September 1, 2014

Are Banks Losing Interest in Small Business?

If you think that banks are less interested in lending to small business than they used to be, you’re right. In 2012, only 29 percent of all non-farm, non-residential, loans were less than $1 million, a Federal Deposit Insurance Corporation (FDIC) proxy for small business lending.

But the financial crisis isn’t the primary cause of bankers’ shift away from small business lending, despite what many people have suggested. The decline in the fraction of small business loans began well before the financial meltdown.

Data from the FDIC, which keeps records of bank loans to small businesses, shows that small loans (less than $1 million) to business have been a decreasing fraction of all bank loans for the past decade and a half.

small loan share

Source: Created from FDIC data.

As the figure above shows, the rate of decline in the small loan share accelerated in 2008 and 2009, suggesting the impact of the financial crisis. But the decline had clearly started much earlier than 2007.

Because banks began to shift away from small business lending well before the financial crisis and Great Recession, post-2007 changes in the small business finance system aren’t the most likely explanation for the decline.

So what is? I don’t know, but the experts have offered a couple of hypotheses.

First, over the past fifteen years, banks have dramatically increased their securitization of loans – packaging of loans into bonds that can be sold to third parties. Small business loans are not easily securitized because the terms of the loans are heterogeneous and different banks have different underwriting standards. As a result, the desire to securitize might have led banks to reduce their small business lending relative to loans that are easier to package into securities.

Second, the banking industry has consolidated over the past 15 years. Smaller banks are more likely than large banks to lend to small businesses. Therefore, the consolidation of the banking industry, and the rising average size of lenders, might account for some of the shift away from providing small business credit.

Third, the banking industry has become more competitive over the past decade and a half. This competition has led banks to focus on their most profitable loans. Bigger loans tend to be more profitable than smaller ones because revenues tend to increase faster than costs as loan size increases. Because bigger loans are easier to make to bigger companies, increased competition may have led banks away from lending to small businesses.

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Scott Shane


Scott Shane Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool's Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: and The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By.

26 Reactions

  1. Scott: In addition to the reasons you list, do you think demand may be playing a role here? In our work we’re seeing fewer and fewer small businesses looking for bank loans. Capital needs are down due to outsourcing, partnering, contracting, etc.

    Also, when we talk/interview small banks they tell us they have a hard time finding small businesses who meet their lending requirements. In many cases the reason is a lack of tangible assets that can be used as collateral. I wonder if the broader shift towards intangible assets is also having an impact.

    • Steve; I agree, although in my business of coaching business clients to become bankable, we never have a problem finding a bank to do a loan when the numbers we submit meet their underwriting guidelines. That said, it’s a process rather than an event and can take some time to get a client into shape but we work on the front end to raise the probability of success when we finally take a client to the bank.

  2. This is interesting info, Scott. Thanks for sharing it with us. I personally think it would be a shame for banks to put small biz on the back burner. They make up a good percentage of the global businesses and there is still money to be made.

    Ti

  3. I agree with the reasons you give and it does make economic sense for banks to focus on larger loans. I just hope that enough smaller banks can succeed to meet the capital needs of the small business community.

  4. Great data points, Scott.

    You wrote that “Bigger loans tend to be more profitable than smaller ones because revenues tend to increase faster than costs as loan size increases.

    So, it’s all about the money–or the amount that banks can make.

    A few niche small business banks that can offer other small business services, (to make up for lower profit small business loans) could open the market up a bit.

    The Franchise King®

  5. Interesting article. While I don’t think it’s a particularly positive trend that banks are funding SMBs less over the years – perhaps the up-side to less institutional funding is more ‘ownership’ in the business. I’ve encountered a number of business owners that ask me how they can set up their books so as to not pay back the bank loans. There seems to be a feeling of distance when it’s not your hard-earned money. On the flip side, businesses that put down their own money or have taken investments from friends or family members seem to be much more emotionally attached to the business (which carries its own set of pros and cons) and therefore may be more likely to persevere when hitting a rough patch.

  6. What has happened is that alernative private lenders have come into the small business loan space.

    [Edited by Editor]

  7. there is so much conflicting information regarding bank lending to small businesses, particularly in whether trends in lending are increasing or not. Regardless of the banks, small business do have alternative sources of access to capital.

  8. A fair about of small business lending is now being done by alternatives to banks; credit unions, private banks, leasing companies, and private investors doing debt financing.

  9. Scott, I think you’ve opened an opportunity for discussion with this article that most of America has been afraid to talk about. Maybe the decline of small business lending is NOT just the result of the recession. And if that’s true, does that mean that with the end of the recession, small business lending will NOT return to late 1990’s/early 2000 levels? The answers to these questions could possibly permanently change the way we think about small business financing in this country. I don’t think it’s a negative outcome, just a shift in thinking. Alternative, non-bank financing companies have stepped into fill the small business capital void left by the banks over the past 5 years or so. Perhaps it’s time we start thinking about these companies as viable long term financing solutions for small businesses rather than an interim solution until the banks start lending again. Follow The Receivables Exchange (@receivables) on Twitter for more small business financing news.

