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Reversing the Decline in Small Business Lending

July 25, 2014 in Economics

By Mark A. Calabria

Mark A. Calabria

Of course small business lending is risky. The annual failure rate for firms with fewer than five employees averages around 20 percent — 1 in 5. That’s true even during a boom.

And younger firms, which are more likely to be minority owned, fail at even higher rates.

While small business lending often declines during a recession, recent regulatory changes may well result in a permanent decline in bank lending to small business. The impact will be felt across all small businesses, but the effect is likely to be greatest for minority-owned small businesses, as statistically these owners often have less personal wealth and weaker credit histories.

Of course, banks are only one conduit for small business and minority lending. Peer-to-peer, crowd-funding and direct capital market financing are poised to play a greater role and potentially offset part of the decline in bank finance.

The future of small business lending may well see its largest growth occur outside the traditional banking sector.”

A useful proxy for bank lending to small business is the volume of loans made sized under $1 million. This flow peaked at about $16 billion in the second quarter of 2006, declining to about $10 billion in third quarter of 2009, around the trough of the current economic cycle. After a long, slow and bumpy climb, small business bank lending had recovered almost all its decline by the first quarter of 2014.

This recovery, however, masks the fact that as a percent of total bank lending, small business lending continues to decline. Estimates from the Federal Reserve Bank of Cleveland show small business lending falling from more than 50 percent of non-farm, nonresidential bank lending in 1995 to less than 30 percent today. This trend has been a steady one, showing little sign of reverse. And these numbers are not adjusted for inflation, which shows small business lending has a long way to go before regaining its previous real peak.

The future of small business lending will have a disproportionate impact on minorities. Although white owners continue to own the majority of small businesses, growth in business ownership has been considerably larger among minority owners. The U.S. Census Bureau reports that during the economic expansion from 2002 to 2007, the number of businesses owned by minorities increased 45 percent, led by African-American owners, who experienced a 60 percent increase in businesses owned. White-owned firms increased only about 13 percent during this period. While minority-owned …read more

Source: OP-EDS

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