Board of Governors of the Federal Reserve System

Availability of Credit to Small Businesses - September 2017

Executive Summary

Section 2227 of the Economic Growth and Regulatory Paperwork Reduction Act of 1996 requires that, every five years, the Board of Governors of the Federal Reserve System submit a report to the Congress detailing the extent of small business lending by all creditors. The act specifies that the study should identify factors that give policymakers insight into the small business credit market, including the demand for credit by small businesses, the availability of credit, the range of credit options available, the types of credit products used, the credit needs of small businesses, the risks of lending to small businesses, and any other factors that the Board deems appropriate.¹

Between 2012 and 2017, the years covered by this report, financial markets were generally tranquil and remained accommodative of growth in spending and investment. Supported by low interest rates, equity prices rose notably over this period, and yields on corporate debt remained low. The U.S. economy expanded at a moderate pace, and labor markets approached full employment. Continuing the recovery from the financial crisis, debt on the balance sheets of nonfinancial businesses expanded, supported by robust increases in corporate bonds and banks' loans. While terms on business credit also eased, on net, debt growth was restrained by limited demand for borrowing by small businesses.

The concerns of the Congress and other policy- making bodies about small business financing largely stem from the perception that small firms have more difficulty gaining access to credit than do large businesses or other types of borrowers. The source of this difficulty may be the higher cost of lending to small firms due to greater riskiness or challenges in evaluating and monitoring credit risks, or it may be inefficiencies in markets that hinder pricing of risk or impede the effective pooling of risks. To the extent that private-market impediments or inefficiencies are the source of any difficulties for small business financing, policymakers may focus on measures that mitigate these market failures. It is important to note that no single policy prescription would likely work for all small businesses, and no single definition of small business would be appropriate for all industries. As discussed in this report, credit needs and borrowing sources differ widely among small businesses.

One challenge for this report is that up-to-date and comprehensive information about the universe of small businesses is sparse, with most evidence about financing needs and sources derived from surveys. One relatively new survey, the U.S. Census Bureau's Annual Survey of Entrepreneurs (ASE), launched in 2015, shows that the use of credit products exhibits some clear patterns. Among all of the types of financing that small business operators were asked about, owner financing was the most commonly used type, followed by financing from banks and other finance companies. While grants and outside investors provide vital financing for certain small businesses, this type of funding is only given to a very small share of firms.

The ASE also shows a clear relationship between firm age and credit use. Young small businesses are more likely to tap into informal sources of credit such as funding from owners or family and friends, while older firms are more likely to receive funding from more traditional sources. This difference is likely tied to the greater informational opacity of new firms. This opacity might make evaluating creditworthiness more difficult for arms-length lenders, which could reduce the supply of more formal credit available to young firms.

In most cases, small businesses appear to have been able to meet their credit needs. However, in some cases, small businesses may have wanted more credit than they were able to obtain. Data from the ASE indicate that in 2014 the majority of firms did not apply for a new loan of any type, although, for those that applied, success rates were relatively high. Among the 13 percent of firms that applied for a bank loan, nearly three-fourths received the full amount for which they applied. Credit card applications were slightly less frequent than bank loan applications, although a bit more likely to have been approved. New home equity loan applications for businesses were even less common, with slightly more than 30 percent of applicants not receiving all of the funding they sought from this source.

Some firms that may have wanted additional credit may not have applied for it because they anticipated that their applications would be denied. Such firms are known as "discouraged borrowers." The ASE asks firms whether there were times during 2014 when the business needed additional financing but the owner chose not to apply. Almost 10 percent of firms fell into this category. The reason most commonly stated for not applying for additional credit was that the firm did not want to accrue debt, with nearly two-thirds of discouraged firms providing that response.

Usage of different types of small business credit varies by the age and industry of the firm as well as by the gender, race, and ethnicity of the owners. However, the usage represents the intersection of what firms would like to use to finance their firms with what providers are willing to supply. The additional questions in the ASE on loan applications and forgone applications would indicate that--at least for some firms--demand exceeds supply. But it is important to keep in mind that not all credit applications should be approved. There is a great deal of fluctuation in the small business population, and determining which businesses are a good credit risk is a challenge that small business credit providers need to carefully evaluate.

Because banks are the leading source of external credit to small business, much attention has been paid to developments in banking that may influence credit availability. The substantial consolidation of the banking industry over the past 25 years is one such development. Mergers and acquisitions have dramatically reduced the number of banks, thereby increasing the importance of large institutions and the concentration of industry assets. These changes to the structure of the industry have raised concerns about possible reductions in the availability of credit to small businesses because large banks tend to be proportionately less committed than smaller banks to small business lending.

Despite their declining numbers and a fall in their share of industry assets, however, small banks continue to account for a sizable share of small business loans. In 2016, banks with assets of $250 million or less accounted for 58.2 percent of all banking organizations but only 2.4 percent of all banking assets (table 16). However, they held 9.1 percent of all small business loans and 8.2 percent of microloans. Similarly, the 30.2 percent of banks with between $250 million and $1 billion in assets held 5.0 percent of industry assets, but 16.9 percent of small business loans and 9.9 percent of microloans.

The relevant market for many small business loans remains local. The structure of the local banking market is particularly important because changes in concentration could affect the level of competition for small business lending, which, in turn, could influence the cost of borrowing and the quantity of credit demanded. To address some key issues associated with the availability of credit to small businesses, one must shift the analysis from lending at the industry level to the local level. Analysis of bank structure within smaller geographic areas is likely to capture more accurately the relevant market conditions that small firms face when seeking credit, and that influence competition in the market for small business loans. The primary measure used by antitrust authorities to assess market concentration is the deposit-based Herfindahl-Hirschman Index (HHI), which is computed as the sum of the squared market shares (that is, the shares of total deposits) of each firm in a market. In 2016, the average level of the HHI was 1,694 in urban areas, 2,396 in micropolitan areas, and 4,254 in rural areas. These numbers were little changed over the period.

Savings institutions, defined as savings banks and savings and loan associations, provide much less credit to small businesses than do commercial banks. The primary lines of business for these institutions, often referred to as thrifts, tend to involve providing retail financial services, such as residential mortgage loans, savings accounts, and negotiable order of withdrawal (or NOW) accounts, to households. As of June 30, 2016, there were 4,824 commercial banking organizations and 763 thrifts (tables 15 and 21). The value of small business loans held by savings institutions was slightly less than one-tenth of the value held by banks, while the value of microloans (loans less than $100,000) held by savings institutions was less than one-fifth the value of commercial bank holdings. Savings institutions held $54.8 billion in small business loans and $25.1 billion in microloans, compared with $551.6 billion and $132.8 billion, respectively, held by commercial banks.

A credit union is a not-for-profit financial cooperative, owned and controlled by the people who use its services. Credit unions offer many of the same financial services that banks do. Like savings institutions, credit unions historically have not provided a great deal of credit to small businesses. According to the 2003 Survey of Small Business Finances, credit unions provided less than 1 percent of aggregate dollars outstanding to small businesses. However, credit unions have become a more important source of small business loans in recent years. In a 2009 National Federation of Independent Business survey, fewer than 4 percent of firms reported using a credit union as their primary financial institution. By 2010, this figure had increased to just less than 5 percent, and it was near 7 percent by 2011, the last time these data were reported. Similarly, 9.6 percent of households that owned small businesses in the 2013 Survey of Consumer Finances reported using a credit union as the firm's primary financial institution.

Venture capital is an important source of financing for the subset of small businesses that are young and have the potential for high growth. Venture capital investment increased dramatically between 2012 and 2015 before falling off a bit in 2016 and the first quarter of 2017 (figure 9 and table 26). The total amount invested by venture capital firms grew from about $41 billion in 2012 to almost $80 billion in 2015 before declining slightly to about $71 billion in 2016. The number of firms receiving funding from a venture capital firm followed a similar trend, climbing from about 7,900 firms in 2012 to around 10,400 in 2015 before declining to just over 8,400 in 2016.

Support for small businesses has been a priority of policymakers for several decades, and federal, state, and local agencies have sponsored programs that assist in channeling capital to small business. Several long-standing government initiatives exist to help support credit access for small businesses, particularly small businesses owned by historically underserved groups such as women and minorities. Two such initiatives of particular importance are the Community Reinvestment Act (CRA) and various loan programs sponsored by the U.S. Small Business Administration (SBA). The CRA was enacted in 1977 to encourage federally insured depository institutions to help meet the credit needs of their local communities, particularly low- and moderate-income neighborhoods, consistent with safe and sound operations. The SBA provides financing to young and growing small firms through several channels such as the 7(a) Loan Program and SBA 504 Certified Development Companies. Among the policy objectives of the SBA loan programs are the goals of promoting entrepreneurship opportunities for women and minorities.

Securitization is the process of packaging individual loans and other debt instruments, converting the package into a security, and enhancing the credit status or ratings to further some securities' sale to third-party investors. The securitization of small business loans has the potential to substantially influence the availability of credit to small businesses, but the obstacles to securitizing small business loans are large. Securitization generally has thrived in markets in which the costs of acquiring and communicating information to investors about loans and borrowers are low. In contrast, most small business loans cannot readily be grouped into large pools that credit agencies and investors can easily analyze: Loan terms and conditions are not homogeneous, underwriting standards vary across originators, and information on historical loss rates is typically limited. The information problems associated with small business loans can be overcome, or offset to a degree, by some form of credit enhancement, as in the case of the SBA's 7(a) loans. However, the more loss protection needed to sell the securities, the smaller are both the net proceeds from the sale of the securities and the incentive for lenders to securitize their loans. Small business loans are an asset for which the high transaction costs of providing credit enhancements have made many potential securitizations unprofitable.

Between 2012 and 2016, the secondary market volume of the guaranteed portion of 7(a) SBA loans grew from around $4.5 billion to about $8.5 billion. The secondary market for 7(a) SBA loans appears to be healthy and operating well. With no programmatic changes in the foreseeable future, the market should continue to move along smoothly at current levels.

Overall, between 2012 and 2017, credit conditions for small businesses were largely stable. Favorable supply conditions prevailed throughout most of the period, coupled with weak loan demand from small business owners. By 2017, credit flows to small businesses had improved, though they remained below their pre-crisis levels.

Flows and Terms of Business Credit

Between 2012 and 2017, the years covered by this report, financial markets were generally tranquil and remained supportive of growth of spending and investment. Supported in part by low interest rates, equity prices rose notably, and yields on corporate debt remained low. The U.S. economy expanded at a moderate pace, and labor markets approached full employment. Continuing the recovery from the financial crisis, debt on the balance sheets of nonfinancial businesses expanded, supported by robust increases in corporate bonds and banks' loans. While terms on business credit also eased, on net, debt growth was restrained by limited demand for borrowing by small businesses.

Aggregate Business Financing

Aggregate business finance data broken down by firm size are generally not available. For this report, various proxies are used, including organization type and the size of the debt at the time of origination.

Aggregate nonfinancial business debt, which contracted in the immediate aftermath of the financial crisis, grew at a steady pace of nearly 6 percent per year from 2012 to 2017 (figure 1, panel A).² As a result, the ratio of nonfinancial business debt to gross domestic product has risen over this period and remains well above historical norms (figure 1, panel B).