  10. Banks profit by making loans, not refusing them. So why are banks making fewer loans to small business these days? The decline is, in part, a response to the Federal Reserve’s incentives for banks to increase their lending standards.

    When bank lending standards increase, fewer companies qualify for loans, cutting small business lending.

    Many small business loans are rejected because the “Business” has not created it’s own credit profile, and does not meet the lenders qualifications. The business owner has to separate their personal credit from that of the business. Once a business establishes a
    D&B paydex score, Experian, and a Equifax business profile, loans are much easier to obtain, including SBA funding

    [edited by Editor]

    • Charlie, while I appreciate your comments, as an owner of a sub S corporation in a small business coming off an IRS tax audit, for IRS tax purposes, you do not have “basis” if you separate business from personal credits with regard to working capital and losses. If you have a loss in the business name, you can not write it off on your tax returns unless you go through your personal credit and lend to the corporation.

  11. Regardless of the reason for the shift in lending away from small businesses by banks, there are commercial finance companies that are still very interested in lending to small businesses. Many small business owners are not aware that these companies exist or have ever heard of asset based lending or factoring (aka receivables financing.) Both asset based lenders and factors offer financing against the value of a company’s assets (accounts receivable, inventory, machinery and equipment, etc.) and are less stringent for credit approval. Factors will finance early stage companies that are facing operational or financial challenges or businesses in transition. You can find a listing of asset based lenders and factors on the Commercial Finance Association website (cfa.com) and on the International Factoring Association website (factoring.org). There are plenty of lenders like my company, Coral Capital Solutions that want to help small businesses with their working capital needs.

  12. Good analysis. And, to the extent that small business lending may mostly come from small banks, there is another gotcha coming. The Dodd-Frank Wall Street Reform and Consumer Protection Act imposes such onerous compliance reporting that small banks can’t afford it, resulting in consolidation. Net result – fewer small banks, so there better be alternatives.

  13. I have been trying to refinance my business for two years now. Not only are large banks, in this case Wells Fargo, reluctant to lend to a small business, but their reason is “decreased sales” in the past few years. Come on, we are just coming off the greatest recession that the US has ever seen! We have $600,000 in equity that we can tap but Wells Fargo is refusing an LOC stating “decreased sales equates decreased cash flows.” That is old news! The big bank has nothing to lose squeezing you out your business equity in real estate so that they make a $600,000 profit on our loan. Futhermore, they cause further harm if you want to refi elsewhere by charing an erroneous SWAPP derivative termination fee based on the suspect “libor rate” of nearly $60,000 that they smuggled into closing documents. Banks are legalized thieves causing harm to small businesses. As a society, we should have let the banks fail instead of bailing them out.

    • Kim,
      I understand your frustration and encourage you to adopt the assumption that there is a bank willing work with you. Finding that bank and making the case for why your business is a good fit for them will be the challenge.

      Recently, my group helped a client get a loan for $950,000 to purchase a business, after he had been turned down by ten banks. It took six months but we got his loan approved at one of the banks that had turned him down. I don’t know the details of your situation but can assure you that amazing results are possible when you know where to go, who to talk to and how to structure a proposal where everyone, especially the bank, emerges a winner.

      Without more information, I can’t be specific about what it may take on your part to put this puzzle together but there is light at the end of the tunnel.

      CH

    • Kim, I don’t mean to sound like a shill for Wells, but I seriously doubt that they are interested in your equity (it cost money to litigate and foreclose) or “smuggled” a SWAP into your loan package. Chances are you accepted a Libor based deal with a fixed rate SWAP option. SWAPS have breakage/termination fees. Did you read and understand the terms of your deal before signing the documents or did you want the money so bad that you signed your name and figured you’d handle the details down the road? Did you have a competent commercial lending attorney review your documents? If the answer to any of the above questions is yes, then you can’t blame the bank. That’s your responsibility. Banks are for profit businesses, just like yours..with P&L statements, employees and expenses.

      Sounds like you jumped into a lending situation that was not right for your business long term. I would encourage you to try to work with your bank to restructure a realistic deal that fits your business.

  14. Another element to the decline in small business lending might be due to the type of credit extended. An interesting comparative statistic would be to see the number of credit cards issued to businesses with credit limits of $500,000 or less. From the banks perspective this is a way to extend credit profitably with minimal manpower, processing time, credit review, etc.

  15. Interesting article, it is worrying to hear that fewer banks are backing small businesses and lending funds to expand. On the flip side, are fewer small businesses turning to the banks for funding? Are more small businesses using alternative financing as their first option rather than going to the banks first?

    Mel

  16. I agree with above, perhaps small businesses are going direct to the alternative finance options such as crowdsourcing (we all know how popular this has become), or alternative lenders.

    Jen

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