Economic Focus: The Demographics of Decline in Small-Business Lending

Gary S. Corner , Rajeev R. Bhaskar

Small-business lending has recently received attention in the media and on Capitol Hill as lawmakers look at factors involved in the financial crisis. Some small businesses rely on family and friends for start-up capital, expansion or financing of day-to-day operations. But many small businesses eventually turn to financial institutions. According to a July 2009 study conducted by the Small Business Administration’s Office of Advocacy, 90 percent of small businesses relied on some sort of credit in 2003. The study further notes that approximately 60 percent of the credit was held by commercial banks.

Just as bank lending is important to small businesses, small-business loans are important to banks. Even though the relationship model may differ, both small and large banks benefit from the small-business lending activity.

Which Size Banks Make Small-Business Loans?

Figure 1 shows the ratio of small-business loans to total loans for commercial banks of five different sizes (grouped by total assets). The figure depicts a distinct picture: On average, the smaller the bank, the greater the percentage of small-business loans in the bank’s loan portfolio. For banks with less than $500 million in assets, for example, small-business loans constitute 27 percent of the overall loan portfolios, compared with only 5 percent for banks with more than $50 billion in total assets. The banks in the other asset size classes hold small-business loans in between these two percentages.

Figure 1

Concentration of Small-Business Loans at Different Bank Groups

Bank sizes per total assets

Figure 1

SOURCE: Call Reports. Small-business loans are defined in the Reports of Condition and Income as nonfarm nonresidential and commercial and industrial loans with original amounts of $1 million or less. Small-business loans are reported annually on June 30.

Trends in Small-Business Lending

Loans to small business are a big business for commercial banks. There were 16.8 million small-business loans outstanding at all U.S. commercial banks on June 30, 2008, with a book value of $615.9 billion. This figure contrasts with just $297 billion outstanding as of June 30, 1993. (See Figure 2.) The increase translates into 6.7 percent average annual growth.

Between June 30, 2008, and June 30, 2009, however, the growth trend reversed. The outstanding loan volume at commercial banks fell by $13.5 billion, or 2.2 percent. This was the first annual decline since 1993, a period that included two recessions. While data are insufficient to quantitatively determine the reasons for the decline, many lenders attribute the decline to a combination of a deep and prolonged recession; a tightening of credit standards, which had become lax during the early part of the decade; and a general lack of demand for credit.

The Growth in Small-Business Loans at Large Banks

The demographics of institutions in the small-loan business have changed dramatically over the past decade. Figure 2 shows that most of the growth in outstanding small-business loans has come from the largest banks (banks with greater than $50 billion in assets). Loans at the largest banks grew from $6.2 billion in 1993 to $234.5 billion in 2009. Over this period, total small-dollar loans to businesses held on the books of banks with less than $50 billion in total assets remained more or less at the same level. As a consequence, the largest banks now have the largest dollar volume of these loans, even though the percentage of the loan portfolio is relatively small. The dollar volume of small-business loans held by the smallest banks, on the other hand, dropped from 47 percent of the total outstanding in 1993 to 25 percent in 2009.

Figure 2

Trends in Small-Business Lending by Banks of Different Sizes

Figure 2

SOURCE: Call Reports

One explanation for the trend is the advent of small-business scoring models in the mid-1990s. This coincides with the surge in small-business lending at the large banks. Credit-scoring models automate much of the human involvement of the loan application process and, thereby, speed up the underwriting process. They are also used in the awarding of credit through small-business credit cards. Of course, such models are also sensitive to changes in such things as credit scores or changes in credit standards.

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