Small businesses play a central role in America’s economic competitiveness. Not only do they employ half of the country’s private sector workforce – about 120 million people, but since 1995 they have created about two-thirds of the net new jobs in the USA. However, in recent years, small businesses have been slowly recovering from the crisis and the credit crunch that hit them particularly hard. This lag raised the question: “Is there a credit gap in lending to small businesses?”
This article compiles and analyzes the current state of access to banking capital for small businesses from the best available sources. It is studied the cyclical impact of the recession on small business and access to credit, as well as a number of structural issues that are holding back a full recovery in bank credit markets for small loans.
One of the answers may be a dynamic market for online lenders who are using technology to disrupt the small business lending market. Although these are small competitors compared to the traditional banking market, these new competitors provide fast turnaround and online accessibility for customers, and often use the data to create more accurate credit rating algorithms. Their presence raises many new questions, including who should regulate these new markets? And what will the players do? Finally, if these innovators are the answer to bridging the credit gap in small businesses, especially in underserved markets, how can we ensure that this is not the next subprime market?
Small businesses are critical to job creation in the US economy.
Small businesses create 2 out of 3 new jobs. Small firms employ half of the private sector workforce, and since 1995, small businesses have created about two out of three new jobs – 65% of total jobs created.
Most small businesses are Main Street companies or sole proprietors. Among America’s 28.7 million small businesses, half of all small businesses are home-based and 23 million are sole proprietors. The remaining 5.7 million Small Firms have employees and can be divided into Main Street Moms and Pop Businesses, small and medium-sized vendors to large corporations, and high-performance startups.
During the 2008 financial crisis, small businesses were hit harder than large companies and were slower to recover from a recession of unusual depth and duration.
Between 2007 and 2012, small businesses accounted for about 60% of total job losses. From the peak in employment to the recession to the latest low in March 2009, small business jobs fell by about 11%. In contrast, salaries in large enterprises fell by about 7%. This discrepancy was even more significant among the smallest businesses. Jobs was down 14.1% in institutions with fewer than 50 employees, compared with 9.5% in enterprises with 50 to 500 employees, and overall employment fell 8.4%.
Bank loan, in particular for term loans, is one of the main sources of external finance for small businesses i Michigan, especially those on Main Street, and is key to helping small firms maintain cash flow, hire new employees, purchase new inventory or equipment.
Bank loans have historically been important to small businesses. Unlike large firms, small businesses do not have access to government institutional debt and equity markets, and the vicissitudes of small business profits make retained earnings inevitably a less stable source of capital. About 48% of business owners report a large bank as their main source of funding, and another 34% say a regional or community bank is their main partner in capital financing.
Bankers say they have lent to small businesses but have difficulty finding creditworthy borrowers. Banks today say they are increasing lending to small businesses, but the recession is having a noticeable impact on demand from small business borrowers. In addition, bankers note the mitigating effect of increased regulatory supervision over the availability of loans to small businesses. Not only is there more regulation and higher compliance costs, there is uncertainty about how regulators view credit performance.
Small businesses argue that loans are still difficult to issue during recovery. Some level of friction in the small business credit markets is natural and indicates that the financial sector is working to allocate scarce resources to achieve the most productive goals. It is also difficult to assess whether small firms are indeed denied access to credit, in fact, credible. However, every major survey indicates that access to credit is an issue and a major growth issue for small firms during the recovery, including national surveys by the National Federation of Independent Enterprises (NFIB) and regional surveys by the Federal Reserve.
Lending to small businesses in Michigan continues to fall, while lending to large businesses is growing. In absolute terms, small business loans on bank balance sheets declined by about 20% following the financial crisis, while loans to large companies increased by about 4% over the same period.