Small businesses are often credited with driving the U.S. economy, creating more jobs than big firms and developing fresher ideas.

Yet while most policymakers agree that small-business growth is crucial to pulling the country out of a crippling recession, no one can seem to settle on what needs to be done to help these firms expand and start hiring again.

Many industry experts say that the government needs to encourage more lending by continuing to offer incentives, such as keeping in place a 90 percent guarantee on Small Business Administration loans (set to expire at the end of February) or making the Troubled Asset Relief Program more attractive to small banks that agree to make more business loans.

Others maintain that if the government really wants to get the economy moving, it should back off. The National Federation of Independent Business, the nation's largest small-business trade group, says its members aren't borrowing because sales are weak, not because they can't get credit.

"Small businesses don't need more programs from Washington; they need lower taxes and fewer intrusions from government so they can take the calculated risks to expand their business," Susan Eckerly, an NFIB senior vice president, said in October in response to a White House plan to boost small-business lending.

And still others wonder why small business is getting all the attention. A recent commentary in The Wall Street Journal by Ethan Penner, the founder and president of the real estate investment firm CBRE Capital Partners, said that jobs created by small businesses are generally low paying and not all that stable. Citing statistics from the SBA, Penner pointed out that 56 percent of all start-ups fail within four years.

"If the government wants to spur the creation of stable and high-paying jobs it would do well not to neglect big business when establishing policy," Penner wrote.

Still, right or wrong, most of the focus in Washington is on small business, and whether banks are reluctant to lend or businesses are wary of borrowing (in truth, it's both), President Obama clearly believes banks need to be doing more. At a White House summit of large-bank CEOs in December, he urged bankers to take second or even third looks at loan applications they previously rejected. In a similar meeting with community bankers the next week, he practically begged them to start making more loans to small businesses. "There are businesses that are looking for loans out there, that are profitable and ready to make money, and the key is to match them up with banks that are in a position to lend," Obama said.

Seems simple enough, except bankers say the message about lending isn't getting through to regulators.

"The president can say he wants us to lend to small business, but he doesn't have authority over our regulators, and our regulators come in and pound community banks over certain kinds of loans," said Matt Gambs, the chief executive officer at Diamond Bancorp in Schaumburg, Ill.

Even well-capitalized community banks are being asked to boost capital ratios these days, leaving them with less capacity for lending.

So what can government do to get banks lending and businesses borrowing again?

One idea many bankers are pushing is to keep the guarantee on SBA 7(a) loans at 90 percent at least through the end of September, with some even arguing that Congress should authorize funding the higher guarantee through 2011.

"When the economy starts to recover is when businesses will need working capital," says Mark Schroeder, the president of German American Bancorp in Jasper, Ind., and one of the 11 community bankers who spoke with President Obama at the Dec. 22 meeting. Given this, the higher guarantee will become a more significant factor going forward, he contends. "You don't want to pull it just as the economy is starting to ramp up."

Still, SBA loans make up just a fraction of the overall small-business lending market, and besides, loan-guarantee programs can only go so far.

We asked several industry experts, with decades of combined experience, what else the federal government could do to get money flowing to small businesses. Here are four of their recommendations.

Back in October, the Treasury Department announced a plan to use TARP funds to make more capital available to community banks that agree to increase their small-business lending. Treasury Secretary Timothy Geithner even mentioned the plan in his arguments for keeping TARP alive.

But by early January, the Treasury had yet to act.

"The Obama plan of making additional TARP funds available to small banks that commit to making more loans is on point," says Rob Klingler, a bank regulatory attorney in the Atlanta office of Bryan Cave LLP. "The trouble is that nothing has happened."

Under the plan, banks with less than $1 billion of assets could apply for TARP funds if they promise to use the money to boost small-business lending. In addition, the Treasury said it would reduce the dividend banks pay on the funds to 3 percent for the first five years (instead of the usual 5 percent).

With little being said about the plan in the months since it was first introduced - with much fanfare - some members of Congress are getting a little antsy.

In a letter to Geithner, Sen. Carl Levin, D-Mich., says that he has heard from "countless creditworthy businesses" in his home state that access to capital from community banks has dried up.

"As the administration is currently considering steps to create much-needed jobs, I urge you to utilize the TARP, which was originally intended to keep credit flowing and our economy moving, to finally do what it was intended," Levin wrote in the Dec. 14 letter. "Smaller banks should have improved access to the program to shore up their positions, so that they may continue to lend."

And if the administration wants a lot more bang for its buck, Klingler offers another suggestion.

"Go a little further and loosen the requirements on which community banks are eligible for TARP funds," he says. "The standards have consistently tightened since the program began. The standard now is such that if banks can demonstrate that they need the funds, that means they are not eligible to get them."

It would be a big mistake to underestimate the effect a relatively small investment can have on a local economy, says Klingler.