Gross equity issuance by nonfinancial firms has also increased notably since 2012, surpassing pre-crisis levels, owing mostly to the recovery in private equity issuance (figure 1, panel C).³ Public equity issuance, through both initial and seasoned offerings, rose at a moderate pace from 2012 to 2015 but retraced part of that increase in 2016 as a result of a lackluster market for initial public offerings. In contrast, estimates of private equity issuance increased sharply over the period and rebounded to levels last seen before 2009. The pace of equity retirements through cash-financed mergers and share buybacks was very strong and has continued to outpace equity issuance by a wide margin. As a result, net equity issuance remained negative throughout the period.

Financing for Nonfinancial Corporations

While there are little available data specifically on financing conditions for small businesses, measures of financing conditions in the aggregate and for large businesses suggest that conditions have largely recovered to pre-crisis levels in recent years. Default rates on corporate bonds and on commercial and industrial (C&I) loans were low to moderate over the period overall, although the rates on C&I loans moved up slightly in 2015 and 2016 (figure 2, panel A). Yields on triple-B-rated and high-yield corporate bonds remained very low by historical standards (figure 2, panel B). The spreads of yields on corporate bonds to those on comparable-maturity Treasury securities rose notably in 2015 and early 2016, reflecting in part concerns about the credit outlook of firms in the energy sector, but subsequently moved to levels similar to those prevailing in 2014. On the whole, corporate bond yield spreads remained a touch above pre-recession levels, though below the median of their historical distributions since 1997 (figure 2, panel C). Borrowing costs for shorter-term debt issued by nonfinancial firms also have remained very low since 2009, with slight increases in commercial paper rates in 2015 and 2016, as shown in figure 2, panel D, about in line with increases in the federal funds rate. As a result, the spreads of rates on A2/P2-rated commercial paper over the target federal funds rate were generally stable at low levels (figure 2, panel E).

 

Nonfinancial corporate debt rose steadily from 2012 to 2016 (figure 3). Debt growth was supported by a robust pace of bond issuance by nonfinancial corporations, as firms took advantage of the low interest rate environment. Commercial paper outstanding at nonfinancial firms rose sharply from 2012 to 2014 and has remained roughly unchanged since then. While these financing sources experienced significant growth in recent years, neither represents a significant source of credit to small firms. On balance, bank lending standards eased over this period, helping support the robust growth of bank loans to corporations. While commercial real estate prices rose rapidly from 2012 to 2016, mortgage debt rose only modestly, on net, over this period.

 

Financing for Small Businesses

Fully comprehensive data that directly measure the financing activities of small businesses do not exist. However, various sources of information can serve as proxies for small business financing activity and can be used to identify patterns of small business financing. These sources suggest that despite robust growth in aggregate nonfinancial business debt, financing flows to small businesses grew slowly over the past several years.

In addition to steady growth in aggregate nonfinancial corporate debt, total outstanding debt of partnerships and proprietorships, of which small businesses represent a significant fraction, rose at a moderate pace from 2012 to 2016 (figure 4).⁴ The two largest components are commercial and residential mortgage debt and loans from commercial banks that are not secured by real estate. Outstanding mortgage debt rose moderately over the past several years, supported by sizable increases in both multifamily residential mortgages and commercial mortgages backed by a range of business property types. In addition, bank loans extended without real estate collateral have grown at a robust pace, reflecting in part the ongoing strengthening of bank balance sheets and a concurrent easing of standards.

However, the amount outstanding on loans to businesses by commercial banks (both with and without real estate collateral) with principal less than or equal to $1 million, which are typically extended to small firms, has shown only modest increases in recent years. Commercial bank loans with principal less than or equal to $100,000 have also seen relatively muted growth, although they grew at a robust 8.3 percent from 2015 to 2016.

Evidence suggests that the slow growth in small business credit has reflected continued weak demand. Some insights into the demand for small business financing can be inferred from small business investment plans as reported in polls conducted by the National Federation of Independent Business (NFIB).⁵ According to the polls, the net percentage of firms with planned capital outlays and the net percentage that anticipated business expansions recovered very slowly from record lows during the financial crisis (figure 5, panels A and B). However, growth in late 2016 and early 2017, particularly for the net percentage that anticipated business expansions, was very strong. Data on observed demand for C&I loans, as reported in the Federal Reserve Board's Senior Loan Officer Opinion Survey on Bank Lending Practices (SLOOS), suggest that demand for loans grew steadily from the recession through 2015, although it decreased slightly in 2016 (figure 5, panel C).⁶

Credit conditions for small business lending became increasingly accommodative during the recovery from the crisis--indicating an increase in the supply of small business credit--although they remain slightly less accommodative than before the crisis. Results from the SLOOS indicate that lending standards for small borrowers were eased a bit from 2012 through 2014, although a small net fraction of banks reported having tightened standards in 2016 (figure 6, panel A). The net percentage of respondents to the NFIB reporting that it was somewhat or very difficult to obtain credit has declined in recent years from its post-crisis high in 2009 (figure 6, panel B). In terms of borrowing costs, data from the SLOOS show that the net fraction of banks that reported narrowing loan spreads for small firms largely mirrors the same series for large and middle-market firms (figure 6, panel C). Despite this improvement, borrowing costs remain elevated relative to their pre-crisis range. Nevertheless, responses to other questions in the NFIB polls suggest credit availability is a relatively minor concern for small businesses. In particular, since 2008, respondents are much more likely to cite weak product demand, taxes, or government regulations rather than the availability and cost of credit as the most significant problem they face (figure 7).

Credit Use by Small Businesses

This section examines the composition and borrowing behavior of small firms to identify characteristics that are associated with important patterns of credit use. It also discusses the special role that small businesses play in the U.S. economy and the unique challenges they face in obtaining credit.

Small Business: Definition and Background

Defining what is meant by "small business" is the difficult first step in conducting a policy-relevant analysis of the financing needs of small business. The financing needs are very different for a "mom and pop" grocery store, a microenterprise in the inner city, a high-tech start-up firm, a business that is ready to expand from early-stage growth to the next higher level, or a business that has neared the point of issuing public debt or equity. Yet the term "small business" encompasses all of these entities. According to a broad guideline used by the U.S. Small Business Administration (SBA), a small business is a firm or enterprise with fewer than 500 employees. This definition encompasses nearly all businesses in the United States.

Data from the U.S. Census Bureau's Business Dynamics Statistics indicate that there were approximately 5.1 million active employer firms across 6.7 million establishments in 2014.⁷ The vast majority of these firms were small businesses according to the SBA definition, with 99.6 percent employing fewer than 500 employees, a fraction that is consistent with previous years.⁸

Among small businesses, more than half employ fewer than 5 employees and nearly one-third employ between 5 and 19 employees (table 1). Fewer than 2 percent of small firms employ more than 100 employees. The breakdown by number of establishments is similar, although the distribution is slightly more concentrated in the larger small businesses. The employment shares reflect a slightly different picture, with employment spread more uniformly throughout the distribution and a larger mass in the center. These last two observations are consistent with the fact that larger firms are likely to have both more employees and more establishments than smaller firms.

Table 1. Characteristics of small employer firms, 2014

Small businesses operate in every major segment of the U.S. economy. The most common industry for small businesses in 2014 was services, which accounted for nearly half of small firms (table 1). Retail trade firms accounted for an additional 18.0 percent of firms, finance and insurance firms for another 8.8 percent, and construction firms for 7.3 percent. The remaining small businesses were principally involved in wholesale trade (6.0 percent), manufacturing (4.4 percent), transportation and public utilities (3.7 percent), and agriculture (2.4 percent).

Geographically, small businesses were widely dispersed throughout the nation, with 21.4 percent in the Midwest, 20.4 percent in the Northeast, 35.3 percent in the South, and the remaining 24.4 percent in the West. This distribution roughly reflects the 2016 population distribution, with 21.3 percent of the population living in the Midwest, 17.6 percent in the Northeast, 37.6 percent in the South, and the remaining 23.6 percent in the West (U.S. Census Bureau, Population Division, 2016).

Small businesses contribute significantly to the strength and vigor of the U.S. economy. According to the SBA, in addition to accounting for the vast majority of all firms, small businesses account for nearly one-half of private-sector employment, about two-fifths of private-sector payroll, and roughly one-third of the total export value (U.S. Small Business Administration, Office of Advocacy, 2016). In addition, most large and successful companies began as smaller firms.

The concerns of the Congress and other policymaking bodies about small business financing stem from the perception that small firms have more difficulty gaining access to credit sources than do large businesses or other types of borrowers. The source of this difficulty may be the higher cost of lending to small firms due to greater riskiness or challenges in evaluating and monitoring credit risks, or it may be inefficiencies in markets that hinder pricing of risk or impede the effective pooling of risks. To the extent that private-market impediments or inefficiencies are the source of any difficulties for small business financing, policymakers may focus on measures that mitigate these market failures. It is important to note that no one policy prescription would likely work for all small businesses, and no one definition of small business would be appropriate for all industries. As discussed in this report, credit needs and borrowing sources differ widely among small businesses.

Risks of Lending to Small Businesses

Lending to small businesses is generally considered riskier and more costly than lending to larger firms. Business Dynamics Statistics data, compiled by the U.S. Census Bureau, provide insights into some of the risks. Table 2 provides information on the failure rates of firms in 2009 and 2014 by the age and employment of the firm. A few important facets of small business dynamics can be observed in table 2. First, small businesses failed at a higher rate in 2009 than in 2014; during 2009, 5 of 100 businesses failed, while only 4.2 of 100 failed in 2014.

Table 2. Failure rates of businesses, 2009 and 2014

Second, the failure rate in the early years of a business--when the firm is likely to be the smallest--is quite high relative to later years. For example, nearly 1 in 10 new businesses failed within the first year of operation in 2009, while, among firms that were at least nine years old, only 1 in 50 failed. The trends are similar in 2014, with the likelihood of failure diminishing with the age of the firm, although failure rates were lower for each firm age group than in 2009.

Finally, smaller firms fail at a higher rate than larger firms. Nearly 11 percent of firms with fewer than 10 employees failed in 2009, while only 2 percent of firms with between 100 and 499 employees did so. Again, the trend for 2014 is similar with a lower baseline level.

Historically, and particularly in the early life of a business, lenders have had difficulty determining the creditworthiness of applicants for small business loans. The heterogeneity across small firms, together with widely varying uses of borrowed funds, has impeded the development of general standards for assessing applications for small business loans and has made evaluating such loans relatively expensive.

Lending to small businesses is further complicated by the "informational opacity" of many such firms. Obtaining reliable information on the creditworthiness of a small business is often difficult because little, if any, public information exists about the performance of most small businesses. Small businesses rarely have publicly traded equity or debt securities, and public information on such firms is typically sparse. Many small businesses also lack detailed balance sheets and other financial information often used by lenders in making underwriting decisions.

The cost to the lender does not end with the decision to grant a loan. Small business lenders typically have to monitor the credit arrangement with individual borrowers. For very small firms, a close association between the finances of the business and those of the owner may increase loan-monitoring costs.

