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.³⁴ 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 issues can provide insight into the availability of credit to small businesses.

Overview

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.³⁵ 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.³⁶ 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 2010 Survey of Consumer Finances (SCF), 78.4 percent of households that owned small businesses indicated that the primary institution for their business was a commercial bank.³⁷ Similarly in 2011, over 85 percent of small businesses in the most recent NFIB finance survey reported that their primary financial institution was a commercial bank.³⁸ 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 Reports of Condition and Income (Call Reports) and Thrift Financial Reports (TFRs).³⁹ 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.⁴⁰ 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.⁴¹

These data are used to estimate the amount of credit extended to small firms. Because firm characteristics are not reported on Call Reports or TFRs, 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.⁴² 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 TFR data, these loans are not typical of the credit obtained by the majority of small firms.⁴³ 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 dollars is directed to firms with revenues of less than $1 million. This volume is likely to be an understatement since many reporters do not collect or submit information on the revenues of the firms they lend to. 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.

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Lending by Depository Institutions

Commercial Banks

Commercial banks are important providers of credit to small firms.⁴⁴ Lending to small businesses involves unique challenges that banks are particularly well suited to meet. Of particular significance, information on the financial condition, performance, and prospects of small firms is not readily available, so lending is often based heavily on information gathered through established relationships, which banks and their staff frequently have with small firms and their owners. Commercial banks continue to maintain local branch networks, which further aid them in gathering such information. Commercial banks have continued providing 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 25 years has dramatically reduced the number of banks, increasing the importance of large banks and the concentration of industry assets.⁴⁵ For example, more than 2,800 bank mergers involving acquired assets in excess of $4.3 trillion were completed between 1999 and 2011.⁴⁶ Even though more than 1,500 new banks were granted charters over this period, the total number of bank organizations fell by more than 15 percent to 5,670 (table 9).

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 10, the average banking organization with $1 billion or less in total assets held over 15 percent of its portfolio as small business loans in June 2011.⁴⁷ In contrast, organizations with assets between $1 billion and $10 billion held almost 12 percent of their assets as small business loans, and the largest organizations--those with assets greater than $10 billion--held only about 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.

The pattern for holdings of microloans, which are defined as business loans of $100,000 or less, is even clearer, with smaller banks maintaining an even larger share of their asset portfolios in such loans. 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 1.2 percent of all commercial banking organizations in June 2011 but held 80.0 percent of the banking assets in the industry (table 11). These large organizations held a much smaller, but nonetheless substantial, share of small business loans, as 47.9 percent of small business loan dollars and 63.0 percent of microloan dollars were held by banking organizations with more than $10 billion in assets. They also account for a substantial portion of the number of loans granted, extending almost 87 percent of all microloans and almost 44 percent of business loans greater than $100,000 but less than $1 million. The only microloan or small business loan category to increase between 2007 and 2011 was that for microloans by banking organizations with more than $10 billion in assets. Small business loans for all other banks decreased (table 12).

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 2011, banks with assets of $250 million or less accounted for 66.8 percent of all banking organizations but only 4.0 percent of all banking assets (table 11). However, they held 13.7 percent of all small business loans and 13.9 percent of microloans.

The share of small business loan dollars held by organizations with assets greater than $10 billion fell slightly between 2007 and 2011, but the share of business microloan dollars for these institutions increased from 54.5 percent to 63.0 percent. In 1997, the share of microloans held by banking organizations with assets greater than $10 billion was only 30.6 percent. The pattern for the number of loans extended is similar to that for total dollar values. The growth in the share of business microloans since 1997 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, may have 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).

The lending shares of the smallest banks--those with assets of $250 million or less--decreased between 2007 and 2011. Some of this decrease was due to the reduction in the share of banking organizations and bank assets that, because of bank consolidation, occurred for this class of institutions. The decrease in the share of small loan holdings at the smallest banks was comparable with the increases experienced by banks with assets between $250 million and $1 billion and banks with assets of $1 billion to $10 billion. Conversely, increases in the shares of microloan holdings and the share of small loans and microloans extended were observed only for the largest banks.

Numerous research studies directly analyze the relationship between consolidation activity and the availability of credit to small firms.⁴⁸ 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 89 percent of the bank assets acquired between 1999 and 2011 belonged to banks with at least $1 billion in total assets. Therefore, a large majority of the banking 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 bank.

