Community banks driving small business formation, growth

As the U.S. Senate works toward a vote on a bipartisan bill targeted at lifting regulations for some banks, several studies published within the last year have looked at the impact community banks have had on serving small- to mid-sized businesses (SMBs) across the country. Historically, community banks have been the loan originator for nearly 60 percent of business loans made to SMBs and have served as drivers of economic growth and opportunity in rural and underserved communities. The reports highlight the impact of these community banks on small business lending pre and post Great Recession; the resiliency of SMB lending activities by these banks during the Great Recession; and policy recommendations to support community banking.

During and after the Great Recession, community bank business lending activities have been mixed with small business loans (those less than $1 million) being more resilient than overall business lending activity, according to a recent paper published by the Small Business Administration’s (SBA) Office of Advocacy. In How Did Bank Lending to Small Business in the United States Fare After the Financial Crisis, the author Rebel Cole looked at the overall business activity pre and post the Great Recession, including activity by both large national banks and smaller community banks. Several of the findings include:

• Prior to the financial crisis, both small business loans and total business loans grew at double-digit rates annually, but small business loans grew only about half as fast at large banks as at small banks;
• New originations of business loans declined abruptly during the crisis years, but more so at large banks than at small banks; and,
• Post-crisis, small business lending grew much faster at small banks than at large banks while total business lending grew much faster at large banks than at small banks.

These findings highlight the importance of community banks in supporting lending activities for SMBs across all industries and the resiliency of the lending activities by those banks.

In another study from September 2017, The Decline of Big-Bank Lending to Small Business: Dynamic Impacts on Local Credit and Labor Markets, the authors reported similar findings to Cole regarding economic resilience of communities that have a strong community banking presences. Their research indicates that small business lending by the largest national banks fell sharply relative to other banks/alternative capital sources in 2008 and remained depressed through 2014. In counties where the largest banks had a high market share, the aggregate flow of small business credit fell, interest rates rose, fewer businesses expanded, unemployment rose, and wages fell from 2006 to 2010. While unemployment returned to normal in those counties and community banks/other lenders slowly filled the void, those counties still face persistent negative effect on wages and higher interest rates for SMB loans. 

Conversely, in counties with a higher market share of community banks and regional banks, the report indicates that there were fewer negative impacts of the Great Recession on aggregate flow of small business credit; and the impacts on interest rates, business expansion, employment, and wages were more muted and rebounded more quickly during the recovery.

While these studies support the importance of community bank SMB lending in creating a resilient credit market in communities across the country. The reports also outline policy recommendations to help support SMB lending by community banks, including:

• Supporting more research on the impact that banking regulation had on assisting or hampering SMB lending post the great recession; and,
• Encouraging the formation of new community banks.

To encourage the formation of new community banks and support SMB lending activities by existing community banks, the federal government and states may consider expanding funding for activities that help de-risk the inherent high risk of lending to SMBs by community banks. In The Impact of the Small Business Lending Fund on Community Bank Lending to Small Businesses, the authors found that community banks that participated in the Small Business Lending Fund (SBLF) increased their small business lending by about 10 percent compared to similar community banks that did not participate in the SBLF program.

Created as part of the 2010 Small Business Jobs Act, the SBFL provides community banks with low-cost funding that they could lend to their small business customers. Results showed SBLF participants increased their small business lending by $12.5 billion over their projected baseline numbers between 2010 and 2013.

In Biz2Credit Small Business Lending Index for January 2018, the importance of SBA-backed loans in the continuing rebound of community bank lending to SMBs is highlighted. In 2016, nearly 50 percent of all loan applications were approved by community banks, the report reveals. One factor attributed to this success was existence of SBA loan guarantees. The authors contend that SBA-backed loans allow community banks to make risky investments in startups and businesses owned by entrepreneurs who might not yet have good credit ratings and don't qualify for traditional term loans from banks.