As the Head of Credit Risk at Biz2credit and Biz2X, I manage a team of risk and data science processionals across North America and India, focusing on credit and price decisioning, automation and efficiency in customer journey, and portfolio risk management. My career spans almost two decades in banking and financial services across both consumer and business lending, including at Goldman Sachs and Citibank. This extensive experience in lending businesses provides me with a unique perspective on the evolving landscape of small business lending (SMB) and the pivotal role interest rate and macro-economic outlook plays.   

Understanding Higher for Longer 

What is Higher for Longer and its Economic Impact? 

The phrase "higher for longer" refers to the scenario where elevated interest rates persist beyond the initial expectations. Originally, there was optimism that interest rates would begin to decline by 2023 or early 2024. However, this has not come to fruition. There is a tapered expectations now of one or two rate cuts in 2024. Whether there is a rate cut or not, and whether there are 2 or 5 rates cuts, we don’t expect to go back to an era of extremely low interest rates in the foreseeable future. The financial sector must prepare for the reality that higher interest rates could be here to stay. 

The impact of sustained high-interest rates on the economy is profound. High rates can dampen consumer spending and business investments, as borrowing costs rise. This can slow down economic growth, as both consumers and businesses are more cautious with their expenditures. Furthermore, higher interest rates can increase the cost of servicing debt, leading to tighter budgets and reduced financial flexibility. 

Impact on Banks and Small Businesses 

Challenges for Banks and Small Businesses 

For banks, higher interest rates mean increased costs of funds, which can squeeze profit margins if these costs cannot be fully passed on to borrowers. This scenario leads to net interest margin compression, where the difference between interest earned on loans and interest paid on deposits narrows. Banks must navigate this delicate balance to maintain profitability while remaining competitive in their loan offerings. 

Small businesses, on the other hand, face higher borrowing costs, which can strain their cash flows and limit their ability to invest in growth opportunities. For many small businesses, the increased cost of credit may result in deferred expansion plans, reduced hiring, and in some cases, difficulty in maintaining day-to-day operations. Additionally, small businesses with variable-rate loans may experience rising interest expenses, further complicating their financial planning. 

Strategies for Risk Managers 

Dealing with Higher for Longer as Risk Managers 

In the lending industry, the past two generations of bankers and risk managers have operated in a predominantly low-interest-rate environment. The shift to a sustained period of higher interest rates requires a strategic reassessment of risk management practices. 

  1. Accepting Margin Compression: Given that passing the entire increase in interest costs to borrowers is not always feasible, lenders must accept some degree of net interest margin compression. This means absorbing a portion of the increased lending costs, which requires a reevaluation of pricing strategies and cost structures. 
  2. Operational Efficiency through Technology: To offset the impact of higher lending costs, banks must look to reduce operational expenses, particularly in origination and underwriting processes. Embracing technology-based automation, including AI, can streamline these operations, enhancing efficiency and reducing costs. Automated underwriting, real-time data analytics, and AI-driven decision-making can significantly cut down processing times and minimize manual errors, leading to cost savings and improved operational agility. 
  3. Leveraging Advanced Analytics: Utilizing advanced data analytics can provide deeper insights into borrower behavior and credit risk, allowing for more informed lending decisions. By analyzing trends and patterns, banks can better predict defaults and manage their loan portfolios more effectively. This proactive approach to risk management can mitigate potential losses and enhance the overall stability of the lending portfolio. 
  4. Enhancing Customer Relationships: In a higher interest rate environment, maintaining strong customer relationships is crucial. Banks should focus on providing value-added services and personalized financial advice to help small businesses navigate the challenges posed by higher borrowing costs. This includes offering flexible loan terms, advising on cost management strategies, and providing tools for financial planning and forecasting. 
  5. Diversifying Loan Portfolios: To spread risk and reduce dependency on any single market segment, banks should diversify their loan portfolios. This includes expanding into new sectors or geographic regions that may be less affected by higher interest rates. A diversified portfolio can provide a buffer against economic volatility and enhance the bank's resilience. 

      Preparing for a Higher for Longer Future 

      As we navigate the possibility of higher interest rates persisting for a longer period, it is essential for banks and small businesses to adapt their strategies accordingly. By embracing technology, enhancing risk management practices, and fostering strong customer relationships, financial institutions can mitigate the challenges and seize the opportunities presented by this new interest rate environment. The ability to adapt and innovate will be key to thriving in a landscape where higher interest rates are the new norm.