President Obama’s proposal to ease the credit squeeze on small business by redirecting $30 billion in TARP funds to community banks is getting a qualified thumbs-up from the head of a community bankers’ organization in the state as well as Minnesota’s two Democratic senators. The plan, however, is drawing fire from congressional Republicans.

Marshall MacKay, president and CEO of the Independent Community Bankers of Minnesota, says “it’s a good idea” to increase small-business lending through community banks, “but the devil is in the details.” However, he does not favor direct government investment into the banks, which is the current administration approach.

“Captial is what you want, and that’s what was so attractive about the TARP program initially” that put needed capital into banks, MacKay said. But “liquidity is not the issue” holding back small-business lending by most community banks in Minnesota.

President Obama’s budget proposes creating a new Small Business Lending Fund to “invest in smaller banks capital under terms that provide strong incentives to increase lending,” according to the White House website.

Citing the negative reputation the TARP program now has among bankers, MacKay would prefer to see the administration strengthen the Small Business Administration lending programs. The SBA guarantees a large portion of an approved small-business loan, offloading most of the risk from the lender. Pointing out that Minnesota small businesses received $525 million in SBA loans in 2009, he said, “It’s a program that works, that’s proven, that community bankers know.”

In addition, MacKay noted that his member banks have not changed their lending criteria, but many small-business owners have become more cautious about taking out loans to expand their business in the middle of a recession, weakening loan demand.

MacKay was not totally surprised by the administration proposal because he had “heard about the $30 billion” last November when he was in Washington, D.C.  Pointing out that community banks have an important role to play in small-business lending, he hopes the administration proposal is “not more political rhetoric.”

Meanwhile, Minnesota’s two senators, Amy Klobuchar and Al Franken, joined with 16 colleagues to send a letter to Treasury Secretary Timothy Geithner calling for “immediate steps to dedicate more attention and resources from TARP to stabilize community banks.” The letter signers offered to work with the administration to “improve existing programs to strengthen community banks” and offered “a number of new proposals to improve the availability of credit for small businesses.”

At the same time, the use of TARP funds is drawing fire from congressional Republicans. In a CNN news report, New Hampshire Sen. Judd Gregg said: "The law is very clear. The monies recouped from the TARP shall be paid into the general fund of the Treasury for the reduction of the public debt ... It's not for a piggy bank because you're concerned about lending to small businesses."

Citing the recent failure of Marshall Bank in Hallock, as a half-dozen community banks in Minnesota since the recession began in 2007, MacKay pointed out that smaller banks are “bearing the brunt of consequences [for a recession] they did not cause,” and “smaller banks are not able to weather the storm.”

MacKay’s organization has 240 community bank members across 560 communities in Minnesota, with assets ranging from $10 million to $2.6 billion.

Minnesota and Wisconsin have led the nation in the use of one particular type of SBA loan, known as an ARC loan (America’s Recovery Capital Loan Program), according to Kristin Wood, executive director of SPEDCO, a St. Paul-based nonprofit that helps small businesses receive SBA loans.

ARC loans provide up to $35,000 to cover up to six months of principal and interest payments on existing debts of small businesses. “This is for a small-business owner who can’t pay his bills,” she said. As a result, most banks are reluctant to participate because they expect a high default rate.

In related news, Reuters reported that “defaults by small and medium-sized U.S. businesses on loans, leases and credit lines to finance capital equipment investment fell for the first time in two years. The drop snapped a two-year increase in defaults which crept up steadily along with other measures of borrower stress as the economic downturn and the shutdown of the credit markets put the squeeze on businesses.”