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Why Banks Don't Lend to Small Businesses

Why Banks Don’t Lend to Small Businesses

Even now, a decade since the onset of the Great Recession, traditional banks aren’t providing the meaningful access to credit small businesses depend on for growth and job stimulation. The lack of banks issuing credit to small businesses has created a ‘small business credit gap’, which is currently being filled by the alternative lending industry, where private funds act as credit resources for small businesses.

Why are Small Businesses important to the US economy?

Small businesses employ half of the nation’s private sector workforce – about 120 million people and have been slow to recover from the great recession. The following credit crisis has made it almost impossible for small businesses to access traditional credit from institutional lenders. Ask any small business owner, banks are simply not approving them for small business loans or lines of credit.

Why do economic shifts hit small businesses more so than larger firms?

Small businesses are more dependent on external bank capital than larger businesses. Bank loans or lines of credit act as ‘financial accelerators’ for small businesses, but when not available small businesses have difficulty weathering the tidal shifts of a recession, since cash flow may become unstable/unpredictable.

How does the alternative lending industry help Small Businesses? 

The presence of alternative lending, with fast turnarounds and arguably more accurate underwriting credit scoring algorithms, fills a void in the small business lending space. There are structural issues in traditional banking that are impeding the full recovery of bank credit markets for smaller loans.

The end of traditional bank lending to Small Businesses

-More Regulatory Oversight and Costs

-Less Community Banks

-Not Profitable to Loan Money to Small Businesses

The recession has had a lingering effect on the ability for banks to lend money to small businesses. Today, banks say that increased regulatory oversight and higher compliance hinders their ability to approve small businesses, where ‘softer’ underwriting criteria and community banking ‘relationship lending’ used to be the norm.

Small businesses across the board aren’t getting approved because of their lower sales reporting due to unilateral low industry retail and service sale performance post recession as compared to before 2008. Also, small business loans are inherently more risky than other bank endeavors, so why would banks take the risk?

Traditionally, community banks have been the backbone of small business lending, but their decline and consolidation by larger big banks have obviously decreased the overall number of issued small business loans. In the mid 1980’s there were over 14,000 community banks, today there are less than 6,000.

Also, the cost to underwrite and process a $100,000 small business loan are comparable to a $1 million loan, due to old-school ‘business profile’ underwriting techniques that banks use to scrutinize small business credit risks.

The small business loan market or the lack thereof – has created the need for small business alternative (non-bank) funding. Businesses can access capital at higher than ‘bank rates’, but have immediate access to private capital, without timely underwriting processes.  Best part is, they get approved!