Any small business owner who has recently tried to take out a loan will tell you that it is not easy. Now data clearly shows the wider effects of this battle.
The Wall Street Journal recently reported that the 10 largest banks in the country that provide small loans to businesses borrowed $27.8 billion less in 2014 than the industry’s peak in 2006, according to the Journal’s analysis of federal regulatory filings. (1) This decline has forced many small business owners to turn to more expensive sources of financing.
The response is similar to that of individuals being rejected by banks and then resorting to expensive and risky alternatives. For businesses, these can be non-bank lenders, often in the form of online businesses that require little or no collateral but charge much higher interest rates than banks. While not all of these lenders are predatory, the space is still largely unregulated. For small amounts of money, some entrepreneurs turn to not-for-profit microloans or crowdfunding to fill gaps, though both have serious limitations.
But many businesses just turn to credit cards when they can’t get traditional small business loans. According to the Journal, small business spending on credit and debit cards will reach an estimated $445 billion in 2015, compared to $230 billion in 2006, when conventional loans were readily available. (1)
It may be more profitable for banks, but this solution is bad and probably unsustainable for entrepreneurs. As Robb Hilson, a small business executive at Bank of America, told The Wall Street Journal, “If someone wants to buy a forklift, there’s no point putting it on a credit card.” (1) Still, many small businesses have little choice for now.
This result is not surprising. Large banks generally find small loans unattractive, partly because of the relatively high costs and partly because of stricter regulations. An analysis by Goldman Sachs earlier this year identified reduced availability of credit as one of the main reasons why small businesses have failed in the aftermath of the financial crisis, while large companies have largely recovered. (2) When regulators cracked down, it became unprofitable for banks to serve other than the most creditworthy customers. Startups rarely make the cut.
My own experience reflects that of others. Even with a 23-year-old company operating across the country, banks want hard collateral before making substantial loans. And when a company’s most important assets are loyal customers and truly savvy employees, personal real estate is the only collateral available. And even real estate wasn’t enough at the first bank I approached; geography also came into play. If banks consider our established business too risky to provide unsecured loans, many smaller or newer companies don’t stand a chance.
With big banks out of reach, small community banks should have been willing to step into the gap and eagerly attract new customers. But that has not happened, largely because the number of such banks continues to decline. This trend predates the Dodd-Frank financial regulation, but the regulation greatly accelerated the community banks’ loss of market share.
This is not to say that all community banks will go under immediately. On the contrary, recent data from the Federal Deposit Insurance Corp. suggest that those who have persevered have expanded lending and narrowed the profitability gap with larger banks.
While this is good news, it is not enough to close the gap in small business lending. And it seems unlikely that will happen any time soon, as new banking establishments have fallen almost to zero, creating a supply from lenders eager to cut off new customers. According to an April 2014 FDIC report, there were only seven new bank charters in total between 2009 and 2013, compared to more than 100 a year prior to 2008.
The small banks that have survived have done so largely by being as risk averse as the big banks they compete with. Regulations have simply made it foolish to act otherwise. But this leaves all small businesses, except those with an established history, sterling credit and substantial collateral, with no resources to secure the capital they need to grow their businesses.
Small businesses are crucial drivers of new jobs and new products for our economy; their credit problems are probably a major reason why this economic expansion has been slow by historical standards. We’ve made it unattractive for big banks to serve small businesses, and small banks aren’t ready to close the gap. We all pay the price.
1) The Wall Street Journal, “Big Banks Cut Small Business Lending”
2) Goldman Sachs, “The Two Speed Economy”