The economy's climb out of recession could be slowed by a negative feedback loop under which small banks - hammered by their disproportionate exposure to commercial real estate assets - pull back lending to small businesses, hindering job growth.
The drag on employment, in turn, could prolong trouble in commercial real estate by making it harder to fill buildings with tenants, according to Dennis Lockhart, the president of the Federal Reserve Bank of Atlanta.
Banks with CRE loans in excess of three times Tier 1 capital hold about 40 percent of small-business loans, according to Lockhart. Many of these banks, concerned about CRE defaults, could be holding on to capital that they might otherwise use to lend to businesses looking to develop new products or expand into new markets.
These banks are also vulnerable. Fifty banks failed in the third quarter and most had CRE portfolios that accounted for one-third to three-quarters of total assets. Yet many were also active small-business lenders. Twenty-two had ratios of small-business loans to total assets of 15 percent or more.