The Continued Decline of Small Business Banking and Lending

Small business banking is on the decline. Given the importance of that sector, there will not be a full recovery of our economy until sufficient capital flow to small businesses is reestablished.

The small business sector of the U.S. economy is struggling. There are numerous reasons that this is the case, not least of which is the ongoing sluggish economic recovery which has hampered economic growth for all firm types. Small businesses, defined as those with less than 500 employees, have suffered more than most. Small firms represent a sizable portion of both the construction and real estate sectors, two of the hardest hit areas of the economy in recent years. It is fair to assume that as the housing market continues its slow, but encouraging, comeback, that these types of businesses will have the opportunity to recover and grow once again. However, there are long term structural issues that have begun to negatively impact small businesses, structural issues that won’t necessarily be alleviated by an economic recovery. Primary among them is the ongoing consolidation of the U.S. banking system, which has led to a decline in the number of small banks who have traditionally been the major suppliers of capital to small firms. This consolidation may even represent a roadblock to an economic recovery as small companies represent 60% of job creation in this country and nearly half of all economic output. If small companies cannot secure access to sufficient capital to satisfy their needs, it is questionable whether an economic recovery is even possible.

There are 184 fewer commercial banks currently operating than there were this time last year, with small banks increasingly representing the industries casualties. During the twelve month period from September 2011 through September 2012, the number of small commercial banks, defined as those with less than $100 million in assets, decreased by 175. To put this another way, of the commercial banks that either went out of business or were acquired by a competitor during that time period, 95% were small institutions. These numbers actually represent an improvement over the twelve months prior, dating back from September 2011 to September 2010, during which time 455 commercial banks ceased operations, with 350 of those firms being classified as small banks. Still, the trend is both clearly evident and alarming. Without a healthy small banking sector it is dubious as to whether there can be a healthy small business sector, given the historical link between the two. This is especially true given the demonstrated reluctance of larger banks to participate in small business banking and lending.

The decline of small business banking and lending since the onset of the recession is truly dramatic with the volume of small business loans, those consisting of $1 million or less, dropping by $56 billion since 2008. The reasons for this drop-off are numerous. The consolidation of the banking industry, as previously outlined, certainly does not help. Larger banks have not traditionally been key players in such transactions due to the relative lack of profitability from engaging in small business banking activities. This profitability has declined even further in recent years due to longstanding low interest rates which impact the primary revenue stream of this type of banking, the accumulation of deposits from small businesses. With little money to be made in loaning these deposits out due to interest rates near zero, many large banks lack incentive to do business with small firms. Further exacerbating the issue is that small firms, generally not borrowers of significant amounts of capital, are borrowing even less than historically has been the case out of concern for the economy. Growth plans have been shelved and work force expansions delayed as small firms, like many other participants in the economy, stay on the sidelines waiting to see how scenarios like the ongoing Fiscal Cliff crisis unfold.

The implementation of stricter regulations on the banking industry by the government hasn’t improved the situation either, as these regulatory actions have had the unintended consequence of making banks even more risk averse when it comes to business lending than they already would be in these uncertain times as the bank’s lending upside is less than the potential downside of running afoul of the various regulatory agencies of the Federal government. As a result borrowers who in the past would have been considered credit worthy can no longer qualify for loans. This has created a vacuum in small business lending, one that would normally be filled by community and regional banks. Unfortunately many of these have not survived the financial crisis and those that have often lack the in house expertise to take advantage of the opportunity presented to them. This leaves small firms with few options via traditional means to acquire capital sufficient for them to grow.

What can small firms locked out of the banking system do to satisfy their monetary requirements? One avenue worth exploration is working with the Small Business Administration (SBA). This government agency does not offer loans themselves, but rather partners with banks who do, acting as a guarantor of loans to small businesses, those removing the onus of risk from the equation which often discourages banks from making such loans on their own. A guide to their loan programs can be found here: Another potential resource is the small business loan section of our website which allows customers to identify banks who focus on small business banking. That link can be found here:

Still, even with assistance from government agencies such as the SBA or from websites such as there is a clear need to be filled here. Free markets abhor a vacuum which often leads to the lifespan of such vacuums being quite short. With the ongoing revolution in the financial services industry being driven by such partnerships as the one between American Express and Walmart to provide low fee pre-paid debit cards, one wonders how long it will take for other such partnerships to be created to provide desperately needed capital to the small firms that are the engine of our economy.

Michael Cancella
Michael Cancella: Michael Cancella graduated magna cum laude from Columbia University with a B.A in History in 2010. After graduating he worked in the finance industry at a hedge fund startup and is currently going through the CFA Program in an effort to broaden his knowledge of finance and the economy. Prior to returning to school to finish his degree at Columbia, he spent a number of years i

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