Historically, the relatively elevated costs of evaluating small business loan applications and the ongoing costs of monitoring firm performance have made loans to small businesses less attractive for some lenders, especially because, when expressed as a percentage of the (small) dollar amount of the proposed loan, these noninterest costs are often quite high compared with loans to middle-market or large corporate borrowers. Financial institutions, especially commercial banks, are believed to have an advantage in dealing with information problems. Through interactions with a firm that uses its financial services, the lending institution can obtain additional information about the firm's activities, ownership, financial characteristics, and prospects that is important in deciding whether to extend credit.⁹ Lenders can use infor-mation gathered over time through long-term relationships with business owners and other members of the local community to monitor the health of the business and to build appropriate incentives into loan agreements.¹⁰ The role of relationship lending will likely continue to be significant, even as developments such as automated banking, credit scoring, and bank consolidation influence the competitive structure of the banking industry.¹¹

Insights on the risks of lending to small businesses may be gained by examining delinquency rates at banks that primarily make business loans of less than $1 million, which will be referred to as small-business-lending-intensive (SBLI) banks.¹² During and following the recent financial crisis, these risks became much more obvious as small businesses struggled to keep current on their outstanding debt. Figure 8 shows the delinquency rates for C&I loans and loans secured by nonfarm nonresidential properties (NNP) for SBLI banks compared with other banks.¹³ Since 2009, the C&I delinquency rate has reached historical lows but stands 1/2 percentage point higher at SBLI banks than other banks. For NNP loans, the story was slightly different. While delinquency rates at all banks have trended downward since 2009, the rates at non-SBLI banks declined more sharply and fell below the rates at SBLI banks in the first quarter of 2012. As of the last quarter of 2016, NNP delinquency rates had returned to pre-recession levels at SBLI banks and reached historical lows at non-SBLI banks.

Credit Use

Up-to-date and comprehensive information about the universe of small businesses is sparse, and most evidence about financing needs and sources is derived from surveys, many of which have limited coverage or rely on nonrepresentative samples. In response to the lack of information on small businesses, the Federal Reserve Banks initiated a convenience sample survey of small businesses, which is described in the box "The Small Business Credit Survey." In addition, the U.S. Census Bureau launched the Annual Survey of Entrepreneurs (ASE) in 2015. The ASE surveys a representative sample of approximately 290,000 firms with paid employees from the universe of private nonagricultural firms. It collects demographic information on up to four individual owners as well as firm-specific information.¹⁴

The survey that was fielded in 2015 solicited information on the firm for 2014. The owner-specific questions cover age, sex, educational attainment, citizenship, ethnicity, race, and veteran status. Firm-specific questions cover a variety of topics, including the year the business was established, how it was funded initially and in the current year, worker types, customer types, digital presence, global presence, and business operations.¹⁵ There are also questions on firm owners' motivations for starting the firm, aspirations for the firm, financial challenges, and profitability.¹⁶ At the writing of this report, only data for 2014 are available.¹⁷

Types of Credit Used

Data from the ASE provide useful insights into credit use by small businesses. Although the use of a particular type of credit is influenced by both demand and supply factors, the data are nonetheless valuable in developing a picture of the demand for credit by small businesses. The data reveal patterns at both the aggregate and the firm levels.

Small businesses use a variety of types of credit to fulfill their financial needs, including banks and other financial institutions; loans from owners; loans from family and friends; outside investors, such as angel investors, venture capitalists, and other businesses; and grants from various government agencies. The ASE collects information on how much new money was received from these sources in 2014. It is important to note that the ASE does not collect information on money received before 2014 and so does not provide a distribution of the complete debt holdings of the firm. It also does not distinguish between monies used from a business versus personal credit card or loans. Nor does it distinguish between banks and other types of finance companies. Nonetheless, understanding where current financing comes from is helpful in understanding small business credit use. Patterns for each product are discussed in the following.

Banks and Other Financial Institutions

Formally, small businesses receive external funding from banks and other financial institutions in the form of business loans, business credit cards where the business carries a balance, and lines of credit. In 2014, about two-thirds of businesses reported having received no funding from this source (table 3). Among firms receiving credit from financial institutions, nearly 26 percent received more than $250,000 in funding from these traditional channels.

Table 3. Use of bank credit, 2014

By age, young businesses were less likely to have received funding from banks or other financial institutions. The likelihood generally increased with a business's age. Among firms that did receive such financing, there is generally an inverse relationship between the age of the firm and the size of the funding received, with older firms being more likely to borrow larger amounts.

Asian-owned firms were least likely to have received a business loan or credit card from a bank, while American Indian-owned firms were most likely to have received bank financing. However, among the recipients of this type of financing, the size of the loan generally appears evenly distributed by race and ethnicity, although a smaller share of black-owned and Hispanic-owned businesses received loans of $100,000 or more. Male-owned firms were a few percentage points more likely than their female-owned counterparts to have received traditional financing. Conditional on borrowing, male-owned firms were also more likely to have received larger loans than female-owned firms.

There is substantial variation in usage of funding from banks and finance companies by industry. Approximately half of unclassified firms and firms in agriculture received such funding in 2014, compared with only one-fourth of firms in real estate and in finance and insurance. There is also large variation in the size of the loans received by industry. For example, 79 percent of management firms receiving credit from financial institutions received loans of $250,000 or more, compared with 20 percent of firms engaged in professional and technical services.

Owner Loans

Small business owners often provide funding for their businesses from their personal savings, retirement accounts, or home equity loans or from funds they borrow personally. In 2014, about 55 percent of firms received funding from their owners, with 20 percent of those firms receiving $250,000 or more (table 4). The pattern of use as well as the size of the loan varies greatly by age of the firm; the race, gender, and ethnicity of the owners; and the industry.

Table 4. Use of owner funding, 2014

Only 29 percent of firms less than 2 years old did not receive funding from their owners. The more established a firm is, the less likely it is to have received owner funding in 2014, with only 44 percent of firms more than 15 years old receiving such funds. The higher propensity of younger firms to use owner loans may be related to an inability to access a traditional bank loan without an established track history.

By race, gender, and ethnicity of the owner, black-owned firms were the most likely to have received owner loans, while white-owned firms were the least likely. Female-owned firms were more likely to have received owner loans than their male-owned counterparts. Conditional on receiving an owner loan, however, female-owned businesses were less likely to have borrowed at least $100,000.

By industry, loans from owners are most common among unclassified firms and least common among management companies. Among unclassified firms that had an owner loan, more than one-fourth received $250,000 or more in funding from their owners. The distribution of loan sizes across industry looks similar to the distribution of loan sizes across age, race, and gender categories.

Family and Friends

Small businesses may also turn to family and friends when more traditional sources of finance are not available. The ASE asked business owners to report the total amount of money the business received from family, friends, and employees. In 2014, the majority of firms did not receive funding from family and friends (87.5 percent), with 10 to 20 percent of recipients receiving each of the loan sizes reported, conditional on receiving any funding (table 5).

Table 5. Use of credit from friends and family, 2014

As with loans from owners, loans from family and friends are less frequent as the firm ages. Slightly more than 80 percent of firms less than 2 years old received no funding from family and friends, compared with 90 percent of firms more than 15 years old, with the rate of disuse rising steadily with age. When funding is received, the distribution of the loan size from family and friends is roughly the same across age groups.

White-owned firms are the least likely race category to have received any funding from family and friends, while Asian-owned firms are the most likely. Male-owned firms are slightly less likely to have received such a loan than a female-owned firm. Among the firms that received a loan from family and friends, a smaller share of American Indian- and black-owned businesses received loans of $100,000 or more, while Asian-owned businesses were slightly more likely to receive those large loans.

By industry, firms in accommodation and food services were most likely to have received a loan from family and friends, while firms in utilities were the least likely. In general, the firms that were unlikely to have received loans from their owners were also the types of firms that were unlikely to have received loans from family and friends.

Outside Investors and Grants

The ASE also asked firms how much they received from outside investors such as angel investors, venture capitalists, and other investment businesses. Less than 1 percent of businesses across all categories reported having received such funding. Similarly, almost no firms reported receiving funding from government grants such as the Small Business Innovation Research and the Small Business Technology Transfer programs.¹⁸

Summary of Credit Use

The use of credit products exhibits some clear patterns. Among all of the types of financing small businesses were asked about, owner financing was the most commonly used type, followed by financing from banks and other finance companies. While grants and outside investors provide vital financing for certain small businesses, this type of funding is only given to a very small share of firms.

There is a clear relationship between firm age and credit use. Young small businesses are more likely to tap into informal sources of credit such as funding from owners or family and friends, while older firms are more likely to receive funding from more traditional sources. This difference is likely tied to the greater informational opacity of new firms. This opacity might make evaluating creditworthiness more difficult for lenders, which could reduce the supply of more formal credit available to young firms.

Credit Application Experience

In some cases, small businesses may have wanted more credit than they received but were unable to obtain it.

Types of Credit Used

The ASE collects information on whether the business sought to establish new funding relationships in 2014 by whether such applications were attempted and, if attempted, were fully funded for several types of credit. As with credit received, the survey does not distinguish between business versus personal credit card or loan applications. Nor does it distinguish between banks and other types of finance companies. In addition, it does not collect information on the amount of funding sought. Patterns for each product application are discussed in the following.

Banks and Other Financial Institutions

Table 6 indicates that the majority of firms (87 percent) did not apply for a new loan with a bank in 2014.¹⁹ Among the firms that did apply, nearly three-fourths received the full amount for which they applied. By age, the oldest firms were the most likely to apply and the most likely to have their application fully funded. There is no clear pattern in the share of the other age categories of firms that applied for bank funding, but the share of firms that received full funding increases with age.

Table 6. Credit application experience: Banks, 2014

There are also interesting patterns by race and ethnicity of the firm owners. While black-owned firms were the most likely to have applied for bank financing, less than 47 percent of these applications were fully funded. This rate of failure to receive full financing is the highest among all categories by more than 10 percentage points. Additionally, female-owned firms were slightly less likely to apply than their male counterparts but more likely to be turned down.

Generally, there is variation across industries in the probability of applying for a bank loan and, conditional on applying, of being fully funded. Firms in finance and insurance were the least likely to have applied for a bank loan, with fewer than 10 percent of such firms applying. About 30 percent of such firms that did apply did not receive full funding. Firms engaged in agriculture, forestry, fishing, and hunting had the second highest rates of application (21.7 percent), with the lowest rate of failure.

Credit Cards

Credit cards can serve as a convenient alternative to paying expenses by cash or check if a business pays balances on time and in full each month. They can also be a substitute for traditional forms of credit when balances are carried month to month. Survey evidence from earlier periods suggests that credit cards are used by small business owners primarily for convenience.²⁰

Credit cards used for business purposes can be issued to the firm itself or to the owners of the firm, who may also use their personal credit cards for business expenses. While the ASE does not specify whether the application is for a personal card or a business card, one assumes that the application for a credit card refers to one to be used for business purposes. Table 7 indicates that credit card applications were slightly less frequent than bank loan applications, although a bit more likely to have been approved. Older businesses are less likely to apply for a credit card but have higher approval rates.