On the other hand, even though relatively few assets have been purchased in mergers of small institutions, deals involving target banks with total assets of $250 million or less accounted for nearly two-thirds of all transactions completed between 1999 and 2011. About 19 percent of these deals involved an acquirer that had assets of $250 million or less, and roughly 26 percent involved an acquirer with assets between $250 million and $1 billion. Even though 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, 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 appears not 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).⁴⁹

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 13 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 2011, the 10 leading holders of small business loans held 29.9 percent of all such loans and 51.2 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. This pattern has two implications for the availability of credit to small businesses. First, because the share of small business lending activity attributable to the 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, an industry in which the dominant providers of credit to small businesses are a relatively few large banking organizations does not appear to be developing.

These data also show that the shares of small business loans held by the most active small business lenders have remained relatively constant since 2007, 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 three-quarters of total assets in both 2007 and 2011. Microloan lending became slightly more concentrated with the top 100 most active small business bank lenders, accounting for over 67 percent of microloans in 2011, up from slightly less than 60 percent in 2007.

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 2007 and 2011, the top 10 holders of small business loans were among the 15 largest banking organizations in the industry.

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. Instead, 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 a small business tends to obtain loans, leases, and lines of credit from a nearby provider.⁵⁰ In 2003, the median distance between a small business and its lender was 11 miles, and in 66.0 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 83.0 percent of lenders were located within 30 miles of the firm's headquarters. More-current data from the 2010 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 3 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 the extent that it promotes 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.⁵¹

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.⁵² 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 14, along with information on the number of banks and banking offices.⁵³ The data show that, in 2011, about 27 banks with 208 offices provided banking services in the average metropolitan statistical area (MSA). The average level of the HHI with 50 percent thrift inclusion was 1664.⁵⁴ In the average micropolitan area, 9 banks with 21 branches provided services. The average HHI with 50 percent thrift inclusion was 2285. Rural areas are much more highly concentrated with respect to their deposits and, on average, have fewer banks and banking offices. In 2011, the average rural market had about 4.4 banks with 7 offices. The average rural market HHI with 50 percent thrift inclusion was 4137.

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 has remained constant or increased somewhat, whereas the HHIs have either remained constant or decreased somewhat. Modest deconcentration, in conjunction with a small increase in the number of banks, suggests that a reduction in competition from commercial banking organizations is not likely to have been a contributing factor in the decline in the availability of credit in recent years.

Overall, small business loans outstanding from commercial banks peaked in 2008 and have declined in each subsequent year (table 1). 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 fact 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 decrease 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, 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 this period.⁵⁵

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.⁵⁶ As of June 30, 2011, there were 1,057 thrifts and 5,670 commercial banking organizations. The value of small business loans held by savings institutions was slightly more than one-tenth of the value held by banks. Savings institutions held $62.9 billion in small business loans and $21.8 billion in microloans, compared with $529.7 billion and $111.2 billion, respectively, held by commercial banks.

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 2011, roughly $11.5 trillion in total assets were held by commercial banks and savings institutions, with the latter holding about 10 percent of the total, or $1.2 trillion (table 15). Overall, in 2011, the average thrift held roughly 9.0 percent of its asset portfolio in small business loans and 1.3 percent in microloans (table 16). In contrast, the average commercial bank held 16.0 percent of its portfolio in small business loans and 3.6 percent in microloans (table 10). 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.⁵⁷

Among savings institutions, the most active lenders to small businesses were not necessarily the largest institutions in terms of assets. In 2011, the 10 most active thrifts accounted for 55.0 percent of thrift small business lending (table 17). In 2007, the 10 most active thrifts accounted for a much greater proportion of thrift assets than they did in 2011, falling by over 10 percentage points from 31.6 percent to 20.8 percent. The failure of the largest thrift, Washington Mutual in 2008, contributed to this dramatic change in the asset holdings of the most active thrifts. Prior to its failure, Washington Mutual held 19.0 percent of total thrift assets and accounted for 3.5 percent of total small business loans. Despite its size, the failure of Washington Mutual does not seem to have disproportionately affected the availability of loans to small businesses from thrifts; the decline in outstanding small business loans at thrifts between 2007 and 2011 was similar to the decline at commercial banks.

