Is A Gap In Small-Business Credit Holding Back The American Economy?

Small businesses are core to America’s economic competitiveness. Not only do they employ half of the nation’s private sector workforce—about 120 million people—but since 1995 they have created approximately two-thirds of the net new jobs in our country.

They are also instrumental in driving the innovation that provides a competitive edge in the global market. Small firms produce 13 times more patents per employee than larger firms, and employ more than 40 percent of high-tech workers in America.

Why is this important? Because our nation has long relied on this engine for innovation and job creation to drive competitiveness, while also providing a path to a prosperous lifestyle for countless American families. But today, small businesses are not creating these jobs at the rate that we need.

The recession saw an unprecedented deterioration in labor market conditions. Both large and small businesses felt the sting of job losses during the crisis, but small firms were hit harder, took longer to recover, and may still be reeling from the economic fallout.

This is consistent with economic literature that tells us small businesses are always hit harder during financial crises because they are more dependent on bank capital to fund their growth and operations. They feel the swings up and down more acutely due to their reliance on the free flow of bank credit, according to a 1994 study by Gertler and Gilchrist.

Unlike large firms, small businesses lack access to public institutional debt and equity capital markets and the uncertainty of small business profits makes retained earnings a necessarily less stable source of capital. About 48 percent of business owners report a major bank as their primary financing relationship, with another 34 percent noting that a regional or community bank is their main financing partner.

Is there a credit gap for small businesses?

There is disagreement over whether there is indeed a credit gap when it comes to small business. Banks say that there is currently a lack of demand and that they can’t find enough qualified borrowers. Small business owners feel that despite being creditworthy today, banks remain either wary or entirely unwilling to lend to them.

There is no data that definitively measures either the credit gap for small business or the impact of that gap on the economy. (As part of recent financial reform legislation, the gap in small business credit data was recognized and a specific provision was included to allow for more credible monitoring for small business access to bank credit. Section 1071 of the Dodd-Frank Act amended the Equal Opportunity Act to entrust the Consumer Financial Protection Bureau with requiring banks to collect and maintain certain data in connection with credit applications made by women- or minority-owned businesses and small businesses.) However, the information that exists paints a troubling picture.

Currently, one of the most indicative metrics of the relative availability of credit is the Federal Reserve’s Senior Loan Officer Survey (SLOS). This survey shows that demand for small business loans tightened significantly in 2009 and began loosening slightly in 2010, but only at relatively low levels. By contrast, the loosening of standards for large businesses has outpaced that for smaller firms in recent years.