Table 7. Credit application experience: Credit cards, 2014

By race, black-owned firms were the most likely group to have applied for a credit card and experienced the highest turn-down rate. Asian-owned firms were the least likely minority-owned type to have applied and also experienced an elevated denial rate. Hispanic-owned firms were more likely than any racial category to have applied and also experienced elevated denial rates. By gender, male-owned firms were slightly less likely to have applied than female-owned firms, although approval rates were similar.

Application behavior varies by industry. Nearly 1 in 7 firms in transportation and warehousing applied for a credit card in 2014, and 80 percent were approved. At the same time, fewer than 1 in 10 firms engaged in finance and insurance applied for a credit card, and almost 80 percent were approved.

Home Equity Loans

Business owners sometimes tap into home equity loans to finance their companies, as home loans are typically easier to obtain than uncollateralized personal loans or business loans. In 2014, only a small fraction of owners attempted to seek a new home equity loan for their businesses (table 8). Among applicants, slightly more than 30 percent did not receive all of the funding they sought from this source.

Table 8. Credit application experience: Home equity, 2014

By age, there is little variation in the share of firms that sought home equity loans, with only 1/2 percentage point difference between the oldest and youngest firms' application rates. However, approval rates do rise with the age of the business, from less than 63 percent among firms in business less than 4 years to almost 80 percent among firms in business 16 or more years.

There is a bit more variation in application rates by the race and ethnicity of the owners. White-owned firms were the least likely to have applied for a home equity loan, while Asian-owned firms were the most likely. American Indian firms experienced the highest approval rate, with 77 percent of their home equity loans being successfully funded, while black-owned firms experienced the lowest approval rate, with less than half of their applications being fully funded.

Firms engaged in retail trade were the most likely to have applied for a home equity loan, and firms engaged in the management of companies were the least likely. Approval rates ranged from 55 percent for firms in educational services to approximately 84 percent among firms in utilities and agriculture.

Trade Credit

Trade credit arises when a business purchases goods or services for which payment is deferred. Like credit cards, firms can use trade credit either as a form of credit or as a convenient alternative to paying cash each time a purchase is made. Less than 3 percent of firms applied for trade credit in 2014, with more than 80 percent receiving all of the credit they applied for (table 9).

The youngest firms were the most likely to have applied for trade credit. The likelihood decreases with age until the firm is 15 years old, after which it increases a bit. The approval rate is lowest for the youngest firms and increases with age.

Minority-owned firms were more likely to have sought new trade credit arrangements than white-owned firms. Minority-owned firms also experienced higher turn-down rates than white-owned firms. Small differences by the gender of the owners of the firm can also be observed, with male-owned firms more likely to have both applied and been approved.

Table 9. Credit application experience: Trade credit, 2014

By industry, trade credit applications varied a bit. Construction firms, wholesale and retail trade firms, and manufacturing firms were the most likely to have sought new trade credit relationships, while finance and insurance firms were the least likely. Approval rates ranged from 99 percent of utilities firms to about 70 percent for firms in the education services and the health-care and social assistance industries.

Family and Friends

About 3 percent of firms reported seeking funding from family and friends, with nearly 70 percent successfully receiving the full amount requested (table 10). This form of financing was sought more frequently by younger firms, with the likelihood of applying declining with the age of the firm. Approval rates generally increase with the age of the firm but experience a substantial drop-off with the oldest of firms.

Table 10. Credit application experience: Family, friends, and employees, 2014

Minority-owned firms were much more likely to have sought funding from family and friends than white-owned firms. They were also much less likely to have been successful, with black-owned firms particularly unlikely to receive the full amount of funding. Female-owned firms were more likely than male-owned firms to have attempted to get funding from family and friends, but had similar success rates.

Accommodation and food services firms were the mostly likely type of firm to have sought funding from family and friends, and about one-third of the requests were unsuccessful. Utilities firms were the least likely to have sought funding from family and friends, and only 20 percent of requests were successful.

Other Applications

As mentioned previously, angel investors and ven ture capital investments are very important to the financing of a small number of businesses. However, as can be seen in tables 11 and 12, very few firms seek out such funding. In both cases, younger firms are much more likely to apply than older firms, with the share applying decreasing strongly by age.

Table 11. Credit application experience: Angel investors, 2014

Table 12. Credit application experience: Venture capital, 2014

Discouraged Borrowers

Some firms that may have wanted additional credit avoided applying for it because they anticipated that their applications would be denied. Such firms are known as "discouraged borrowers." The ASE asks firms whether there were times during 2014 when the business needed additional financing but the owner chose not to apply. Respondents who responded affirmatively were asked to provide a reason or reasons for avoiding applying.

Table 13 indicates that almost 10 percent of firms fell into the discouraged borrower category. The reason most commonly stated for not applying for additional credit was that the firm did not want to accrue debt, with nearly two-thirds of discouraged firms responding so. Half of firms that did not apply felt that their application would not be approved. About 30 percent of discouraged firms felt that the cost was too high. Approximately 15 percent of such borrowers also reported forgoing credit because they felt the process was too time consuming, because they decided to invest firm profits instead of getting a loan, or because they were waiting until funding conditions improved.

Table 13. Reasons for forgoing applying for credit, 2014

The share of firms that did not apply for additional funding, although the firm needed it, decreased with age. There is also a similar relationship with the share of firms that did not apply because they felt the firm would be turned down or because the firm was waiting for a particular milestone so that the company would be in a better position to raise funds.

Slightly more female-owned firms than male-owned firms indicated they did not apply for credit even though the firm needed the funding. The female-owned firms were more likely to indicate that they did not want to accrue debt, felt that they would be turned down, felt that the costs were too high, felt that the process was too time consuming, or were waiting for the firm to hit a milestone. Male-owned firms were more likely to indicate that they had reinvested profits, that they no longer needed the financing, or that they were waiting for better financing conditions. White-owned firms were the least likely to have forgone applying for credit, closely followed by Asian-owned firms. One in four black-owned firms reported forgoing applying for credit, with 56 percent of those firms stating that they did not want to accrue debt and 60 percent indicating they felt like they would be turned down if they applied.

Only 3 percent of firms engaged in the management of companies did not apply for credit that they needed, while nearly 13 percent of firms in other services and retail trade reported forgoing applying for credit. Utilities firms were the most likely to have believed that their application would be denied, while educational services and unclassified businesses were the most likely to report not wanting to accrue debt. Educational services firms were also the most likely to report that the cost was too high, while agriculture firms were the least likely to report so. The largest disparity in the share of firms providing a reason is in firms reporting that they reinvested firm profits rather than taking on a new loan, where 8 percent of agricultural firms did so compared with 73 percent of utilities firms.

Overall, small business owners report using a variety of sources to fund the day-to-day operations of their firms. These patterns vary by the age and industry of the firm as well as by the gender, race, and ethnicity of the owners. However, the usage represents the intersection of what the firms would like to use to finance their firms with what the providers are willing to supply. The additional questions in the ASE on loan applications and forgone applications would indicate that--at least for some firms--demand exceeds supply. But it is worth keeping in mind that not all credit applications should necessarily be approved. As discussed earlier, there is a great deal of fluctuation in the small business population, and determining which businesses are a good credit risk is a challenge that small business credit providers need to carefully evaluate.

 

Providers of Credit to Small Businesses

This section examines providers of small business credit, which include commercial banks, savings institutions, credit unions, finance companies, nonfinancial firms, and individuals such as family members or friends.²¹ Because commercial banks traditionally have been the leading source of credit to small businesses, the analysis focuses primarily on their activities. This section explores the relationship between bank size and small business lending and discusses the concentration of small business lending by commercial banks. The section also presents a more modest analysis of small business lending by savings institutions, credit unions, and some nondepository institutions, which account for substantially less small business credit than commercial banks. Together, these analyses can provide insight into the availability of credit to small businesses.

Past survey data highlighted the importance of depository institutions to small business credit availability. According to the 2003 Survey of Small Business Finances (SSBF), more than 60 percent of small businesses had outstanding credit lines, loans, or leases.²² Commercial banks provided credit lines, loans, or leases to 41.1 percent of small firms, a proportion that corresponds to about 68 percent of the small firms that obtained a traditional form of credit from any source. In addition, 5.5 percent of small businesses obtained traditional credit from a savings bank or a savings and loan association, and 3.9 percent obtained it from a credit union. In total, depository institutions supplied credit to more than three-fourths of the businesses that reported having outstanding credit.

Nondepositories, which include both financial and nonfinancial firms, provided credit to about one-third of small businesses in 2003. The key sources of credit among nondepository financial firms were finance companies (22.2 percent of firms) and leasing companies (4.3 percent). Family and individuals (6.5 percent) were the most important nonfinancial source of credit.

Commercial banks were, by a wide margin, the most common source of virtually every credit product included in the survey. They supplied more small businesses with lines of credit, mortgage loans, and equipment loans than any other type of provider. They were also the second most common supplier of motor vehicle loans and "other" loans.²³ Finance companies were the most important sources of motor vehicle loans and leases, whereas family and friends were the most important sources of other loans.

More-current data suggest the continued importance of commercial banks to small businesses in recent years. According to the 2013 Survey of Consumer Finances (SCF), 73.2 percent of households that owned small businesses indicated that the primary institution for their business was a commercial bank.²⁴ Similarly, in 2011, more than 85 percent of small businesses in the most recent NFIB finance survey reported that their primary financial institution was a commercial bank.²⁵ According to both surveys, nondepository institutions are rarely the firm's primary institution.

Beyond survey data, an important source of information on the small business lending activities of commercial banks and savings institutions is the small business loan data collected by the Federal Reserve and other regulatory agencies on the Consolidated Reports of Condition and Income (Call Reports).²⁶ These data, which have been collected annually since June 1993 and quarterly since March 2010, include information on outstanding small C&I loans and loans secured by nonfarm nonresidential properties.²⁷ The number of loans and amount outstanding are collected for loans with original amounts of $100,000 or less, more than $100,000 but less than $250,000, and more than $250,000 but less than $1 million.²⁸

These data are used to estimate the amount of credit extended to small firms. Because firm characteristics are not reported on Call Reports, loan size is often used as a proxy for the size of the firm receiving credit. However, this approach to measuring small business lending introduces two sources of inaccuracy in the measurement of the number and dollar amount of loans to small businesses. First, the data likely include loans equal to or less than $1 million extended to large firms, and, second, the data exclude loans of more than $1 million made to small firms.²⁹ According to the 2003 SSBF, only about 3.5 percent of credit-line extensions to small businesses were associated with commitments greater than $1 million. However, these relatively few loan extensions accounted for roughly two-thirds of the dollar value of credit-line commitments to small businesses. Although a large share of the total dollar value of small business loans may be excluded from what is considered a small business loan on the Call Report and Thrift Financial Report data, these loans are not typical of the credit obtained by the majority of small firms.³⁰ According to data from Community Reinvestment Act (CRA) reporters, a little more than one-third of the loan dollar volume of loans with initial values of less than $1 million is directed to firms with revenues of less than $1 million. This volume is likely to be an understatement because many reporters do not collect or submit information on the revenues of the firms to which they lend. This result does indicate, however, that a significant portion of loans included in the less than $1 million category are made to larger businesses. It is not possible to tell which inaccuracy is likely to be larger.

