This is the second in a series of articles based on a Harvard Business School working paper by Karen Mills that analyzes the current state of availability of bank capital for small business.
During the 2008 financial crisis, small businesses were hampered in securing bank credit because of a perfect storm of their falling sales and weakened collateral, and growing risk aversion among lenders. Those days are not over. While lingering cyclical factors from the crisis may still be constraining access to bank credit, there are also structural barriers that seem to be preventing banks, both large and small, from ever fully returning to the small business market.
CYCLICAL FACTORS LINGER FROM THE RECESSION
In the recent recession small-business sales were hit hard and may still be soft, undermining their demand for loan capital. Income of the typical household headed by a self-employed person declined 19 percent in real terms between 2007 and 2010, according to the Federal Reserve's Survey of Consumer Finances. And a survey by the National Federation of Independent Businesses (NFIB) noted that small businesses reported sales as their number one problem for four straight years during the crisis and subsequent recovery.
In addition, collateral owned by small businesses lost value during the financial crisis, potentially making small business borrowers less creditworthy today—in fact, small business credit scores are lower now than before the Great Recession. The Federal Reserve's 2003 Survey of Small Business Finances indicated that the average PAYDEX score of those surveyed was 53.4. By contrast, the 2011 NFIB Annual Small Business Finance Survey indicated that the average small company surveyed had a PAYDEX score of 44.7. Moreover, the values of both commercial and residential real estate, which represent two-thirds of the assets of small-business owners and are often used as collateral for small-business loans, were decimated during the financial crisis.
On the supply side, banks remain more risk averse in the recovery then they were prior to the recession. Measures of tightening on loan terms, including the Federal Reserve Senior Loan Officer Survey, for small businesses increased at double-digit rates during the recession and recovery, and have eased at just single-digit rates over the past several quarters. Loosening has been much slower and more tentative for small firms than for large firms.
Regarding points of access to capital, community banks have long been crucial to small business lending. But community bank failures have been high and few new ones have started up. Troubled and failed banks reached levels not seen since the Great Depression during the financial crisis of 2008, with the failures consisting mostly of community banks. This environment—where troubled local banks appear unable to meet re-emerging small firm credit needs—would be an ideal market for new banks, but new charters are down to a trickle. In fact, a year recently went by with no new bank charters issued by the Federal Deposit Insurance Corporation (FDIC), the first time that happened in the agency's 80-year history.
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