When Big Banks Won't Lend, and Small Banks Fail

In the world of small-business loans, it's the worst of times and the worst of times.

The volume of new small-business loans amongst the nine big U.S. banks that received federal bailout money plummeted nearly $20 billion in January compared with December, the U.S. Treasury Department reports. The banks loaned nearly $36 billion, the smallest monthly total since last October, when the banks loaned $41.6 billion.

With big-bank lending still down, many finance experts point entrepreneurs toward smaller, community banks as a better option. The problem? A substantial number of those are going bust.

Treasury has expressed concern that small banks continue to fail at a steady pace -- 27 more so far this year, nearly 200 since the beginning of 2008. The chaos created by bank failures includes broken relationships between entrepreneurs and local bankers, leaving entrepreneurs to scramble to find a new bank and establish the rapport that usually precedes getting a loan.

Partly as a result, total U.S. bank lending is down 7.4 percent. One forecaster predicts a small-business lending shortfall of as much as $500 billion as the economy continues to struggle. That's a lot of small-business activity being stymied for lack of capital. Surviving community banks are being unusually cautious in lending further, as they closely monitor how their existing small-business lenders are faring.

So entrepreneurs are caught in a pincer -- the biggest best banks not lending on one hand, community banks overleveraged or overcautious on the other. It's hard to see a good solution here.

It's no surprise that alternative lending vehicles that don't involve banks are getting a lot of attention lately, from purchase-order financing to peer lending to selling receivables.

Entrepreneurs have always been creative when it comes to operating their businesses. Now, they have to be more creative than ever when it comes to finding the funds they need to grow.