Lending by Depository Institutions

Commercial Banks

Commercial banks are important providers of credit to small firms.³¹ Lending to small businesses involves unique challenges that banks appear particularly well suited to meet. Of particular significance, information on the financial condition, performance, and prospects of small firms may not be readily available, so lending is often based more heavily on information gathered through established relationships than is true for other types of loans. Commercial banks continue to maintain local branch networks, which aid them in nurturing relationships and gathering firm-specific information. Commercial banks also provide credit to small businesses through business credit cards, which rely on business or consumer credit ratings rather than established relationships.

Bank Size

The relationship between bank size and the extent to which banks engage in small business lending may have implications for the availability of credit to small firms. Substantial consolidation in the banking industry over the past 30 years has dramatically reduced the number of banks, increasing the importance of large banks and the concentration of industry assets.³² For example, more than 3,800 bank and savings institution mergers involving acquired assets in excess of $6.7 trillion were completed between 2000 and 2016.³³ Even though more than 1,400 new banks were granted charters over this period, the total number of banking organizations fell more than 27 percent to 4,824 (table 14).

Table 14. Structural measures and the size of the U.S. commercial banking industry, 2000-16 (selected years)

One merger-related structural development that has raised concerns about the availability of credit to small businesses stems from the fact that large banks tend to be proportionately less committed than smaller banks to small business lending. As seen in table 15, the average banking organization with $1 billion or less in total assets held over 14 percent of its portfolio as small business loans in June 2016.³⁴ In contrast, organizations with assets between $1 billion and $10 billion held just over 10 percent of their assets as small business loans, and the largest organizations--those with assets greater than $10 billion--held less than 5 percent of their assets as such loans. Small business loans play a larger role in the portfolios of small banks than they do in the portfolios of large institutions.

Table 15. Average microloan and small business loan holdings as a share of assets for U.S. commercial banking organizations of different sizes, 2016

The pattern for holdings of microloans, which are defined as business loans of $100,000 or less, is even stronger, with smaller banks maintaining an even more disproportionate share of their asset portfolios in such loans when compared with larger banks. While only about 4 percent of the loan portfolio of the smallest banks is in small business microloans, this figure is about 1 percent for banks larger than $1 billion in assets.

The smallest banks tend to be proportionately more invested in the smallest business loans for two primary reasons. First, many small banks provide banking services to a particular local area. As a result, these banks are likely to accumulate knowledge of their local markets, which is often important in making risky, relationship-dependent small business loans. Difficulties in evaluating and monitoring loans likely become more severe as firms, and therefore loans, decrease in size. Second, bank regulations limit the amount that a bank can lend to a single borrower to 25 percent of the bank's capital; by definition, small banks are limited by their assets in their ability to make very large loans. Small banks can also maintain a more diversified portfolio by making many smaller loans, rather than fewer larger loans.

Even though small business lending represents a smaller share of banking activity by the largest banking organizations, these banks are still significant providers of small business loans. Banking organizations with assets greater than $10 billion accounted for 1.8 percent of all commercial banking organizations in June 2016 but held 83.1 percent of the banking assets in the industry (table 16). These large organizations held a smaller but nonetheless substantial share of small business loans, as they held 52.0 percent of small business loan dollars outstanding and 72.0 percent of microloan dollars outstanding. They also account for a substantial portion of the number of loans granted, extending 91.1 percent of all microloans and 47.2 percent of business loans greater than $100,000 but less than $1 million.

Table 16. Share of small business loan and microloan holdings of U.S. commercial banking organizations, by asset class, 2012 and 2016

Despite their declining numbers and a fall in their share of industry assets, small banks continue to account for a sizable share of small business loans. In 2016, banks with assets of $250 million or less accounted for 58.2 percent of all banking organizations but only 2.4 percent of all banking assets (table 16). However, they held 9.1 percent of all small business loans and 8.2 percent of microloans. Similarly, the 30.2 percent of banks with between $250 million and $1 billion in assets held 5.0 percent of industry assets, but 16.9 percent of small business loans and 9.9 percent of microloans.

The lending shares of the smallest banks--those with assets of $250 million or less--decreased between 2012 and 2016. Some of this decrease was due to the reduction in the share of banking organizations and bank assets that, because of bank consolidation, were accounted for by this class of institutions. The decrease in the share of small loan holdings at the smallest banks was comparable with the decrease experienced by banks with assets between $250 million and $1 billion. Banks with assets of $1 billion to $10 billion increased their share of small business loans but, like smaller banks, lost share in the market for business microloans. Conversely, increases in the share of small loans and microloans extended were observed for the largest banks.

In terms of loan growth, the volumes of small business loans and of microloans decreased for the smallest of the four size classes of banks--those with less than $250 million in assets--between 2012 and 2016 (table 17). In fact, total lending decreased for these small banks over this period, but at a slower rate than the decline in small business loans. The three larger size classes of banks saw positive growth in total lending and business microloans. However, banks with between $250 million and $1 billion in assets saw a slight decline in total small business lending. Still, growth of both small business and microlending was much more rapid among banks with more than $1 billion in assets than among smaller banks.

Table 17. Growth of small business loan and microloan holdings of U.S. commercial banking organizations, by asset class, 2008-12 and 2012-16

The growth in the share of business microloans reflects the increasing importance of large banking organizations in providing the smallest loans. Increased use of sophisticated technological and analytical tools, particularly credit-scoring techniques, has likely contributed to the rise in the share of microloans held and originated by large banking organizations. The largest banks may also have expertise in credit card programs and may have leveraged this experience to provide business credit cards that typically have low balances (Brevoort and Hannan, 2006).

 

Numerous research studies directly analyze the relationship between consolidation activity and the availability of credit to small firms.³⁵ Although mergers and acquisitions sever existing bank-firm relationships and may introduce some short-term uncertainty (Berger and Udell, 1998), the results of the research generally suggest that, overall, they have not materially reduced credit availability.

One issue that has been addressed is the effect of mergers on the small business lending activities of the banks directly involved in those mergers. The results of these studies generally indicate that deals involving at least one large bank tend to reduce small business loans as a share of assets, whereas deals between two small banks tend to increase small business loans as a share of assets (for example, Critchfield and others, 2004; Avery and Samolyk, 2000, 2004; Samolyk and Richardson, 2003; Peek and Rosengren, 1998; and Strahan and Weston, 1998).

Both results are relevant to assessing the influence of consolidation on the availability of small business credit from banks and savings institutions. On the one hand, about 90 percent of the assets acquired between 2000 and 2016 belonged to institutions with at least $1 billion in total assets. Therefore, a large majority of the assets that have changed hands have been purchased in deals in which a decline in small business loans, as a share of assets, typically takes place at the consolidated firm.

On the other hand, even though relatively few assets have been purchased in mergers of small institutions, deals involving target firms with total assets of $250 million or less accounted for nearly two-thirds of all transactions completed between 2000 and 2016. About 18 percent of these deals involved an acquirer that had assets of $250 million or less, and roughly 25 percent involved an acquirer with assets between $250 million and $1 billion. Although relatively few assets have been acquired in a deal typically associated with an increase in small business lending ratios, nearly three-fifths of all deals have occurred with small- or medium-sized acquirers. Therefore, after merger activity, many banks have had an overall increase in the share of their asset portfolios dedicated to small business lending.

Another issue that has been studied is the "external" effect of mergers--that is, what happens to small business lending at banks that compete directly with recently merged institutions. Evidence suggests that banks competing with recent merger participants tend to increase their lending (Berger and others, 1998; and Berger, Goldberg, and White, 2001). Two other empirical findings suggest that a growing amount of credit may be supplied by banks that compete with recently merged banks. First, consolidation increases the likelihood of new entry into a market (Adams and Amel, 2007; Berger and others, 2004; Seelig and Critchfield, 2003; and Keeton, 2000). Second, younger banks tend to make more small business loans than similar, but more mature, institutions (DeYoung, Goldberg, and White, 1999). These two empirical findings suggest that a common response to merger activity is greater entry of new banks into affected markets, which tend to be active lenders to small businesses.

From the perspective of small firms, the effect of banking consolidation on credit availability may not be especially substantial, given that the size of the banks operating in a market does not appear to affect the availability of credit. Small businesses in areas with few small banks are no more credit constrained than small businesses in areas with many small banks (Jayaratne and Wolken, 1999). In addition, the likelihood that a small business will borrow from a bank of a given size is roughly proportional to the local presence of banks of that size, although some evidence shows that small banks are more likely to make very small loans (Berger, Rosen, and Udell, 2001). In sum, the potential gap in credit availability to small businesses due to bank consolidation by the largest banks is usually attenuated by competition from small- and medium-sized banks, by the entry of new banks, and by the substitution of credit extended by nonbank financial institutions for that extended by commercial banks (Ou, 2005; and Craig and Hardee, 2007).³⁶

Industry Structure

As large banks have acquired other institutions, especially other large ones, the number of banks has declined, and the size of the largest banks has increased. These developments may enable the most active lenders to account for a growing share of all small business lending. In this section, the distribution of small business loan holdings at the industry level is analyzed to assess the importance of the leading small business lenders in the overall provision of small business credit.

Data on industry structure in table 18 indicate that the leading small business loan holders account for a small share of loans relative to the share of total assets they hold. For instance, in 2016, the 10 leading holders of small business loans held 28.3 percent of all such loans and 55.4 percent of all banking assets. Similar differences between the share of small business loans and the share of total assets are observed among the 25, 50, and 100 leading small business loan holders.

Table 18. Share of assets and microloan and small business loan holdings of leading U.S. commercial banking organizations, 2012 and 2016

These data also show that the shares of small business loans held by the most active small business lenders increased a bit since 2012, as have the shares of banking assets for these firms. The 100 most active small business bank lenders accounted for just over one-half of the outstanding small business loans and about five-sixths of total assets in both 2012 and 2016. Microloan lending became slightly more concentrated, with the top 100 most active small business bank lenders accounting for more than 75 percent of microloans in 2016, up from slightly less than 70 percent in 2012.

This pattern has two implications for the availability of bank credit to small businesses. First, because the share of small business lending activity attributable to the 100 most active lenders is smaller than their share of total assets, the relatively less active small lenders remain a key source of credit for small firms. Second, although the share of small business lending attributable to the leading banks has increased, particularly with respect to microloans, the industry has not moved toward one in which a relatively few large banking organizations are the dominant providers of credit to small businesses.

Although large banking organizations are proportionately less active in small business lending than smaller banks, the leading small business lenders nonetheless typically include the largest banking organizations. For example, in 2012 and 2016, the top 10 holders of small business loans were among the 31 and 24 largest banking organizations in the industry, respectively.

Local Lending Patterns

The relevant market for many small business loans remains local. The structure of the local banking market is particularly important because changes in concentration could affect the level of competition for small business lending, which, in turn, could influence the cost of borrowing and the quantity of credit demanded. To address some key issues associated with the availability of credit to small businesses, one must shift the analysis from lending at the industry level to the local level. Analysis of bank structure within smaller geographic areas is likely to capture more accurately the relevant market conditions that small firms face when seeking credit, and that influence competition in the market for small business loans.

