Bank lending to small businesses has fallen significantly since the 2007-2009 recession. A recent report from the Federal Reserve Bank of Cleveland found multiple reasons for this decline, including increased regulatory scrutiny and lack of demand, and recommended policymakers to consider all the causes when developing new interventions.

“Since the Great Recession, small business lending has declined substantially. Given the importance of small businesses to the economy, this situation became a source of concern for policymakers,” Ann Marie Wiersch, MBA, policy analyst at the Federal Reserve Bank of Cleveland, told O&P Business News. “While overall economic conditions have improved since the end of the recession, we’ve seen that small business lending remains well below pre-recession levels. For our analysis, we looked at what is driving the weakness in small business lending, and found that there are a number of factors behind the trends.”

Reasons for decline

Through their research, Wiersch and her co-author, Scott Shane, PhD, the A. Malachi Mixon, III professor of entrepreneurial studies at the Weatherhead School of Management at Case Western Reserve University, found bankers and small business owners blame each other, along with regulators, for the slowdown in small business lending. They said bankers claim business owners have cut back on loan applications amid lessened demand for their products and services, while regulators compel banks to tighten lending standards. In turn, small business owners claim bankers increased collateral requirements and are not as focused on small business credit markets, while regulators make loans more difficult to obtain. The researchers found support for all these perspectives, and said fewer small businesses are interested in borrowing now compared with years past. Small business financials remain weak, depressing small business loan approval rates.

“Some of the subdued demand for loans may stem from business owners’ perceptions that credit is not readily available,” the researchers wrote. “According to the Wells Fargo/Gallup Small Business Index survey, in the second quarter of 2007, 13% of small business owners reported that they expected that credit would be difficult to get in the next 12 months. By the second quarter of 2013 that figure had increased to 36%. By contrast, 58% of small business owners said credit would be easy to get during the next 12 months when asked in 2007, compared to 24% 6 years later.”

As real estate prices have declined, collateral values have also stayed low, the researchers found, which limits the amount that small business owners can borrow. And although banks loosened lending standards for big businesses during the current economic recovery, banks tightened small business lending standards, so fewer small businesses were considered good risks for bank loans, according to the Office of the Comptroller of the Currency’s Survey of Credit Underwriting Practices.

Ann Marie Wiersch

The researchers pointed out the decline in small business lending is not only due to the recession, but also reflects longer-term trends in financial markets. There are fewer small banks, which are more likely to lend to small businesses, due to a 15-year-long consolidation of the banking industry. Increased competition means banks now make bigger, more profitable loans, resulting in a decline in small business loans, which are less profitable.

“As our report shows, we see evidence of supply constraints, including those related to the creditworthiness of borrowers,” Wiersch said. “We also see indications of limited demand. Increased regulatory scrutiny and consolidation in the banking industry have factored into the lending decline as well. It is important to note that several of the driving factors reflect longer-term trends. As a result, the drop in small business lending that manifested during the recession is unlikely to spontaneously resolve during the recovery.”

Making changes

As fewer small businesses look to expand, the demand for small business lending has diminished and credit has become harder for small businesses to obtain. Because small businesses make a considerable contribution to employment and economic activity, the researchers believe policymakers should consider steps to ensure that small business owners can get the credit they need.”

“This is a complex issue — more so than it seems on the surface — and different groups have different views, depending on their own perspectives and experiences,” Wiersch said. “Our report shows there is evidence to support all sides of the debate.” — by Casey Murphy