Small business lending remains constrained across the U.S. Loans outstanding in the first quarter of 2010 stood at $670 billion, substantially lower than the $710 billion level in 2008. The Federal Reserve, understanding that small businesses employ half of U.S. workers and generate an even larger percentage of job growth, has been looking into why banks aren’t lending to this crucial sector. Some analysts say businesses are being cautious and not seeking financing. Other analysts indicate that banks are being too conservative when lending to small businesses.
A recent report by the Small Business Administration (SBA) sheds light on the complex topic of where and why small operators look for financing.
First, not all small business owners use credit, and when they do, they tap a variety of sources as these statistics show:
- No credit 20%
- Trade credit only 20%
- Bank credit only 20%
- Trade and bank credit both 40%
Firms that use no credit could be potential future customers for local banks who survive by making business loans. As these banks reach out to small businesses that have never used credit, they should understand the following details:
- These firms are more likely to be owned by Asians, Hispanics, or blacks.
- These firms are likely be located in rural areas.
- The owners are often less experienced and possess less education than average.
Non-borrowers operate primarily services businesses, or in the wholesale or retail-trade industries.
Firms that use trade credit are often in need of short-term financing. Suppliers are more likely than banks to offer trade credit when the money supply is tight, i.e. during a recession. Also, small businesses maintain a close relationship with suppliers who often understand the industry well and extend trade credit based on that knowledge.
And finally, up to 60% of small businesses rely solely on bank credit or a combination of bank and trade credit. In general, operators in the transportation and insurance/real estate industries are most likely to seek bank credit. In addition, these businesses are often younger and lack an established track record. The demographics of business owners who use bank credit include:
- Younger than average
- Have a college/graduate degree
- More likely to be Hispanic
Fed Chairman Ben Bernanke says "The formation and growth of small businesses depend critically on access to credit. Unfortunately, those businesses report that credit conditions remain very difficult." Banks looking to profit on small business loans should forge stronger relationships with operators in the local community and then market to specific business groups to increase loans while minimizing risk.[Source: Bank Credit, Trade Credit or No Credit: Small Business Financing. SBA.gov. June 2010. Web. 13 Jul. 2010; Raice, Shayndi. For Small Business, Slow Gains in Credit. Wall Street Journal. 13 Jul. 2010. Web. 14 Jul. 2010]