Big banks avoid small businesses

Any small business owner who has recently tried to get a loan will tell you that it is not easy. Now the data clearly shows the broader effects of this struggle.

The Wall Street Journal recently reported that the nation’s 10 largest banks that make small loans to businesses decreased by $ 27.8 billion in 2014 from 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 answer is similar to that of people who are turned away 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 or no collateral, but charge much higher interest rates than banks. While not all of these lenders are predators, the space is still largely unregulated. For small amounts, some business owners are turning to nonprofit microlenders or crowdfunding to try to fill in the gaps, although 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 charge cards will total 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 business owners. As Robb Hilson, a Bank of America small business executive, told The Wall Street Journal, “If someone wants to buy a forklift, there is no point 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 stricter regulatory requirements. An analysis by Goldman Sachs earlier this year cited the reduced availability of credit as one of the main reasons why small companies have faltered in the wake of the financial crisis, while large companies have largely recovered. (2) As regulators cracked down, it became uneconomical for banks to serve clients other than the most creditworthy. 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 solid collateral 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 find our established business too risky to make unsecured loans, many smaller or newer businesses don’t stand a chance.

With the big banks out of reach, the small community banks should have been ready to step up, enthusiastically courting new customers. But that has not happened, largely because the number of those banks continues to decline. This trend predates the Dodd-Frank financial regulations, but the regulations dramatically accelerated the loss of market share for community banks.

This is not to say that all community banks are in immediate danger of collapse. In contrast, recent data from Federal Deposit Insurance Corp. suggests that those who have stayed have expanded their loans 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 shrunk to near zero, thus cutting off a supply of lenders eager for new customers. According to an April 2014 FDIC report, there were only seven new bank bylaws in total between 2009 and 2013, compared to more than 100 annually before 2008.

The small banks that have survived have done so largely 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 an established track record, sterling 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; Their credit struggles are probably a major 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 prepared to fill the void. We all pay the price.

Sources:

1) The Wall Street Journal, “Big Banks Cut Small Business Lending”

2) Goldman Sachs, “The Two-Speed ​​Economy”