Previous data from the SSBFs indicate that small businesses tend to obtain loans, leases, and lines of credit from nearby providers.³⁷ In 2003, the median distance between a small business and its lender was 11 miles, and in 66 percent of all business-lending relationships, the lender was located within 30 miles of the firm's headquarters. For depository institutions and banks, the major suppliers of small business credit, lenders were located even closer--the median distance was 4 miles, and 83 percent of lenders were located within 30 miles of the firm's headquarters. More-recent data from the 2013 SCF reinforce this pattern. Among households that report owning businesses with fewer than 500 employees, the median distance to their firm's primary financial institution was 2 miles.

This proximity offers small firms convenient access to their lenders. Also, banks have traditionally preferred to extend loans to small businesses near their branches. The importance of relationships in small business lending suggests that credit providers concentrate their lending activities in geographic areas with which they are familiar (Berger and Udell, 1998; Brevoort and Hannan, 2006; Critchfield and others, 2004; and Scott, Dunkelberg, and Dennis, 2003).

Local Market Concentration

Conventional economic theory predicts, and empirical evidence suggests, that highly concentrated markets exhibit less competition, which results in higher prices and the provision of less credit. Some theories, however, predict that a less competitive lending environment may increase credit availability to at least some firms by allowing local banks more flexibility in structuring loan programs over time to promote longer-term relationships (for example, Petersen and Rajan, 1995). Long-term relationships, which facilitate loans to many small businesses, may be more difficult to maintain in highly competitive markets because businesses that are earning good profits will likely seek out the lender offering the most favorable, low-cost loan terms. A bank in a less competitive market might offer a below-market interest rate on a loan to help a new business or an ongoing firm experiencing hard times with the expectation that the bank will receive above-market returns on loans when the business is operating successfully. To date, tests of these theories have produced mixed results.³⁸

Data from the annual Summary of Deposits, which reports the location and deposit level of every commercial bank, savings bank, and savings and loan branch as of June 30, are used to examine bank market structure and competition in local areas.³⁹ The primary measure used by antitrust authorities to assess market concentration is the deposit-based Herfindahl-Hirschman Index (HHI), which is computed as the sum of the squared market shares (that is, the shares of total deposits) of each firm in a market. These measures are shown in table 19, along with information on the number of banks and banking offices.⁴⁰ The data show that in 2016, about 25 banks with 193 offices provided banking services in the average metropolitan statistical area (MSA). The average level of the HHI with 50 percent weighting of savings institution deposits was 1,694.⁴¹ In the average micropolitan area, 9 banks with 19 branches provided services. The average HHI with 50 percent weighting of savings institution deposits was 2,396. Rural areas are much more highly concentrated with respect to their deposits and, on average, have fewer banks and banking offices. In 2016, the average rural market had about 4 banks with 7 offices. The average rural market HHI with 50 percent weighting of savings institution deposits was 4,254.

Table 19. Average structural measures of U.S. commercial banking and thrift organizations, by metropolitan statistical area, micropolitan area, and rural county, 2000-16

Comparing these indexes with those of earlier years, we find that despite the significant amount of consolidation in the banking industry, local banking markets do not appear to have become more concentrated. Generally, in rural, micropolitan, and MSA markets, the number of banks and offices increased slightly until a point during the recent recession (2008 to 2010), then decreased slightly, but there remain more banks and offices, on average, in each of the three types of market than there were in 2000. As would be expected, the trends in the average HHI for local markets followed the opposite pattern: decreasing slightly until 2007 or 2008, then increasing a bit. Metropolitan and rural markets had lower levels of the HHI in 2016 than in 2000, but micropolitan markets ended with higher average concentration levels because of large increases in the past three years. Modest effects on concentration, in conjunction with a small increase in the number of banks, suggest that a reduction in competition from commercial banking organizations is not likely to have been a major contributing factor in the availability of credit in recent years.

Overall, small business loans outstanding from commercial banks fell during the recent recession but have increased in every year since 2013 (table 20). Despite significant industry consolidation, concentration in local banking markets--the geographic units that are most relevant for small business lending--did not increase, on average, over the past decade. This lack of change in concentration suggests that the observed decline in small business loans outstanding was not due to reduced competition among commercial banks in the provision of credit to small businesses. Rather, the decline in small business lending by commercial banks was likely caused by a combination of a reduction in demand for credit on the part of small businesses, an increase in competition from nonbank commercial lenders, a decline in the credit quality of many potential small business borrowers, and a tightening of terms and standards on the part of commercial banks. In addition, some of the decrease was likely due to deterioration in the financial condition of many banks during and after the recent recession.⁴²

Table 20. Small business loan and microloan holdings of U.S. commercial banking organizations, by type of loan, 2012-16

Savings Institutions

Savings institutions, defined as savings banks and savings and loan associations, provide much less credit to small businesses than do commercial banks. The primary lines of business for these institutions, often referred to as thrifts, tend to involve providing retail financial services, such as residential mortgage loans, savings accounts, and negotiable order of withdrawal (or NOW) accounts, to households.⁴³ As of June 30, 2016, there were 4,824 commercial banking organizations and 763 thrifts (tables 15 and 21).⁴⁴ The value of small business loans held by savings institutions was slightly less than one-tenth of the value held by banks, while the value of microloans held by savings institutions was less than one-fifth the value of commercial bank holdings. Savings institutions held $54.8 billion in small business loans and $25.1 billion in microloans, compared with $551.6 billion and $132.8 billion, respectively, held by commercial banks.

Table 21. Average microloan and small business loan holdings as a share of assets for U.S. savings institutions and thrifts of different sizes, 2016

These differences between commercial banks and savings institutions reflect both the disparity in overall size between the two groups of institutions and the lower proportion of small business lending conducted by the typical savings institution. In terms of overall size, in 2016, roughly $14.9 trillion in total domestic assets were held by commercial banks and savings institutions, with the latter holding about 7 percent of the total, or $1.1 trillion (tables 14 and 22). In terms of small business lending intensity, the average thrift held roughly 7.8 percent of its asset portfolio in small business loans and 1.1 percent in microloans in 2016 (table 21). In contrast, the average commercial bank held 14.1 percent of its portfolio in small business loans and 3.0 percent in microloans (table 15). These substantial differences in small business lending activity between banks and thrifts clearly indicate that the typical savings institution has been much less active than the typical commercial bank in providing credit to small firms.⁴⁵

Table 22. Structural measures and the size of insured U.S. savings institutions, 2000-16 (selected years)

Among savings institutions, the most active lenders to small businesses were not necessarily the largest institutions in terms of assets. In 2016, the 10 most active thrifts accounted for 42.9 percent of thrift small business lending (table 23). These 10 firms held 48.7 percent of all thrift assets. Both of these numbers were about 6 percentage points greater than comparable statistics for 2012.

Table 23. Share of assets and microloan and small business loan holdings of leading U.S. savings institutions and thrifts, 2012 and 2016

Thrift microloan lending is more highly concentrated. In 2012, the 10 most active lenders accounted for 84.5 percent of thrift microloans outstanding. By 2016, the top 10's share had increased to 88.9 percent. However, unlike commercial banks, the most active microloan lenders are not necessarily the largest institutions. In 2016, while the 10 most active lenders accounted for almost nine-tenths of thrift microloan dollars outstanding, they held only about one-sixth of total thrift assets.

Credit Unions

A credit union is a not-for-profit financial cooperative, owned and controlled by the people who use its services. Credit unions offer many of the same financial services that banks do. Like savings institutions, credit unions historically have not provided a great deal of credit to small businesses. According to the 2003 SSBF, credit unions provided less than 1 percent of aggregate dollars outstanding to small businesses. However, credit unions have become a more important source of small business loans in recent years. In a 2009 NFIB survey, fewer than 4 percent of firms reported using a credit union as their primary financial institution. By 2010, this figure had increased to just less than 5 percent, and it was near 7 percent by 2011, the last time these data were reported. Similarly, 9.6 percent of households that owned small businesses in the 2013 SCF reported using a credit union as the firm's primary financial institution.

Although outstanding small loans to businesses by credit unions remain a small fraction of those by commercial banks, they have increased rapidly throughout the post-recession period, while commercial banks' small loans to businesses have increased much more slowly (table 24). Between 2012 and 2016, credit union outstanding loans to business members increased 53.4 percent, while outstanding small loans to businesses by commercial banks increased only 1.4 percent.⁴⁶

Table 24. Business loan holdings of federally insured U.S. credit unions, 2012-16

Since 1998, credit union lending to member businesses has been subject to a cap of 12.25 percent of total assets.⁴⁷ Before the passage of the Credit Union Membership Access Act of 1998, there was no limit to the amount that credit unions could lend to member businesses. Bills that would have increased this cap have been introduced in recent Congresses, but none have passed. As of June 2016, 5.6 percent of credit unions had outstanding loans to businesses totaling in excess of 80 percent of their cap. Among the largest credit unions--those with assets of more than $1 billion--23.2 percent had outstanding loans to business in excess of 80 percent of their cap. Thus, an increase in the cap has the potential to accelerate the rate of small business lending by credit unions.

Lending by Nondepository Sources

In this changing financial marketplace, small businesses have been diversifying their providers of financial services. Nondepository institutions have become increasingly important sources of financial services to small businesses. According to the 1998 and 2003 SSBFs, while two-fifths of firms reported using at least one nondepository source for their financial services in 1998, more than one-half of them did so in 2003. However, firms reported receiving most of their credit products (lines of credit, loans, and capital leases) from depository sources. Among nondepository sources, finance companies were the primary provider of credit.⁴⁸

More recently, small firms are turning to alternative nondepository sources for credit products. While a growing share of firms interviewed in the 1998 and 2003 SSBFs indicated using nondepository institutions, less than 2 percent reported that such institutions were their primary source for financial products. The 2009 NFIB survey reported a similar share of businesses using something other than a bank, credit union, or savings and loan association as their primary financial institution. This share more than doubled by 2011, when 5 percent of firms reported having a nondepository primary institution. In addition, firms may receive credit from institutions that are not their primary financial institution, likely making the shares of firms reporting nondepository institutions as a primary institution a lower bound for their total usage. While the fraction of total loans in this category is relatively small, the fact that it is increasing may indicate a growing need for this type of funding. Although there are an ever-growing number of nondepository sources of financing, data are scarce. This section briefly discusses finance company lending, venture capital funding, and online nondepository lending to small businesses.

Finance Companies

Businesses use finance companies primarily for the purchase of motor vehicles or other business equipment.⁴⁹ Lending by finance companies for motor vehicles grew steadily between 2013 and 2016, although at a much slower rate in 2016 (table 25). At the same time, outstanding equipment loans, which were much higher than motor vehicle loans in 2013, declined substantially over this period (particularly between 2015 and 2016) and ended the period in line with motor vehicle loans. Other business receivables grew more than 20 percent over the period, with a substantial fraction of the growth occurring between 2014 and 2015. It is important to note that it is not possible to separate the data according to the size of the business, but if one assumes that the trends broadly hold for both large and small businesses, it would appear that lending to small businesses by finance companies likely increased over the most recent period.

