impact on borrowing costs and loan repayment terms — benefiting either the borrower or the lender in different conditions.

When inflation rises, the value of money decreases, as does purchasing power. In response, central banks may attempt to stimulate the economy by reducing interest rates. This makes loans more affordable for the borrower and boosts economic activity.

On the other hand, to counter rising inflation rates, the bank may increase interest rates. This translates to higher borrowing costs, which benefit the lender but lead to a slowdown in consumer spending, decreased investment, and more stable prices.

To see how this works in action, consider this example: In 2021, the interest rates of business loans in Canada were as low as 2.8%. However, following high inflation rates in 2022, which touched 8.1%, the banks raised interest rates to over 6%. This had its intended effect, bringing down inflation rates to 2.5% by July 2024.

Entrepreneurs who understand this symbiotic relationship can leverage periods of low interest rates to access more favorable terms or tighten up their budgets during periods where interest rates are high.

Businesses that take out fixed-rate loans prior to rising inflation also stand to greatly benefit — as the repayment amount doesn’t increase with inflation. Those looking for a
quick small business loan during periods of high inflation benefit from shopping around instead.

Relationship Between Government Policies and Business Loans

The third major macroeconomic factor that directly impacts lending is government policy. Through various monetary and fiscal policies, governments may either make it easier to get business loans or make borrowing harder.

Through its monetary policy, a government may influence the central bank to incentivize lending or tighten the reins, making borrowing more or less attractive.

Fiscal policies, meanwhile, relate to the government’s spending and taxation stance. Governments offer tax incentives or increase spending to spur economic activity. On the flipside, raising the taxes may lead to less lending. Regulatory policies also play a role. Banking regulations, for instance, directly impact loan terms.

Government Loan Guarantees

Governments may also make it easier for businesses to access capital and funding through loan guarantees. Under such an agreement, the government agency assumes the debt obligation in case a borrower defaults. This essentially shifts the risk from the lender to the government and results in more favorable rates for businesses.

Under the Canada Small Business Financing Program, the government backs the lender for up to 90% of the loan amount. Without this guarantee, many loan requests would be rejected outright, and many others would be approved with much higher interest rates.

Strategies for Business Lending During an Economic Downturn

As we’ve seen, there are two sides to economic fluctuations. While businesses understandably thrive during periods where lending is incentivized, they may struggle during an economic downturn. In this case, the following strategies may come in handy:

• Manage Cash Flow: Businesses must strike a balance between incoming and outgoing cash. One way to ensure inflow is higher than outflow is to review expenses and retain only those that generate revenue.
• Cut Spending: During a recession, businesses must review all expenses in great detail to weed out and curtail unnecessary spending. This ensures that even if they require immediate financing, they only borrow what they actually need.
• Consider Alternative Funding: The rise of FinTech has given firms access to a wide range of alternative financing options with extremely favorable terms. This is especially useful during credit crunches.
• Improve Forecasting: Businesses can analyze historical data to predict future trends and market conditions, allowing them to make more informed decisions, and identify favorable loan terms.

Essentially, how well an organization survives economic fluctuations depends on its
financial planning and risk management capabilities.

Conclusion

At the end of the day, developing a greater understanding of macroeconomics doesn’t just help businesses secure loans. It also enables them to boost their overall financial health and thrive even during the most unfavorable conditions.

Fortunately, businesses have access to several tools to achieve this. The rise of alternative financing, for example, has made it easier than ever to get a
business loan with bad credit, while modern forecasting and financial planning practices can help identify favorable loan terms with increased accuracy.

Entrepreneurs who adopt a more proactive approach to business finance will better navigate the financial landscape, and be more likely to see long-term success.

1. Bank lending behaviour and macroeconomic factors: A study from strategic interaction perspective
2. Bank lending behaviour and macroeconomic factors: A study from strategic interaction perspective
3. Macro Environment: What It Means in Economics, and Key Factors
4. Economic Factors: How Economic Factors Affect Businesses
5. Credit Crunch Definition, Causes & Consequences