Overall Summary Statements

The report first states that banking consolidation has significantly reduced credit access, and although actual credit balances have reduced as well, they have reduced by a lesser amount.

As a result of these reductions, small businesses have a lower likelihood of using banks as a source of credit. Firms that do use a bank find that pricing advantages offered by large banks allow greater credit to be obtained per borrower. Small businesses appear to be increasingly turning to non-bank sources of financing to find access to credit. The authors define "non-bank" sources as: credit unions, finance companies, brokerages, and trade credit.

As the banking consolidation continues, "relationship" lending is becoming increasingly rare. As credit scoring and formal, formulaic methods are used more and more, specifically by the large banks, many small businesses may find they do not "fit" the model, especially those enterprises with negative equity.

In summary, small businesses may be filling the financing void that is being created by the bank consolidation with non-bank sources of funds.

The authors found that bank consolidation has resulted in significant reductions in credit limits for small businesses, but that actual credit balances have fallen by much less. Small businesses are the source of approximately 75% of the net new jobs. Further, their primary source of financing is from banks. The consolidation within the banking industry creates an institutional change that is a major economic and job creation issue.

The statistics in this report indicate that small businesses receive less credit on average in regions where a large share of deposits is held by the largest banks, regardless of how debt is measured.

Two notable areas of financing are of special concern as banking consolidation continues. The first is that non-bank institutions have not been able to compensate for the reductions in line of credit access.

Second, non-bank institutions have not been able to make up for shortfalls in credit limit levels. Non-bank institutions appear to be compensating for reductions in bank credit, although they appear to be compensating more effectively for reductions to credit levels rather than to reductions to credit access.

Business Development Implications

While it is true that bank consolidation has had an effect on small business access to credit as well as credit balances, the report does not appear to address the competition among the large banks in the business lending market. It also does not appear to address the relationship lending that remains within even the largest banks.

As consolidation within the banking industry continues, the competition among fewer remaining banks becomes more intense. Banks, like any investor, continually monitor their portfolio of loans and measure level of risk to the potential return. This can be a very lucrative market given the fees and interest rates associated with many small business loans. At present, there appears to be relatively heavy competition among banks for small business loans.

Formulaic methods are used more in the loan process within the larger banks. However, at least for the short term, relationships remain important even within the largest institutions. Although mass bank consolidation began over a decade ago, relationships remain vital, even now. Frequently, the people responsible for business loans were involved with the process prior to and throughout the consolidation. The institution's name may have changed several times, but the employees often remain the same. Each institution's priorities may vary, but there are people within that institution who are responsible for loaning money to small businesses. While these people are still involved, relationship lending remains extremely important to business lending, at least for the short-term.

Careful observation of the banking industry is key to the success of small business, if banks are to remain the primary source of lending. As the study illustrates, entrepreneurs are a resourceful lot, and while credit levels and credit access have decreased, small business owners have managed thus far to fill the void with non-bank sources. If funds from non-bank sources become too restrictive, it's possible a more efficient replacement within the banking industry will evolve, either from large banks themselves that find ways to accommodate the needs of small business or from mid-size banks that remain. It is very important to note that non-bank sources must provide efficient access to capital as banks have done in the past.

Recently the Small Business Administration has brought credit unions into the small business-lending arena. Credit unions do not appear to be extremely active in business lending at present. However, if bank consolidation continues and credit access is further reduced by banks, credit union members may begin to demand more small business financing from their credit unions. Credit unions have historically always been very relationship oriented.

Bank consolidation and credit reductions are of major concern to the small business community. Formulaic methods used in credit decisions often do not allow the entrepreneur to tell his or her story either in word or in a written business plan. Only the relatively small number of businesses that "fit" the formulaic model will maintain efficient access to credit. Firms with negative equity will obviously be the first to suffer, if relationship lending is ever completely eliminated within the lending community. The entrepreneurs running these firms often have their personal assets collateralized and have no other options for funding. If consolidation eventually leads to the exclusive use of formulaic methods for loan decisions, these firms will suffer the most. Using strict, formal methods, these entrepreneurs will not get the opportunity to "tell their story".

By their very nature, entrepreneurs are resourceful. Throughout the first decade of bank consolidation, they have found ways to fill at least a part of the financing void created by this consolidation primarily through non-bank sources. There is concern in the small business community about credit access in the future as consolidation continues. It is the responsibility of entrepreneurs to become better educated in the lending process and to do everything in their power to maintain relationships with key bank personnel, no matter how large the bank may be.

Link to full study