Banks and Small Business Lending
If you’re a small business owner, you’re probably familiar with the common practice that many banks don’t lend to small businesses. But why, especially if small businesses are the engines that are responsible for economic growth?
Some years back, it was quite easy to find funding to start or grow your business. You probably had a personal relationship with the banker which translated to a financial relationship: you knew for sure that you could get the loan that you needed.
However, the economy has changed and it is becoming more difficult to obtain a loan from a bank. It’s more and more common to see big banks driving out many of the community banks from the market.
This has also had an adverse impact on banks lending practices when it comes to small businesses. The fact is, if you own a small business and need financing for a new project or expansion there’s an 80% probability that you will be denied a loan.
Let’s take a look at why small business bank lending is declining.
Why banks are no longer lending to small businesses
Small business lending got a hit hard during the 2008 recession although many believed that it would eventually find its way back again. Even so, that has not been the case, and bank loans to small businesses have declined by 20% since the recession.
These figures continue to decline, even after the recovery, and here is why:
- Increased regulation. The 2008 recession led to increased regulation which caused many banks to be more careful about the risk in their investments thus tightening up their standards. Since small businesses are riskier than large businesses, they usually experience challenges acquiring funding through traditional banks.
- Less profit on smaller loans. Banks prefer funding large business loans to small business loans since the latter accrue fewer profits than the former. Usually, small businesses are seeking small business loans, and therefore their requests are usually declined since it does not make financial sense for a bank to process a small loan.
- Lack of collateral. Most banks usually require collateral to give out a loan which acts as a guarantee that the loan will be repaid. The amount that the banks will lend often depends on the value of the collateral. This becomes a major challenge for small businesses which may have no valuable asset to offer as collateral.
- Bad credit or lack of credit history. Banks usually analyze your credit history to evaluate your creditworthiness. Having a bad credit or lacking a credit history may make your loan application to be rejected by the bank. Since most of the small businesses are usually too new to have created a favorable credit history, it becomes a challenge for them to obtain loans from the bank.
- The downturn in community banking. It has always been easier to get a loan at a community bank than a big bank for small businesses. This is because community banks have had a higher loan approval rate for small businesses than the big banks. However, the number of community banks have been declining with time making it difficult for small business owners to find a loan at a traditional banking institution.
These challenges have led to the emergence of other sources of funding outside of traditional banking which is more accessible to small business owners.
Alternative lenders are any non-bank lenders. Many of these lenders can be found online. They help fund small businesses that traditional banks will not and they include companies like Lending Club and OnDeck and many others.
They offer short-term loans, traditional term loans, invoice financing and other services. See Loans for Your Business
Unlike the traditional bank loans, alternative lending sources like WPFSI entail quick and easy loan application processes, immediate remission of cash after the loan is approved, high loan approval rate, and short repayment cycle for the loan.
WPFSI is an SBA Micro Lending Intermediary Lender & CDFI. Our purpose is to provide financial resources to underserved small business communities in the Philadelphia region.
We have a simple prequalification process that does not impact your credit. Just answer 5-6 basic questions and we will let you know if you are a candidate for a loan through West Philadelphia Financial Service Institution.
Less profit on smaller loans. More often than not, small business owners are looking for smaller loan amounts. In fact, our average loan size at Fundera is $40,000. Other data shows that about 80% of small businesses want loans that are less than $500,000. But, it doesn’t make financial sense for banks to provide these smaller loans. Why? It costs banks just as much to underwrite a $1 million dollar loan as it does a $100,000 loan. Therefore, they can make way more money focusing on larger loans. At the end of the day, banks are businesses too.
[…] Source: WPSFI […]
[…] are less willing to lend than they used to be. The reason? The 2008 financial crash, as well as greater reliance on collateral, increased regulation and lenders’ preferences for larger […]
I found that getting a line of credit was a good way to gradually ramp up covering the extra cash-flow necessary for expansion. It’s worked well for me since I get to repay the loans quickly and only incur short term interest costs.
[…] main reason why traditional money lenders, like big banks, aren’t interested in small businesses is that the reward they will gain from them is not worth the risk, resulting in high loan rejection […]