Any small business owner who has tried to get a loan recently will tell you it’s 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 loans to businesses 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 companies 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, some business owners are turning to nonprofit microloans 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, compared to $230 billion in 2006, when conventional loans were readily available. (one)
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 the reduced availability of credit as one of the main reasons small companies stumbled after the financial crisis, while large companies largely recovered. (2) As regulators cracked down, it became uneconomical for banks to serve less than the most creditworthy customers. Rarely do startups make the cut.
My own experience mirrors that of others. Even with a 23-year-old business operating across the country, banks want firm collateral before making substantial loans. And when a company’s main assets consist of loyal customers and really smart employees, the only available collateral is personal real estate. And even real estate wasn’t enough at the first bank I approached; geography also came into play. If the 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, the small community banks should have been ready to fill the void, eagerly courting new customers. But that has not happened, largely because the number of such banks continues to decline. This trend predates the Dodd-Frank financial regulations, but the regulations greatly accelerated the loss of market share by community banks.
This is not to say that all community banks are in immediate danger of going under. By contrast, recent data from the Federal Deposit Insurance Corp. suggests that those who have hung on 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 anytime soon, as new banking establishments have dwindled to almost zero, thus cutting off supply from 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 to more than 100 annually before 2008.
The small banks that have survived have largely done so by being as risk averse as the large banks with which they compete. Regulation has simply made it foolish to act otherwise. But this leaves all small businesses, except those with established histories, excellent credit, and substantial collateral, without the means to secure the capital they need to grow their businesses.
Small businesses are critical drivers of new jobs and new products for our economy; its credit problems are probably a major reason why this economic expansion has been slow by historical standards. We have made it unattractive for big banks to cater to small businesses, and small banks are not prepared to fill the gap. We all pay the price.
Sources:
1) The Wall Street Journal, “Big Banks Cut Lending to Small Businesses”
2) Goldman Sachs, “The Two-Speed Economy”