The small business lending sphere has changed enormously over the last few years. As online lending is becoming more and more of a real option for those not meeting the credit standards of the banks, it is easy to forget that this is a brave new world. Looking at the data from the last eight years offers valuable understanding of how this change came to be. As necessity is the mother of invention, it is vital to look back at the past issues of this specific sphere and what brought on this unique change. If small businesses make up over 85% of all US economy why has this change come only just recently?
Every five years US Congress is given a report of small business lending by the Board of Governors of the Federal Reserve System. This extensive study’s purpose is to offer an overview of the field including and extensively focusing on small business’s credit needs, what alternatives are available for small businesses, and even what the risks are in lending to these businesses. This report is essential for keeping up with market trends, overseeing business developments and most importantly, making sure the 2008 economic crisis does not repeat itself. Beyond these, Congress and other legislature bodies understand why small business funding is difficult and often come with greater risks. It is interesting to note that there have been government attempts to solve the issue of small business funding for a while now.
Self-reliance Instead of Financial Aid
One of the problems with constructing a report of this magnitude is the act of gathering all the information in order to draw a true, complete picture of the small business lending sphere. The reasons are that it is an everchanging field, the funding sources are extremely varied and the credit needs change from one small business to another. Using different surveys this report gives some interesting insights to the changing world of small business lending. For example, and perhaps not surprisingly, the most common type of financing for small businesses, up until 2017 was owner financing. Entrepreneurs understood that in America, if you want to start a business you must be self-reliant. At least, as you are starting out.
Older businesses have a background and a history and therefor are much better candidates for bank loans. The younger the business, the more likely it had to rely on self-funding, or help from family and friends. Another interesting thing shown by the report is that in 2014 most of the small firms simply did not apply for bank loans. Surprisingly, of the 13% that did apply more than half received the requested funding. This means that the anticipation of a loan rejection was a big factor for small businesses needing finance. Also, many of those surveyed said the reason for not applying for a loan is simply not wanting to accumulate debt.
The Conflicts of the Banking System
The small business lending market has always been dependent on the banking sphere which has changed greatly over the last 25 years. With mergers and acquisitions narrowing the banking field, a bank has much less leeway for mistakes. Simply put, the bank cannot afford to take a chance on newer, insecure groups. This is obviously the explanation for the bank’s clear preference for large, stable companies. In 2016, 58.2 of all US banks had assets of 250M or less, but only 9.1% of their loans were to small businesses. Savings and loans offered even less. Between 2012 and 2015 Venture capital investment in small businesses increased by 50%, from 41B to almost 80B, with the numbers dropping a little in 2016.
The policymakers and the government have long been searching for a solution for the financial needs of small businesses. The understanding that this is an important federal interest has been discussed in the US for decades. Several programs have been initiated whether locally, state-wide or federal, especially those encouraging minorities and women-owned businesses. Some of the loans offered in promoting businesses in low-income communities and underprivileged neighborhoods are SBA loans. From 2012 to 2016 SBA loans grew from 4.5B to 8.5B dollars. Overall the analysis is that in these years the funding options were stable, while limited. Surprisingly small business owners displayed little demand for loans.
Prejudice and Discrimination
This report shows another surprising element, which if considering the social infrastructure of the US, might not be so surprising after all. Of all black-owned small businesses applying for funding from banks, less than half received bank funding. In fact, even the black-owned companies that received loans, did not get the full amount they had asked for. This blatant discrimination is dismissed by the banking system with different excuses. One of them is that the black community lacks the understanding of the loan system, due to insufficient education, and so presents a bigger risk. Many black and Latin owned companies stated in the report that they did not even seek out a bank loan, knowing the prejudiced attitude would leave them out in the cold.
Luckily, these days, the options are growing and the bank is no longer the only means of obtaining a small business loan. Alternative lenders should be aware of the potholes of small business lending but strive to offer better options. Looking at the small business’ capabilities should be thorough but fair. The assessment should be based on the business potential and not the color of the owner’s skin or neighborhood. The bank system, abiding by the rules of yesterday, is just now realizing its’ old road has given room to endless competition. It is up to these alternative lending facilities to revolutionize not just the system, but the approach to loan seekers. With these options, a real change is going to come.