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The Impact of Inflation on Small Business Lending

26 Apr 2022
impact inflation small business lending

Inflation is already having a profound impact on consumers and businesses alike. According to MarketWatch, the personal consumption price index—which the Federal Reserve views as the most accurate measure of inflation—climbed to 6.4% in the 12 months ending in February. This represents the steepest increase since 1982.

As if rising inflation in the U.S. didn’t create enough concern, the global forecast isn’t much better. According to Fitch Ratings, global inflation is back with a vengeance after being mostly absent for at least two decades. Additionally, rising oil and gas prices will increase industry costs and reduce consumer real incomes. Anticipating these shockwaves, Fitch has cut its world gross domestic product (GDP) growth forecasts for 2022.

Given these continuing economic challenges, small business lenders will need to know what to expect when it comes to inflation and small business lending. Here’s how current inflation rates are affecting small businesses now and how continued inflation could influence small business lending in the coming months.

The State of Small Business

Although the pandemic shuttered some businesses, many others were able to thrive. According to the Ocrolus Small Business Health Index, the average daily balance of business bank accounts has grown by almost 80% since the start of the pandemic, as businesses saved and built up cash buffers to deal with further unexpected events. This is due in part to extensive government support for small businesses via lenders and improved cash flow from operations.

At the same time, small businesses are demonstrating a greater appetite and readiness for access to capital. Small business credit application volume rose by 28% during this same time frame. In fact, the overall volume of applications for small business credit through Ocrolus-enabled lenders now exceeds levels seen before the pandemic.

How Inflation Affects Small Business

Although many small businesses are in a stronger financial position, they may encounter difficulties with inflation and access to capital this year. On top of the existing supply chain challenges they may already be encountering, small businesses may also notice a shortage in materials or finished products in the market.

The cost of borrowing may also go up as inflation rises. The Fed already increased rates once in March, and indications point to more rate hikes in the near future. According to Nasdaq, the Fed is expected to raise interest rates several times more throughout 2022 in an attempt to keep inflation from worsening. Small business owners may feel those interest rate increases in the form of more expensive loans, higher credit card fees, and slower business growth.

These economic trends may make it more difficult for small businesses to manage their finances. At the same time, many businesses have successfully passed the cost of inflation through to consumers so far, which has helped them weather these challenges up to a certain point.

Bull or bear: what could 2022 look like?

Given all these developments, how would 2022 look for small business lending given a bull or bear market?

In a bull scenario, the stock market may have already priced in the cost of an economic downturn. Home prices may still increase as housing supply continues to significantly trail demand. But if housing and energy prices end up subsiding, inflation could cool. We may also see record corporate profit growth and record wage growth. And as Paycheck Protection Program (PPP) funding wraps up, private lenders may see an uptick in small business demand for credit.

In a bear scenario, the Fed will take much more aggressive action to halt inflation. These steps will lead to higher interest rates, lower credit demand, and slower economic growth— possibly even a recession—in 2023. These economic developments, in turn, will result in lower credit demand and higher credit losses for lenders.

Small Business Lenders Need to be Prepared

Although many small businesses find themselves in a surprisingly strong financial position thanks to their cash buffers and access to widespread government support during the pandemic, continued inflation may diminish their purchasing power and make the cost of borrowing more expensive, meaning lenders will need to be prepared for lower demand. The Fed has already signaled its intention to increase rates throughout 2022, which could lower small business demand for credit.

Whether a bear or bull scenario happens, it’s best for lenders to be as prepared as possible for the potential impacts of inflation on small businesses and their need for credit. By leveraging document automation, small business lenders can gain the agility they will need to cope with either scenario. With Ocrolus, small business lenders can automate their underwriting workflows from end to end, allowing them to successfully navigate periods of economic uncertainty.

Learn how Ocrolus can help you automate your workflows and accelerate your lending processes.