It’s no secret that bank lending to small businesses is on a steady decline. If you’re reading this, you may be a part of the 80% of merchants who have applied for a bank loan and got rejected. Since 2005, the percentage of business loans issued by banks to small businesses has dropped from 33% to a mere 24%.
Before President Obama had been elected to his second term, he vowed to “tailor his second term policies to the needs of small business owners and entrepreneurs, promising to improve their access to capital, limit their tax burden and alleviate their regulatory headaches to encourage job creation and business expansion” (Harrison, The Washington Post). Entrepreneurs across the nation would argue that no such change has been in effect. The million dollar question that everyone wants to know the answer to is: Why?
Small businesses felt the brunt of the recession crisis, accounting for over 40% of job losses. Without access to capital, small firms were a lot slower to recover than larger firms. Since 2008, the number of struggling entrepreneurs has increased drastically because of the result of declining sales, banks tightening their loan standards, along with weakened housing and stock market collateral.
In fact, more than 80% of banks have admittedly reported tightening their standards after the 2008 economic crisis. Small businesses that would have been approved for loans 10+ years ago are simply being denied day in and day out.
Their reasons for tightening their standards are because they believe smaller loans are a whole lot more “time consuming”.
When lending capital, it is important to develop close relationships, and banks feel smaller firms are too costly/time consuming. While merchants of smaller firms are very optimistic about the talent and ability of their business, they remain concerned about what they can in fact control.
Furthermore, the main argument banks have is that small businesses represent a higher risk. They have higher failure rates, fewer assets, and/or bad credit. Moreover, these smaller firms are harder to underwrite. They tend to have tax liens, history of bankruptcies, or inadequate financial statements.
Traditional banks have simply tailored their protocol in ways that owners of small businesses do not fit. They require a strong cash flow, some sort of collateral, and a detailed look of the owner’s credit. Most merchants lack one, if not all, of these guidelines.
While community banks are the answer for some, they definitely aren’t the final solution. While small business loan approval rates are triple the amount of approval at big banks, the number of “local banks” have been steadily declining since the 80’s. The big banks keep getting bigger, and the number of community banks are on pace to diminish completely.
According to Financial Times, the state of bank lending to small firms remains a big problem. Of the 27 million small businesses, 10 million do not require financing. However, 14 million do not get the businessfunding that was requested, whether it was because they simply were denied, or that they were discouraged by the long process and gave up.
That leaves a remarkable number of only 3 million business owners who get the financing they requested. The void that these banks have left upon us all has opened the door for a new wave of financing: Alternative lending.