Who Lends to Small Businesses?

Who lends to small businesses?

This question has gained new urgency as the federal government scrambles to bring emergency funding to millions of small businesses across the country under the Paycheck Protection Program (PPP). The PPP consists of forgivable loans that borrowers may use to cover employee payroll, rent, and utilities for eight weeks. The Small Business Administration (SBA) manages the PPP, but funds are allocated by authorized private lenders.

Although the program ostensibly seeks to assist the smallest concerns in America, which cannot gain access to funding through other Fed and Treasury facilities, it came under strong criticism when it emerged that several rather large firms had benefited from it. Data from the SBA for its first ($342 billion worth) round of PPP loans corroborate these anecdotes: 44 percent of loan volume consisted of loans of over $1 million and went to just four percent of (presumably the largest) applicants.

The apparent inequity prompted public outrage, followed by a string of exculpatory press releases and stern official "clarifications" concerning eligibility for PPP loans. The public shaming seems to have hit a nerve: SBA data for part of round two lending, which will total $310 billion, show that loans under $150,000 accounted for 37 percent of volume, compared to just 17 percent in the first round. The average loan so far in round two is $79,000, against $206,000 for round one loans. Still, loans over $1 million represented 27 percent of total lending, and those loans went to just 0.96 percent of applicants. The big guys continue to get a large slice of the PPP pie.

This disappointing outcome has occurred despite a tweak Congress made to the program, ostensibly for the sake of getting more PPP funds to the smallest of small businesses. Of the $310 billion in round two funding, $60 billion was set aside for small banks, credit unions, and community financial institutions (CFIs).[1] Specifically, $30 billion was earmarked for banks and credit unions with assets between $10 billion and $50 billion, while another $30 billion was reserved for institutions, including CFIs, with assets below $10 billion. Thanks partly to this carve-out, lenders with under $50 billion in assets have collectively accounted for 48 percent of round two loans so far, while $27 billion (15 percent) of all lending has come from lenders under $1 billion, including CFIs.

It's tempting to suppose that small depository institutions are more likely to lend to smaller businesses. Didn't Bailey Building & Loan, the thrift in It's A Wonderful Life, serve the Main Street shops next door? Alas, life doesn't always imitate art: it turns out that the average large-bank loan is a lot smaller than the average small-bank loan. Since a commercial loan's amount is usually indicative of the borrower's size, these data suggest that large banks are actually more likely to cater to the smallest businesses. Specifically, recent FDIC filings show that the average small loan made by a bank with assets in excess of $10 billion was $13,250, against $40,650 for banks with assets between $1 billion and $10 billion, $30,170 for those between $100 million and $1 billion, and $42,095 for banks under $100 million.[2]

That tendency seems to hold for PPP loans as well: according to a recent survey by BPI, a trade association of America's largest banks, the average PPP loan for the nine BPI members who submitted data was for $115,000, which is 10 percent smaller than the PPP average so far ($130,000). The same survey shows that 64 percent of loans were for less than $50,000, and that 75 percent of them went to businesses with fewer than ten employees. SBA data corroborate BPI's findings, showing no relationship between total PPP loan volume originated (a proxy for the lender's size) and average loan size.

Not all the preliminary evidence shows large banks in a better light than smaller banks. Economists at the New York Fed compared the percentage of small businesses receiving PPP loans with the deposit market share of community banks (those with under $10 billion in assets) in each state, finding a positive relationship. Many factors could be behind this trend, though, such as the sectoral composition of PPP borrowers in each state, whether small businesses have established relationships with banks, and how FDIC statisticians allocate deposits. (South Dakota, home to many credit-card banks with few offices, scores very high on PPP penetration but extremely low on community-bank market share.) According to another analysis, it is bank branch density, regardless of bank size, that has a strong positive correlation with PPP lending. But note also that BPI's finding, that large banks are making smaller loans on average, is not incompatible with the NY Fed's, that small banks are making more PPP loans.

There are many reasons why large banks may be better at dealing with the smallest of small businesses. Economies of scale may make smaller loans more profitable than they would be for smaller institutions. Large banks also issue most corporate credit cards, which many of the smallest businesses rely on as their chief source of working capital. Smaller banks, on the other hand, tend to focus on more intensive, relationship-based business lending, which is costlier to provide and therefore only worthwhile for larger loan sizes.

None of this means that small banks don't reach businesses that larger banks might never cater to, because they are in remote areas, operate niche businesses, or have idiosyncratic financial circumstances that put them outside the large-bank "credit box," which is often less discretionary. Nor does the evidence disprove the accusation that large banks favored larger PPP applicants, many of them existing customers, in round one. But the evidence does seem to contradict the main argument for setting aside a portion of round two PPP funding for smaller lenders. While reserving a share of the funds for CFIs may have improved the smallest businesses' odds of getting PPP loans, because CFIs do indeed focus on microloans, minority businesses, and low-income communities (although they often partner with large banks for that purpose), shunting funds to smaller banks doesn't help to get funding to the smallest borrowers.

The $60 billion set-aside might have worked better had it not excluded nonbank lenders that use technology to underwrite loans more cheaply and can therefore afford to make smaller loans. Unlike most small banks, these fintech lenders often specialize in the smallest businesses and those without access to bank credit: according to the Federal Reserve Banks' 2019 Small Business Credit Survey, they are the third-most-popular source of outside funding, and especially so among higher-risk applicants and minority businesses. Data from Funding Circle show their average PPP loan so far has been for $75,000, with 78 percent of applications asking for amounts under $50,000. If officials really wanted the $60 billion set-aside to reach underserved small businesses, they would have done better to include fintech firms, instead of keeping them out.

In subsequent PPP rounds and other liquidity provision programs, policymakers should let all lenders take part on equal terms. There's no point in playing favorites when doing so only makes for more bad optics.


[1] CFIs include community development financial institutions, minority depository institutions, certified development companies, and microloan intermediaries.

[2] My sources are FDIC call report data as of the end of December 2019. The relevant line item is commercial and industrial loans under $1 million.