Small Business Credit Markets and Selected Policy Issues

Summary

Small businesses are owned by and employ a wide variety of entrepreneurs—skilled trade technicians, medical professionals, financial consultants, technology innovators, and restaurateurs, among many others. As do large corporations, small businesses rely on credit to purchase inventory, to cover cash flow shortages that may arise from unexpected expenses or periods of inadequate income, or to expand operations. During the Great Recession of 2007-2009, lending to small businesses declined. A decade after the recession, it appears that while many small businesses enjoy increased access to credit, others might still face credit constraints.

Congress has demonstrated an ongoing interest in credit availability for small businesses, viewing them as a medium for stimulating the economy and creating jobs. In general, Congress’s interest in the small business credit market focuses on quantity and price—specifically (1) whether small businesses can reasonably obtain loans from private lenders and (2) whether the prices (lending rates and fees) of such credit are fair and competitive. Congress passed legislation to facilitate lending to small businesses that are likely to face hurdles in obtaining credit:

The Small Business Act of 1953 (P.L. 83-163) established the Small Business Administration (SBA), which administers several types of programs to support capital access for small businesses that struggle to obtain credit on reasonable terms and conditions from private-sector lenders.

The Community Reinvestment Act (CRA; P.L. 95-128) encouraged banks to address persistent unmet small business credit demands in low- and moderate-income (LMI) communities.

The Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank Act; P.L. 111-203) required the Bureau of Consumer Financial Protection (CFPB) to collect data from small business lenders concerning credit applications made by women-owned, minority-owned, and small businesses with the goal of better understanding their financing needs. The CFPB has not yet implemented this requirement.

Data that capture small business borrowers’ characteristics and lenders’ underwriting processes (i.e., their processes for determining whether borrowers are creditworthy) could help to accurately determine whether small businesses have sufficient and fairly priced access to private credit. Various government agencies and financial institutions define small business using factors that may be based upon annual revenues, number of employees, market scope, market share, and some or all of the above factors. Because no consensus definition of a small business exists, data to analyze the small business credit market’s performance are limited and fragmented. Moreover, certain small businesses face additional challenges that may force them to seek financing outside of traditional business credit markets. Many new start-up firms, for example, do not have the financial track records to qualify for standard business loans and frequently must rely on mortgage and consumer credit. In addition, many small businesses rely on customized lending products, thus limiting their choice of lenders to those with specialized underwriting methodologies or business models. The lack of a consensus definition of small business, along with the wide variety of idiosyncratic business risks, hinders the availability of conclusive evidence on the small business credit market’s overall performance and, therefore, the ability to assess the effectiveness of various policy actions designed to increase small business lending.

In 2017, the CFPB issued a request for information on the small business lending market to solicit feedback on how to implement the Dodd-Frank requirement to collect data from financial institutions on small business credit applications. Final rulemaking, however, has been delayed. In addition, various bills regarding the small business credit market have been introduced in the 116th Congress. For example, H.Res. 370 would express “the sense of the House of Representatives that small business owners seeking financing have fundamental rights, including transparent pricing and terms, competitive products, responsible underwriting, fair treatment from financing providers, brokers, and lead generators, inclusive credit access, and fair collection practices.” H.R. 3374 would amend the Equal Credit Opportunity Act to require the collection of small business loan data related to LGBTQ-owned businesses. H.R. 1937 and S. 212, the Indian Community Economic Enhancement Act of 2019, among other things, would require the Government Accountability Office to conduct a study to assess and quantify the extent to which federal loan guarantees, such as those provided by the SBA, have been used to facilitate credit access in these communities.