Changes in Financial Services during a recession

With the Federal Reserve aggressively increasing interest rates, there’s a high likelihood that our economy is going to be entering a recession very soon. As measured by the Consumer Price Index, inflation rose 9.1% in June, the largest jump since December 1981.

When a recession occurs, there are several industries that get impacted, including small businesses (SMBs) and lenders. SMBs start to see a decline in customer demand as a result of price increases on goods and services. A lot of SMB owners have also started to see challenges in rising costs including their wage bills, packaging and shipping costs, inventory and supply chain issues and more. Covid, labor, inflation, supply chain issues have all led to a pending recession and a potentially tough time for SMBs.

Whether it’s the rise of interest rates or the increasing cost of capital during a recession, a lot of SMBs start to tighten their spend, balance sheet and operating cost. So lenders also have to think about how to navigate underwriting businesses during a recession.

While we haven’t seen a drastic shift in consumer spending, as the recession goes into full play, the spending patterns of consumers will start to shift which means SMBs need to adapt to the potential slow down of consumer spending. SMBs should start to think about their recession forecasting plan and how the change in consumer spending might impact their sales, their inventory and how much capital they need as well in the next few months.

This new behavior from SMBs then opens up an opportunity for lenders to capitalize and provide the best lending solutions during a recession. Lenders also have to think about what changes they need to make in their underwriting models in order to underwrite the risk SMBs can face during a recession.

In this post, we go over both perspectives of SMBs and lenders and best practices for SMB Lending during a recession.

Key Factors to think about in a recession

For SMBs:

Some of the key things SMBs should think about during a recession is how to manage their balance sheet to make sure they are able to sustain business during a recession. Some of the key questions SMBs can ask themselves during a recession include:

1. How will I get impacted by a recession?
2. Is the good or service that I sell an essential one?
3. How much capital do I have to spend?
4. What are my essential and non-essential costs?
5. What should I invest in during a recession?

In addition to these key questions for SMBs, they should also think about what types of lenders might be able to help them build a cash pile that will enable them to sustain their business and potentially even grow during a recession. It’s important for every SMB to develop strong relationships with lenders that can offer resources that they can access quickly.

For Lenders:

For lenders, a recession can be a double edge sword. It’s important to really be diligent in how to approach underwriting SMBs and digging into the data available. Some of the key questions lenders can ask themselves during a recession include:

1. How will I get impacted by a recession?
2. What sectors will be risky for us to lend to that we should not be underwriting?
3. What sectors will be resilient and have the opportunity to grow during a recession that we should be spending more time with?
4. How should I package my lending products in order to capture the right amount of value during a recession?
5. How do I de-risk and protect myself from the downside cases?

Best Practices during a recession

For SMBs:

1. Focus on core competencies - Every business has something they’re really good at and now is the time to really focus on the core product or service you offer and doubling down on what’s been working.
2. Invest in existing customers - It costs more to acquire new customers than to keep existing customers happy. This is especially true during a recession where people are cutting down on their spending making it harder for new customers to give you a try.
3. Understand and protect cashflow - It’s important to really understand what your profit margins, sales, cash flow looks like in order to make sure that you’re able to build a cushion in case sales start to drop during a recession. In addition, having a strong understanding of your cashflow can also help you know if you should start exploring different financing options for your business whether it’s a traditional loan or an alternative financing product like revenue-based financing, invoice factoring, inventory financing, etc.

For Lenders:

1. Streamline the lending application process - By streamlining the lending application process, lenders can help SMBs have a reliable option to tap into and lenders are able to easily capture the business of SMBs looking for quick financing in this environment.
2. Adjust underwriting model - Given the recession, it’s good for lenders to be wary that historic trends of a SMB from their previous sales and financial statements might not translate to what the future sales and cashflows will be in a recession which means adjustments to how one underwrites is important to make.
3. The more data the better - During a recession, it becomes even more important for lenders to get the full picture of a business through accounting, commerce and payments data. These additional data points can help you really dig into understanding key metrics like: how much runway a business has, what the incremental margin looks like, what their customer concentration looks like, how sticky their customers are, how fast their costs are growing, what their profit margin looks like, etc. These are all key metrics that can help one understand whether or not a business will do better during a recession or not.

For lenders out there, a solution like Rutter’s Universal Commerce API to read data from accounting systems, ecommerce platforms, payment processors can help you get the full picture on any business you’re underwriting to make the best decision especially in this market environment.

Some of the most innovative neolenders and fintech companies like Uncapped, Wayflyer, Ramp, Mercury, Parafin and more use Rutter’s Universal Commerce API to access this data. Get a demo here.