"Five million dollars in additional capital in New York City isn't a blip. But $5 million in small-town USA can make a huge difference. We're talking not about loans to General Motors but to the hardware store on the corner looking to expand. Bank of America doesn't have a branch in every town in the U.S., but every town in the U.S. has a bank."

If the real goal is to increase the amount of capital flowing to small businesses, then the federal government ought to lift the moratorium on charters for new industrial loan companies, says Kirk Weiler.

Weiler is the president and CEO of Wright Express Financial Services Corp., a Salt Lake City industrial loan company that provides funding for small businesses to buy fuel. The ILC is a subsidiary of Wright Express Corp. in South Portland, Maine, which provides fuel charge cards to companies with vehicle fleets.

Most ILCs, like Weiler's company, target a particular niche. Postage meter manufacturer Pitney Bowes Inc., for example, has an ILC that provides credit for small businesses to finance their postage.

More than four years after Wal-Mart Stores Inc.'s 2005 application to create an ILC sparked an outcry from bankers across the country, ILC activity has mostly stagnated. From mid-2006 to early 2008, the Federal Deposit Insurance Corp. had a moratorium on nonfinancial firms applying for ILC charters.

Bankers generally dislike the ILC model because it allows commercial companies, which do not have the burden of oversight by federal regulators, to get into the banking business. (Only the ILC itself is subject to state supervisors and the FDIC.)

But, Weiler says, ILCs are in a much better position than banks to fund small businesses. That's because ILCs are under less capital strain.

"Right now, banks are faced with this pressure to lend more yet to maintain appropriate amounts of capital and to reduce their credit losses," he says. "If you look at the numbers over time, industrial banks have been the best capitalized in the nation."

Weiler concedes that lifting the moratorium would be hugely unpopular with the banking community. But, he says, the government's goal should be helping small businesses grow, not making bankers happy.

Strictly speaking, U.S. banks are required to maintain a total risk-based capital ratio of 10 percent to qualify as well capitalized. However, regulators often pressure banks to hold capital above the 10 percent level-particularly in bad economic times.

Times don't get much worse than these, and regulators' predilection for increasing capital requirements is, by some accounts, at an extreme. Many banks are facing significant capital hurdles, even some that already comply with the usual standards.

"All of the federal regulators are requiring capital levels higher than historical levels and statutory requirements," Klingler says. "It varies by regulator and institution, but we are not surprised when we see 14 percent capital."

The obvious effect of increased capital requirements is that it makes lending more expensive, and with margins already tight, an effective 40 percent increase in required capital can be enough to lead bankers to turn away borrowers they would ordinarily welcome.

Diamond Bancorp's Gambs says that regulators could immediately free up more lending capacity by changing the way capital is calculated and the way loan losses are accounted for. Currently loan-loss reserves do not count toward a bank's capital, and Gambs thinks regulators ought to consider changing that rule.

The idea is not a new one. As both loan-loss reserves and capital are meant to protect the institution against losses, many have argued that they should be accounted for in the same way. But regulators and accounting-standards groups have never warmed to the idea.

Failing a change in capital treatment, regulators could look to a tactic that was used during the last major industry crisis: allowing banks to spread loan losses over 10 years. Gambs says such a provision would make a huge difference to community bankers concerned about taking on risk in troubled economic times.

"A million-dollar loss is nothing to Citibank," he says. "But it is a deal-changer for a small bank."

Have banks stopped lending to small businesses? Some absolutely have. Can the government change that? Maybe not.

But bankers can find ways to do more.

"The government can't fix anything," says Dale Kluga, president of Cobra Capital LLC in Darien, Ill. "The banks need to take a little self-help medicine here."

Kluga's firm, which primarily provides equipment-lease financing, is what he calls a "second-tier" lender. Essentially, companies that can't get bank financing come to him.

Lately, he says, the caliber of borrower coming to him for financing has been extremely high. "We are seeing very bankable credits getting turned down by banks out of hand and randomly. We are proof that it is not only the big banks that put this credit freeze on small business. It is unequivocally clear that it is permeating into the small banks now."

Kluga's suggestion for getting more credit flowing to small firms is for community banks to simply take initiative - and stop following the lead of the big banks. He advises banks to network with strong business customers to identify growth sectors and consider doing more asset-based lending, either directly or through partnerships with nonbank financial institutions.

"This is what successful banks tell us they are doing: forming strategic partnerships with healthy nonbank financial institutions, like asset-based lenders and factors," Kluga says.

Others agree that banks have it largely within their power to increase loans to small businesses - if they are willing to ditch their recent focus on real estate lending and get back to the business of real loan underwriting.

"We have to go back to doing the job," says Gambs. "A lot of people just got lazy about doing the work. I don't think solving the problem is that complicated. We just have to be willing to do the work."

In the end, real relationship banking is what will propel small-business growth, he says. "Community bank lenders are the people small businesses want to bank with, and they are the people who we want to do business with."

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