Finance Companies Account for a Decreasing Share of Small Business Credit

Finance Companies Account for a Decreasing Share of Small Business Credit

Bank lending to small businesses has been on a long term decline, with number of loans of less than $1 million – a common proxy for small business lending – falling from 51 percent of the number of commercial and industrial loans in 1998 to 25 percent in 2014, data from the Federal Deposit Insurance Corporation reveals.

Some observers have suggested that finance companies – non-bank entities that raise money by issuing commercial paper and bonds rather than by taking deposits – have been substituting for banks as a source of small business credit. However, Federal Reserve data show that finance companies have been accounting for a shrinking share of small business loans for nearly two decades.

Finance companies are an appealing source of credit to some small business owners. While they often charge higher interest rates than banks, they also tend to approve small company loans at a higher rate than banking institutions. Moreover, finance companies offer a variety of secured and unsecured credit to small businesses, from vehicle loans to equipment loans to loans against accounts receivable. (At the end of 2013, the Federal Reserve estimates that vehicle loans and leases accounted for 35.6 percent of the value of business loans and leases owned and securitized by finance companies; equipment loans and leases made up 43.0 percent of the total value of finance company business loans and leases, and accounts receivable financing comprised 21.4 percent of the total.)

Using data from the Federal Reserve’s Financial Accounts of the United States accounts, which summarizes the on-and-off balance sheet data that the monetary authority collects quarterly from finance companies, I calculated outstanding financing company loans as a fraction of both total liabilities and outstanding loans at the Federal Reserve’s proxy for small companies, noncorporate nonfinancial businesses (the combination of sole proprietorships and partnerships that comprises 82 percent of all U.S. companies), annually from the 1980s until last year.

As the figure below shows, finance companies were a growing source of small business finance in the 1980s and first half of the 1990s. However, since the mid-1990s, their share of outstanding small business loans and liabilities has decreased substantially, falling from 2.6 percent of outstanding loans in 1995 to 0.9 percent in 2013, and from 2.0 of outstanding liabilities in 1995 to 0.6 percent in 2013.

Finance companies have not, it appears, made up for the declines in bank lending to small businesses that have occurred in recent years. While the $38.9 billion in finance company loans to nonfinancial noncorporate businesses outstanding in 2013 may sound like a lot, it’s not when it’s compared to the $4.2 trillion in total outstanding loans on the books of these businesses.

finance company

Money Photo via Shutterstock

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.