Table 25. Outstanding loans to businesses by finance companies, 2013-16

Venture Capital

Venture capital is an important source of financing for the subset of small businesses that are young and have the potential for high growth. Puri and Zarutskie (2012) find that firms financed by venture capital accounted for approximately 0.14 percent of firms between 2001 and 2005. However, these same firms accounted for about 5.3 percent of aggregate employment.

Because of the high risk of investing in these firms, even relative to other small businesses, venture capital investments typically take the form of convertible preferred securities rather than debt (Kaplan and Stromberg, 2003). Broadly speaking, these securities transfer control of the firm to the venture capitalists when the firm does poorly, as is the case with traditional debt, and they transfer control of the firm to management when the firm goes well, as is the case with common equity.

Venture capital investment increased dramatically between 2012 and 2015 before falling off a bit in 2016 and the first quarter of 2017 (table 26 and figure 9). The total amount invested by venture capital firms grew from about $41 billion in 2012 to almost $80 billion in 2015 before declining slightly to about $71 billion in 2016. The number of firms receiving funding from a venture capital firm followed a similar trend, climbing from about 7,900 firms in 2012 to 10,400 in 2015 before declining to 8,400 in 2016.

Table 26. Venture capital Investment, 2012-17

Venture capitalists tend to invest in a firm relatively early in the firm's life and then continue to finance the firm as it grows. Thus, venture capital includes financing both young, small firms and more mature, large firms. To demonstrate the evolution in venture capital investment in smaller firms, table 26 breaks down investment activity by the stage of the firm's development. There are a couple of trends to highlight across the three categories. First, angel and seed firms, which represent the youngest and likely smallest set of firms, received the smallest average investment, of approximately $1 million to $1.8 million across the sample, but saw the largest number of firms receiving an investment. Late-stage firms, on the other hand, received much more financing, with an average investment of between $14 million and $26 million, but many fewer firms received such financing. Second, the trends in investment activity were broadly similar for all three groups of firms; investment levels grew rapidly from 2012 to 2015 before falling off in 2016 and early 2017.

Online Lending to Small Businesses

The development of financial technology has enabled small businesses to access credit in ways previously unavailable to them. Specifically, online lenders provide technology-based platforms for matching borrowers and investors. These platforms leverage their web-based and data-driven technologies to provide consumer and business loan products more efficiently than traditional lending platforms.⁵⁰

Online lending--also referred to as marketplace or peer-to-peer lending--generally refers to platforms that bring together potential borrowers and lenders to facilitate the provision of loans. Online lending can be broadly characterized as a nonbank entity that uses technology to simplify the loan process--including the application, decision process, funds distribution, and loan repayment--and operates as a two-sided market of consumers and investors. Along with interest, the borrower is typically charged a fee to originate the loan, and investors pay for servicing the loans. In general, marketplace lenders offer uncollateralized low-dollar loans with rapid decision times. The loans are typically funded and repaid via electronic transfers, with the lender and borrower never meeting in person.

The online lending market has continued to evolve and expand. According to a recent report from the Cambridge Centre for Alternative Finance, online alternative finance platforms in the United States facilitated more than $6.9 billion of loans to small and medium enterprises in 2015 (Wardrup and others, 2016). While this amount remains small relative to the small business credit market as a whole, this market has been growing very rapidly over the past few years; the $6.9 billion in loans in 2015 represents a 145 percent increase over 2014, which, in turn, was 147 percent greater than 2013. This high sustained growth rate suggests that online lending is increasingly becoming an important source of credit for small businesses.

Special Issues

This section examines some developments in small business credit markets that have affected the delivery and availability of credit to small businesses and are likely to continue doing so: government initiatives to support credit access for small businesses and securitization of small business loans. First, government initiatives such as the CRA and SBA lending programs are reviewed. These programs focus on the financing needs of small firms in underserved communities and the financing needs of young firms without much, or any, financial history. Second, the securitization market is examined. A well-functioning secondary market increases small businesses' access to credit by providing an efficient funding supplement to direct lending.

Government Initiatives to Support Credit Access for Small Business

Several long-standing government initiatives exist to help support credit access for small businesses, particularly small businesses owned by historically underserved groups such as women and minorities. Two such initiatives of particular importance are the CRA and several loan programs sponsored by the SBA.

Community Reinvestment Act

The Congress enacted the CRA in 1977 to encourage federally insured depository institutions to help meet the credit needs of their local communities, particularly low- and moderate-income (LMI) neighborhoods, consistent with safe and sound operations.⁵¹ These local communities, referred to hereafter as CRA assessment areas, are generally identified as the areas where banking institutions have a physical branch office presence and take deposits. LMI neighborhoods have been defined for regulatory purposes as census tracts with a median family income of less than 80 percent of the median family income of the broader area according to decennial census data.⁵²

Under the CRA, the bank regulatory agencies regularly review institutions' performance in this endeavor and prepare publicly available written evaluations, which include ratings. The CRA requires that supervisory agencies consider a financial institution's CRA performance when evaluating an institution's application for expansion or relocation of depository facilities through branching, mergers, or acquisitions. Decisions on these applications are made public.

Although much of the small business lending of financial institutions occurring in LMI areas cannot be directly attributed to the CRA, bankers and community representatives indicate that some of it is the result of individual banks responding to their CRA obligation. Some lending activity also results from interaction with community representatives and government agencies familiar with the CRA and the possible roles that financial institutions can play in community development and reinvestment.

A common type of community reinvestment intermediary used by banks to help finance small businesses in lower-income areas is the bank-owned or bank-affiliated community development corporation. Under certain conditions, bank holding companies, national- and state-chartered commercial banks, and savings institutions may make equity investments in small businesses through a community development corporation or a limited liability company. Generally, these entities can make debt and equity investments in small businesses when the firms are located in LMI areas and the jobs created and services provided benefit primarily LMI persons.

Another form of intermediary is the consortium lending organization that specializes in financing young or start-up small and minority businesses. By participating in such consortiums, banks can mitigate the risks and costs of lending to small firms. These loan consortiums are usually organized in corporate form and may be nonprofit or for-profit organizations. Although many are organized primarily by banks, they often have nonbank participants such as insurance companies, utilities, other corporations, religious institutions, and other institutional investors. Other loan consortiums are quasi-public arms of state, regional governments, or local governments.

Because many institutions do not have the expertise or cannot bear the development costs of special small business finance programs, especially those focusing on reinvestment areas, many banks have created or assisted intermediaries that support small businesses in their communities. Indeed, a notable development in bank reinvestment programs has been formal and informal working partnerships among banks, regional or neighborhood nonprofit organizations, and community-based development corporations. These organizations identify prospective borrowers, provide loan counseling, serve as experienced developers in low-income and minority areas, and assist banks in marketing loan programs. These types of partnerships have also been effective in helping reduce the high transaction costs often associated with lending to very small firms. Such organizations also frequently package financial resources for small firms from several public and private sources. Overall, these types of partnerships enable banks to make small business loans that might not otherwise have been financially feasible.

Community Reinvestment Act Data on Lending in Lower-Income and Minority Neighborhoods

CRA regulations require larger commercial banks and savings associations to collect and report data regarding the geographic location of their small business lending. As a consequence of amendments to CRA regulations in 2005, banking institutions with assets less than $1.221 billion are no longer required to report data on their small business and small farm lending. However, many smaller institutions still elect to report these data. Analysis of Call Report data indicates that lenders reporting CRA data account for over two-thirds of the dollar volume of small business loans outstanding at all commercial banks and savings associations.

Each reporting bank makes an annual report on the total number and dollar volume of small business loan originations by census tract. As in the Call Report data, small business loans encompass C&I loans and NNP loans whose original amounts are $1 million or less. However, unlike the Call Report data, the CRA data provide information on originations, or the flow, of small business credit rather than the stock of outstanding loan balances.⁵³ The CRA data also provide information on the number and dollar volume of small business loans originated to businesses with revenues of less than $1 million, to the extent that the reporting institution collects such information when making credit decisions.

Figure 10, panel A, shows that the dollar volume of small business loan originations has barely recovered from effects of the financial crisis; it grew about 25 percent between 2010 and 2015, the latest year for which data are available, but remains approximately 33 percent below their 2007 high. Similarly, after dropping more than 50 percent between 2007 and 2010, originations to the smallest businesses, those with revenues of less than $1 million, grew approximately 25 percent between 2010 and 2015. Panels B and C disaggregate these two series by whether
loans were made in a bank's CRA assessment area and whether loans were made in LMI neighborhoods (see previous section for assessment area and
LMI definitions).⁵⁴

Both panels show stronger recovery in small business loan origination volume outside of assessment areas. Origination volumes were about 20 percent higher outside assessment areas in 2015 in comparison with 2012, while they were 8 percent higher inside assessment areas. The disparity was slightly starker for originations to firms with revenues less than $1 million. At the same time, it is important to note that the decline in originations during the financial crisis was significantly steeper outside of assessment areas; as a result, some of the higher growth outside of assessment areas may be reversion back to pre-crisis levels. The recovery in lending has been similar across LMI and non-LMI neighborhoods inside and outside of assessment areas.

Panels D and E display the trend in lending across neighborhoods with higher (at least 30 percent) and lower (less than 30 percent) shares of minority residents. Since 2012, higher-minority-share-neighborhoods have experienced higher growth in origination volume; as a result, while the origination amounts in lower-minority-share neighborhoods are approximately 8 percent higher in 2015 than in 2012, they are 14 percent higher for higher-minority-share neighborhoods. The trend is similar for loans to the smallest businesses--those businesses with revenues less than $1 million.

Table 27 provides additional data on small business lending in LMI versus non-LMI neighborhoods, and inside versus outside of CRA assessment areas. The top panel shows data for 2010, while the bottom panel shows data for 2015. Comparing across columns, the volume of lending is considerably higher in non-LMI neighborhoods than in LMI neighborhoods in both years, reflecting, at least in part, that roughly three-fourths of the population reside in non-LMI neighborhoods.

Table 27. Small business lending, by neighborhood income and assessment area status, 2010 and 2015

Within each income group, assessment area lending generally exceeds non-assessment area lending in dollar terms, but not in terms of the number of loans. This pattern results from specialized credit card lending institutions making up a large portion of non-assessment area lending. A dozen or so such institutions issue business cards nationwide but generally do not have an extensive network of bank branches and therefore have limited CRA assessment areas.⁵⁵ Comparing LMI with non-LMI areas, table 27 indicates that credit card lenders made up a larger share of loan origination volume in non-LMI areas than in LMI areas in both 2010 (9.1 percent versus 6.9 percent) and 2015 (21.9 percent versus 19.0 percent).

Finally, table 27 also shows the share of small business lending by banks in the top 10 banking organizations according to total assets, by neighborhood income group. These data reveal that the top 10 organizations accounted for just under one-third of dollars loaned in both LMI and non-LMI neighborhoods in both 2010 and 2015.⁵⁶

Small Business Administration Programs

Support for small business development has been a priority of policymakers for several decades, and federal, state, and local agencies have sponsored programs that assist in channeling capital to small business. At the federal level, the agency with the most direct role in this objective is the SBA, which the Congress created in 1953 to help entrepreneurs form successful small enterprises. The SBA provides financing to young and growing small firms through several channels such as the 7(a) Loan Program and SBA 504 Certified Development Companies (CDCs). Among the policy objectives of the SBA loan programs are the goals of promoting entrepreneurship opportunities for women and minorities.