Thrift microloan lending is highly concentrated. In 2007, the 10 most active lenders accounted for 85.2 percent of thrift microloan outstandings. By 2011, 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 2011, while the 10 most active lenders accounted for almost nine-tenths of thrift microloan dollars outstanding, they held less than one-fourth 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 have not historically 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 the 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. Similarly, 7.1 percent of households that owned small businesses in the 2010 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 steadily throughout the recession and post-recession period, while commercial banks' small loans to businesses have shrunk (table 18). Between 2007 and 2011, credit union outstanding loans to business members increased by 54.5 percent, while outstanding small loans to businesses by commercial banks decreased by 11.1 percent.⁵⁸

Since 1998, credit union lending to member businesses has been subject to a cap of 12.25 percent of total assets. 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 increase the cap to 25 percent of assets are currently pending in both the House and the Senate.⁵⁹ As of June 2011, 3.6 percent of credit unions had outstanding loans to business members totaling at least 10 percent of their assets. Among the largest credit unions--those with assets of more than $1 billion--13.9 percent had outstanding loans to business members that were at least 10 percent of their assets. Thus, an increase in the cap has the potential to accelerate the rate of lending by credit unions if that legislation is enacted.

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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.⁶⁰

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 as their primary financial institution. This share more than doubled by 2011, when 5.0 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 them 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 indicates a growing need for this type of funding. While there are an ever-growing number of nondepository sources of financing, data are scarce. This section will briefly discuss finance company lending, venture capital funding, and crowdfunding and peer-to-peer lending.

Finance Companies

Businesses use finance companies primarily for the purchase of motor vehicles or other business equipment.⁶¹ As with lending by commercial banks, lending by finance companies fell steeply between 2008 and 2009 (table 19). It is not possible to separate the data according to the size of the business, but given the size of the decline, it is safe to conclude that finance company lending to small and large businesses fell. Lending by finance companies has continued to decline through the first quarter of 2012.

Venture Capital

Venture capital provides funding to early-stage companies with potential for high growth. Venture capital funds make money by owning equity in the companies in which they invest. Investments by venture capital funds fell from about $30 billion in 2007 to $20 billion in 2009, but they have recovered somewhat since then and are on pace to reach $23 billion in 2012 (figure 9). Financing of firms at very early stages of development also declined in 2009 but rebounded in 2010 and 2011.

Peer-to-Peer Lending and Crowdfunding

Peer-to-peer lending allows individuals to lend money to other individuals without using a traditional financial institution. Since 2005, many peer-to-peer lending sites have been launched on the Internet to link potential borrowers to potential lenders. In 2008, the Securities and Exchange Commission (SEC) determined that peer-to-peer lending must be regulated as securities. As a result, businesses and major sites were shut down while participants attempted to get their sites registered with the SEC and reconfigure their platforms to conform to the new regulations. Since relaunching, lending volumes have steadily increased, boosted in part by the financial crisis and difficulties encountered by traditional financial institutions.⁶²

Peer-to-peer lending sites have seen a dramatic increase in the number of loans over the past several years. Loan-level data provided by Prosper.com and LendingClub.com--the largest peer-to-peer lending sites--indicate that dollar volume of peer-to-peer lending grew by nearly 300 percent between 2008 and 2011 (figure 10). The total dollars that went to small businesses has also been steadily increasing since 2009.⁶³

Over the past four years, Lending Club and Prosper have been responsible for over $50 million in small business loans (table 20). For Prosper, business loans represent 16.1 percent of all dollars lent over this period; for Lending Club, business loans are only 5.6 percent of loan dollars. However, the average loans funded by Prosper have higher interest rates and are one-half to two-thirds the average loan funded by Lending Club. Although the total dollar volume is small relative to other sources, this high growth reflects the overall increase in all types of Lending Club and Prosper loans and a rapidly growing influence in this type of lending.

On a final note, both sites also provide some information on loans that were not funded. The data indicate that there were over $600 million in requests for business loans over this four-year period that were not funded, nearly $400 million in 2011 alone. This unmet demand suggests that as the economy began to improve and standards at commercial banks were still relatively tight, small businesses began searching for alternative sources of finance.

Similar to peer-to-peer lending, many crowdfunding sites have surfaced online. Crowdfunding involves large numbers of people purchasing small equity stakes in the firm. However, the legality of sites such as Kiva, MicroPlace, Indiegogo, and Kickstarter has come into question, and it has been argued that such sites should be registered as broker-dealers to facilitate the selling of shares in order to minimize fraudulent offerings. In early April of 2012, the Jumpstart Our Business Startups (JOBS) Act was signed into law; it creates a crowdfunding exemption from SEC regulations for firms raising less than $2 million, but with limits on individual investments. Due to the act's recent passage, data are not yet available on the extent to which small businesses use crowdfunding sources to raise capital.

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