Any small business owner who has tried to get a loan recently will tell you that it is not easy. Now the data clearly shows the broader effects of this fight.
The Wall Street Journal recently reported that the nation’s 10 largest banks that make small business loans lent $27.8 billion less in 2014 than the industry 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 higher-cost sources of financing.
The response is similar to that of people who are turned down by banks and then turn to expensive and risky alternatives. For businesses, these can be non-bank lenders, often in the form of online businesses that require little to 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, some business owners are turning to nonprofit microlending or crowdfunding to try to fill the gaps, though both have serious limitations.
But many businesses simply turn to credit cards when they can’t get traditional small business loans. According to the Journal, small business spending on credit and payment cards will total an estimated $445 billion in 2015, up from $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 business owners. 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 in putting it on a credit card.” (1) However, many small businesses have few options for now.
The result is not surprising. Large banks generally find small loans unattractive, partly because of their relatively high costs and partly because of more stringent regulatory requirements. An analysis by Goldman Sachs earlier this year cited reduced credit availability as one of the main reasons why small companies faltered in the aftermath of the financial crisis, while large companies largely recovered. (2) As regulators cracked down, it became uneconomic for banks to serve less than the most creditworthy customers. Rarely do startups make the cut.
My own experience reflects that of others. Even with a 23-year-old business operating across the country, banks want firm guarantees before making substantial loans. And when a company’s main assets consist of loyal customers and really smart employees, the only collateral available is personal real estate. And even real estate wasn’t enough at the first bank I approached; geography also came into play. If banks deem our established business too risky to make unsecured loans, many smaller or newer businesses won’t stand a chance.
With the big banks out of reach, small community banks should have been ready to fill the void, eagerly courting new customers. But that hasn’t happened, largely because the number of such banks continues to decline. This trend predates the Dodd-Frank financial regulations, but the regulations significantly accelerated the loss of market share for community banks.
This is not to say that all community banks are in immediate danger of going under. By contrast, recent data from Federal Deposit Insurance Corp. suggests that those who have held out have expanded their lending and narrowed the profitability gap with the largest banks.
While this is good news, it is not enough to fill the gap in small business loans. And it seems unlikely that it will soon, as new banking establishments have dwindled to almost zero, thus cutting off supply for lenders eager for new customers. According to an April 2014 FDIC report, there were only seven new bank authorizations in total between 2009 and 2013, compared with more than 100 per year prior to 2008.
The small banks that have survived have largely done so by being just as risk-averse as the big banks with which they compete. Regulation has simply made it foolish to do otherwise. But this leaves all small businesses, except those with an established track record, excellent credit, and substantial collateral, without the means to secure the capital they need to grow their businesses.
Small businesses are crucial drivers of new jobs and new products for our economy; its credit problems are probably a big reason this economic expansion has been slow by historical standards. We have made it unattractive for big banks to serve small businesses, and small banks are not equipped to fill the void. We all pay the price.
1) The Wall Street Journal, “Big banks cut lending to small businesses”
2) Goldman Sachs, “The Two-Speed Economy”