SBA 7(a) Loan Program

The largest SBA program is the 7(a) Loan Program, which provides lenders with a partial loan guarantee for extending credit to small businesses that meet the SBA's underwriting and eligibility criteria. Participating lenders agree to structure loans according to the SBA's requirements, and they apply for and receive a guarantee from the SBA on a portion of this loan. The SBA does not fully guarantee 7(a) loans--the lender and the SBA share the risk that a borrower will not be able to repay the loan in full. The SBA provides a guarantee of as much as 85 percent for loans less than or equal to $150,000 and a guarantee of as much as 75 percent for loans greater than $150,000. The maximum loan amount is now generally $5 million, increased in 2010 from $2 million under the Small Business Jobs Act of 2010. However, under the Express loan program, which requires less loan documentation and provides quicker turnaround time, only 50 percent of the loan is guaranteed, and the maximum loan amount is $500,000.

Figure 11, panel A, shows that although the dollar volume of SBA 7(a) loans dropped off some in 2012, it grew steadily through 2016 with gross loan approvals increasing from about $15 billion to more than $24 billion. The number of loans grew roughly in parallel with the dollar volume throughout the period, leaving the average 7(a) loan size relatively unchanged over the five-year period.

Panel B shows time trends in the fraction of 7(a) loans reported to have gone to minority- and women-owned businesses as well as the fraction of loans below $150,000, which qualify for a larger guarantee percentage and are more likely to have gone to smaller businesses. The share of loans to women-owned businesses was between 12 and 14 percent between 2010 and 2016. The share of loans to minority-owned businesses ticked up over the period--from 24 percent in 2010 to 30 percent in 2016. This panel also shows that the fraction of loans under $150,000 has decreased slightly
since 2010.

SBA 504 Certified Development Companies

Banks often work with certified development companies (CDCs) to leverage funds for small business financing. CDCs are generally nonprofit corporations specializing in small business finance and are certified by the SBA to participate in the agency's section 504 financing program. The SBA 504 program is intended to help small businesses expand and to create jobs by providing CDCs with the ability to issue SBA-guaranteed long-term debentures to fund small firms' purchase of plant, equipment, or real estate. These loans are typically structured with three components: (1) a first mortgage or lien, which is made by a private commercial lender for 50 percent of the total project and does not come with a government guarantee; (2) a second mortgage or lien, which is made by a CDC for 40 percent of the total project and is backed by a 100 percent SBA-guaranteed debenture; and (3) borrower equity for the remaining 10 percent of the total project.

The Commercial Real Estate and Economic Development (CREED) Act was passed by the Congress in 2015.⁵⁷ Under the CREED Act, an SBA 504 loan may be used to refinance conventional (non-SBA) debt rather than for expansion or job creation. This change allows small businesses to refinance long-term debt taken on with a 25-year amortization schedule with a balloon payment due at the end of 10 years. During the financial crisis, a similar measure was instituted as part of the 2010 Small Business Jobs Act and was quite popular. The CREED Act allows the SBA to offer the refinance program as long as it operates at zero subsidy with fees covering the cost of operating the program.

Figure 12, panel A, shows that funding under the 504 program hit a peak of $6.7 billion in 2012 and fell to $4.7 billion in 2016. The total number of loans followed a pattern similar to the total dollars. Panel B shows that the trends in 504 demographics are similar to those of the 7(a) program. The share of 504 loans issued to female-owned businesses was 13 to 14 percent for the entire period. The share of loans to minorities generally increased over the period, from 24 percent in 2010 to 28 percent in 2016. The share of 504 loans under $150,000 has drifted slowly down over time, accounting for just 1 percent of 504 loans in 2016.

Small Business Investment Companies

The Small Business Investment Company (SBIC) program was initiated in 1957 to provide debt and equity capital to young and growing companies. Although the venture capital market has matured, the SBIC program remains important because many small, growing firms find it difficult to obtain equity financing from venture capital companies. Banks and bank holding companies can own and operate SBICs, which are licensed and regulated by the SBA. SBICs can be organized as separate subsidiaries of one institution or of multiple institutions and other private investors, or they can be controlled by private interests not affiliated with financial institutions. To obtain capital, SBICs often sell long-term debentures that are guaranteed by the SBA. The proceeds of these debentures are used to provide longer-term financing for small businesses, often in conjunction with the issuance of equity interests in the small business to the SBIC. In fiscal year 2016, SBIC's gross approvals were $2.5 billion in 65 debentures. This figure represents about a 30 percent increase over 2012 gross approvals of $1.9 billion.

Microloan Program

SBA's Microloan Program provides small businesses with small short-term loans for working capital or the purchase of inventory, supplies, furniture, fixtures, machinery, or equipment. The SBA makes funds available to specially designated intermediary lenders, which are nonprofit community-based organizations with experience in lending as well as management and technical assistance. These intermediaries make loans to eligible borrowers. The maximum loan amount is $50,000, but the average microloan is about $13,000. In fiscal 2016, gross approvals for the microloan program were $35 million.

Securitization of Small Business Loans

The securitization of small business loans has the potential to substantially influence the availability of credit to small businesses. Potential benefits exist for lenders, borrowers, and investors. However, the obstacles to securitizing small business loans are large.

Process of Securitization

Securitization is the process of packaging individual loans and other debt instruments, converting the package into a security, and enhancing the credit status or rating to further the security's sale to third-party investors (Kendall and Fishman, 1998). This process is generally seen as an efficient funding supplement to direct lending in markets for certain financial assets--notably, agency-backed residential mortgages, commercial mortgages, credit card receivables, and automobile loans.

Active secondary markets in these assets can benefit all parties. Lenders profit from scale economies or from originating and servicing loans without having to add all of the loans to their own balance sheets. They can therefore improve their return on capital by substituting off-balance-sheet, fee-based sources of income for riskier capital-intensive direct lending. This practice potentially results in added liquidity and greater balance sheet diversity. Borrowers whose loans are eligible for securitization typically enjoy lower financing costs. Investors in the securities, while still earning attractive returns, may receive greater liquidity and lower risk than they would by investing directly in the individual loans. Overall, credit risk, in principle, could be allocated more efficiently.

Successful securitization requires that the costs of pooling individual loans and administering the securities collateralized by the loans be less than the spread between the average contract rate on the underlying loans and the yield that investors demand on the securities. Besides various expenses for administration, costs stem from obtaining a high credit rating to reassure investors of the reliability of a security's cash flow. High ratings are often obtained through the provision of "credit enhancements" to the security's purchaser by the originator or others. These enhancements sometimes involve an agreement by the originator or other party to absorb, through the portion of the pool held by them, specified first dollar losses of the pool before any loss falls on the investors in the securitized pool.

Securitization generally has thrived in markets in which the costs of acquiring and communicating information to investors about loans and borrowers are low. These conditions usually occur as a result of standardized loan underwriting criteria; advances in information technology, which make estimating default probabilities and prepayment patterns easier under various economic conditions; and experience in developing and selling loan pools in the secondary market. Most small business loans cannot readily be grouped into large pools that credit agencies and investors can easily analyze: Loan terms and conditions are not homogeneous, underwriting standards vary across originators, and information on historical loss rates is typically limited. The information problems associated with small business loans can be overcome, or offset to a degree, by some form of credit enhancement, as in the case of the SBA's 7(a) loans. However, the more loss protection needed to sell the securities, the smaller are both the net proceeds from the sale of the securities and the incentive for lenders to securitize their loans. Small business loans are an asset for which the high transaction costs of providing credit enhancements have made many potential securitizations unprofitable.

A significant step in encouraging the development of markets for securitized small business loans has been the removal of certain regulatory impediments. The Riegle Community Development and Regulatory Improvement Act of 1994 (Riegle Act) extended some of the regulatory accommodation provided by the Secondary Mortgage Market Enhancement Act of 1984 to issuers of securities backed by small business loans (and commercial mortgages). The 1984 act applied only to issuers of residential mortgage-backed securities. The benefits of the Riegle Act include the elimination of state-level investment restrictions and securities registration requirements as well as the establishment of favorable federal regulatory treatment. Investment restrictions for federally regulated banks, thrifts, and credit unions and for state-chartered thrifts, insurance companies, and pension funds were relaxed as well. Also, risk-based capital requirements for depository institutions that securitize loans but retain "recourse" on subordinated classes of securities were reduced.

A remaining impediment to the development of markets for securitized small business loans has been the lack of more-uniform standards for underwriting and loan documentation. However, the use of credit-scoring systems in the origination of small business loans could address this problem, at least to some extent, by providing a credible, low-cost measure of the expected performance of small business loans. As a result, the information gap associated with small business lending could be lessened, and the volume of securitizations could increase. To date, however, this practice has not been broadly adopted.⁵⁸

Securitization of SBA Loans

Historically, most of the small business loans that have been securitized involved the guaranteed portion of loans made under the SBA's 7(a) Loan Program. These securitizations have been fairly common because they do not involve the risk and information impediments typically associated with the securitization of small business loans. SBA 7(a) loans tend to be highly standardized because the underlying loans are often backed by similar types of collateral and loan documentation. In addition, the originators are SBA "preferred lenders" and are perceived to have clear and rigorous underwriting standards that are consistently applied.

Between 2012 and 2016, the secondary market volume of the guarantee portion of 7(a) SBA loans grew from around $4.5 billion to about $8.5 billion. Because the guaranteed portions trade with a premium, these sales represent total sales of nearly $5 billion to more than $9 billion, respectively (U.S. Small Business Administration, 2016).

The secondary market for 7(a) SBA loans appears
to be healthy and operating well. With no pro-
grammatic changes in the foreseeable future, the market should continue to move along smoothly at current levels.

The other large loan program from the SBA is the 504 program, which primarily finances real estate. As noted earlier, 504 loans are typically funded through a combination of funds from a private lending institution, the SBA CDC, and the business owner. CDCs assist small business borrowers in preparing and submitting the SBA 504 loan applications. The debentures are packaged with other debentures into a national pool and sold monthly to investors. As the traditional markets become more volatile, the demand for these safe investments generally increases. The market for the guaranteed portion of SBA 504 loan on the secondary market has traditionally been much smaller than that for the 7(a) program.

Securitization of Non-SBA Guaranteed Loans

The secondary market for non-SBA loans is limited. According to a Moody's report (2014), the sector has had very little issuance since 2008, largely because of the recession and the decline in real estate prices. The outstanding aggregate balance on these securities was roughly $8 billion. As this sector of lending has shown no signs of recovery since the crisis, it is not likely to grow much in the near future. There have been a small handful of marketplace lenders that successfully bundled some of their small business loans to raise additional capital. However, the total over the past five years was only $1.7 billion, and there have been no new securitization packages in the past year. This amount is a very small fraction of total small business loan dollars outstanding.

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Footnotes