Since 2000, the overall volume of business lending per capita at banks has grown by 26 percent (adjusted for inflation). But this expansion has entirely benefited large businesses. Small business loan volume at banks is down 14 percent and micro business loan volume is down 33 percent. While credit flows to larger businesses have returned to their pre-recession highs, small business lending continues to decline and is well below its pre-recession level. Growth in lending by credit unions has only partially closed this gap.
There are multiple factors behind this decline in small business lending, some set in motion by the financial crisis and some that reflect deeper structural problems in the financial system.
Following the financial collapse, demand for small business loans, not surprisingly, declined. At the same time, lending standards tightened dramatically, so those businesses that did see an opportunity to grow during the recession had a harder time gaining approval for a loan. According to the Office of the Comptroller of the Currency’s Survey of Credit Underwriting Practices, banks tightened business lending standards in 2008, 2009, and 2010. In 2011 and 2012, lending standards for big businesses were loosened, but lending standards for small businesses continued to tighten, despite the beginnings of the recovery. These tightened standards were driven in part by increased scrutiny by regulators. In the aftermath of the financial crisis, regulators began looking at small business loans more critically and demanding that banks raise the bar. Many small businesses also became less credit-worthy as their cash flows declined and their real estate collateral lost value.
All of these recession-related factors, however, do not address the longer-running decline in small business lending. Fifteen years ago, small business lending accounted for half of bank lending to businesses. Today, that figure is down to 29 percent. The main culprit is bank consolidation. Small business lending is the bread-and-butter of local community banks. As community banks disappear — their numbers have shrunk by nearly one-third over the last 15 years and their share of bank assets has been cut in half — there are fewer lenders who focus on small business lending and fewer resources devoted to it.
It’s not simply that big banks have more lucrative ways to deploy their assets. Part of the problem is that their scale inhibits their ability to succeed in the small business market. While other types of loans, such as mortgages and car loans, are highly automated, relying on credit scores and computer models, successfully making small business loans depends on having access to “soft” information about the borrower and the local market. While small banks, with their deep community roots, have this in spades, big banks are generally flying blind when it comes to making a nuanced assessment of the risk that a particular local business in a particular local market will fail. As a result, compared to local community banks, big banks have a higher default rate on the small business loans they do make (see this graph) and a lower return on their portfolios, and they devote far less of their resources to this market.
More than thirty years of federal and state banking policy has fostered mergers and consolidation in the industry on the grounds that bigger banks are more efficient, more effective, and, ultimately, better for the economy. But banking consolidation has in fact constricted the flow of credit to the very businesses that nourish the economy and create new jobs.
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