Small businesses employ 47.5% of the total workforce, making them essential to the U.S. economy. However, a business owner’s ability to obtain financing can either expand or stall growth.
There have been multiple research reports recently that focused on the importance of lending for small businesses and provided a catalyst for further discussion.
The National Community Reinvestment Coalition’s (NCRC) 2019 report on discouragement and disinvestment in small business lending provided objective measures to behaviors that, taken as a whole, discouraged potential customers from applying for bank loans. Using matched-pairs testing, NCRC found that behaviors as simple as greeting and introducing oneself to the potential client could determine how the relationship between lender and client progressed.
When small business owners are discouraged from applying to banks for loans, they either do not apply for credit at all, thus freezing growth, or they seek loans from unconventional lending sources. This has serious implications and a business owner can suffer tremendous loss. For example, a common complaint about online lenders is that they charge higher interest rates than banks, causing the business owner to be burdened with a higher debt-load and reduced growth.
NCRC’s research, conducted jointly with academic partners, provided a more complete understanding of the relationship between loan officers and prospective clients seeking information on small business financing. It is imperative for banks to understand how the behavior of their employees discourages borrowing, and why that’s important:
- Compliance with fair lending laws. Under the Equal Credit Opportunity Act, banks can be in violation of the law if they discourage an applicant from applying.
- Discouragement of creditworthy potential customers is a business failure. Banks are in the business of making loans and if they discourage or have a reputation of discouragement then they are not fulfilling their business objectives.
- The racial wealth divide. Access to safe credit enables business growth which works to close this divide. When business owners turn to unsafe products, the divide expands.
Additional recent work that builds on NCRC’s findings include a 2019 study by the Woodstock Institute on small business lending in Illinois. This report analyzed small business loans made under the Community Reinvestment Act (CRA). It found that, despite levels of lending slowly rebounding after the Great Recession of 2008, small business lending had yet to reach pre-recession levels. The number of CRA reported loans by racial and ethnic composition of the census tract showed that minorities were not obtaining loans. For example, in Illinois, if banks issued small business loans at the same magnitude to the number of businesses listed in neighborhoods with higher minority populations as they had to white neighborhoods, they would have made an additional 721,348 loans during the same recorded period.
Following Woodstock Institute’s paper, the New York Federal Reserve Bank released its annual Small Business Credit Survey on small businesses without employees. The study was based on individual online surveys sent by the Federal Reserve to small business owners throughout the country. The survey found that the owner’s primary source of income for the 63% of small businesses that do not have employees was derived from their business. However, when compared to white businesses, non-Hispanic Black companies were more likely to operate at a loss than at a profit. This means that for a group of Black business owners, their business was not a benefit, but rather an obstacle to creating wealth, further increasing the racial wealth divide. One of the major factors impacting Black businesses’ ability to turn a profit is the lack of appropriate financing. The survey found that 60% of Black business owners and 54% of Hispanic-owned businesses had unmet funding needs, which limited business growth and could cause a business to operate at a net loss.
Similar results were found for minority-owned businesses with employees. According to the Federal Reserve study, 27% of Black and 21% of Hispanic business owners with employees reported feeling discouraged from applying for credit. This means that Black and Hispanic business owners would not apply for financing, because they believed they would be turned down. This concept of discouragement is vague because it’s based on subjective feelings rather than objective observations. This is why the recently released research by NCRC is so important. It provides the objective testing needed to determine why minorities are feeling discouraged in asking for small business loans from banks.
What to do
Fair lending and compliance teams at banks should implement their own mystery shopping systems in the small business arena to determine their role in making minority loan seekers feel disheartened. There needs to be ongoing training of employees on fair lending laws, basic marketing and customer service practices and implicit biases to ensure equal access to credit for all. Banks also should work on hiring a diverse staff as minority business owners may feel more comfortable discussing loan products with someone who is of a similar racial, national origin or gender as them. These are significant steps in helping bridge the racial wealth divide.
Ali Lederer is NCRC’s Director of Fair Lending and Consumer Protection