source: CNNMoney.com by Catherine Clifford

The biggest Wall Street banks slashed their small business loan portfolios by 9% between 2008 and 2009, more than double the rate at which they cut their overall lending, according to a government report released Thursday.

The Congressional Oversight Panel report spotlights the role banks, especially the largest ones, played in the credit crunch that has plagued small companies throughout the recession.

“Big banks pulled back on everyone, but they pulled back harder on small businesses,” Elizabeth Warren, the panel’s chairwoman, said on a conference call with reporters ahead of the report’s release.

Warren’s oversight committee was established to keep tabs on the federal government’s financial stabilization effort, the Troubled Asset Relief Program (TARP). The committee’s May report focuses on the role TARP played in improving credit access for small companies.

The grim conclusion: It failed.

The biggest TARP program pumped billions in low-interest capital into banks, but did not require that banks lend that money back out. When it came to extending credit to small firms, most big banks took a knee.

In the seven months that the Treasury required the 22 biggest TARP recipients to report their small-business lending, the banks collectively cut their lending by 4.6%, reducing their outstanding balances by $12.5 billion.

The problem remains an urgent one. “Small business credit remains severely constricted,” the report’s authors concluded. “Unable to find credit, many small businesses have had to shut their doors, and some of the survivors are still struggling to find adequate financing.”

Mapping the problem: Just how bad is the small-business credit shortfall? It’s impossible to tell, thanks to lax data collection and regulatory reporting requirements.

The definition of “small business” varies widely — even the government’s Small Business Administration uses different measures for firms in different industries — and what banks consider a “small business loan” includes everything from traditional installment loans to credit lines and credit cards.

The Treasury briefly required the biggest TARP takers to report monthly on their small-business loans, which offered a good snapshot of lending trends through the second half of 2009. But banks were allowed to stop reporting those numbers once they paid back their TARP loans. That left Warren’s commission scrambling through piecemeal data sets.

The government needs to step up its data collection “so that in the future policymakers will not be forced to make decisions with too little information about what is actually happening,” the report says.

Warren called the data problem “enormously frustrating,” adding that it is “virtually impossible to get a clear assessment of these programs when you don’t have good data.”

Within the limited data available, a pattern is clear: Small companies can’t get the credit they need. Federal Reserve data shows “a precipitous drop in lending to small businesses in the last quarter of 2008, and conditions that remained tight throughout 2009,” the report notes.

Small banks still not lending

One bright spot in a bleak credit landscape has been SBA lending. Thanks in part to government incentives, the number of SBA-backed loans rebounded from last year’s lows and is approaching pre-recession levels. The agency’s flagship program backed almost 29,000 loans in the past six months, totaling $7.5 billion.

But SBA lending represents only a sliver percentage of the overall small business credit landscape: about 4%, Warren’s report estimates.

The Treasury is attempting to jumpstart other lenders with new plans to pump inexpensive capital into financial intuitions, especially small banks and community lenders.

Warren’s report criticizes many of the plans being discussed. Supply-side solutions may be doomed to failure, it suggests, because small banks have limited reach and megabanks simply won’t start lending again until it’s in their financial interests to do so.

But if the federal government does move forward with new lending incentives, Warren wants to see them tightly focused and tied to measurable goals.

“Our experience with TARP has shown that giving money to banks without strings attached does not produce the advertised result,” she said.