Financial hurdles for minority small businesses appear on both sides of the banker’s desk

In a previous Digest, SSTI discussed the positive impact that community banks have had on small business lending activity and economic growth in communities across the country since the Great Recession. In this article, SSTI shares two studies on the existing roadblocks and pessimism faced by minority small business and entrepreneurs as they seek financing through banks.

In a recent study – Financing Patterns and Credit Market Experiences: A Comparison by Race and Ethnicity for U.S. Employer Firms – published the Small Business Administration’s Office of Advocacy, Alicia Robb examined racial and ethnic differences in financing patterns, access to capital, and credit market experiences among U.S. employer firms. After nearly a decade since the Great Recession, the researcher found that minority-founded firms face ongoing financing challenges including issues related to amounts received as compared to requested, and avoidance of financing.

Robb reports that Hispanic and black Americans are underrepresented in business ownership compared with their shares of the general population. And, as the figure at the right shows, black Americans are less than half as likely to own an employer business as Hispanic Americans. Black Americans represented 13.2 percent of the population in 2014, yet they owned only 2.1 percent of employer businesses. Hispanic Americans represent 17.6 percent of the U.S. population, but owned just 5.8 percent of employer businesses in 2014.

One primary issue faced by minority entrepreneurs was unmet capital needs, Robb found.  Blacks and Hispanics were more likely to demonstrate unmet credit needs than other population groups. While they were more likely to try to establish new funding relationships with banks, credit unions, and other financial institutions than their Caucasian and Asian peers, they were less likely to receive funding from those institutions. Robb reports that 53 percent of black American business owners reported not receiving the full amount requested from banks and other financial institutions, compared to 24.5 percent of Caucasian business owners.

Another issue faced by minority entrepreneurs was avoidance of financing despite needing additional funds. While 9.6 percent of all business owners indicated that they needed additional funds but chose not to apply for bank financing, 26 percent of black and 15 percent of Hispanic Americans indicated that they did not apply for financing despite needing the funds. 

Of those who did not apply, 60 percent of black and 53 percent of Hispanic Americans said they didn’t think they would be approved by the lender. In comparison, only 47 percent of Caucasian and 44 percent of Asian Americans reported similar concerns. Of the 60 percent of black American entrepreneurs, Robb found that many well-qualified (based upon standard lending characteristics) minority borrowers do not apply for credit because of a pessimistic expectation of the outcome. 

Robb concludes that these issues of unmet capital needs and avoidance of applying for finance have a significant impact on firm profitability, wealth creation, and economic growth. Approximately 28.4 percent of blacks and 17.5 percent of Hispanics said lack of access to financial capital had a negative impact on their firms’ profitability – in comparison, only 11.3 percent of all firms cited the cost of financial capital negatively impacting profitability.

To address this issue, Robb points toward the need for new policies and efforts that will help minority entrepreneurs improve their credit scores, shift away from credit card financing (due to the high interest rates), and increase banking relationships.  However, improving banking relationships might be hard, given the findings of our second report reviewed this week.

In Shaping Small Business Lending Policy Through Matched-Paired Mystery Shopping, authors found several trends in lending practices that may discourage or create roadblocks for minority businesses to gain access to capital. Using a matched-paired mystery shopping methodology to test for racial discrimination in small business lending, the authors found that black American testers were more frequently requested to provide more information for their financial applications than Caucasian testers (see figure below).

The disparities are compelling; no Caucasians were required to provide information regarding personal W-2 forms while nearly 31 percent of black Americans were. The authors also found that black American testers were more likely to be asked about marital status (23.1 percent versus 3.8 percent), despite being a violation of fair lending law as is asking about spousal employment status (experienced by 11.5 percent of black applicants versus none of the Caucasians).

In addition to differences in information requirements, black American testers also received less assistance and encouragement from banks. Compared with their Caucasian counterparts, black American testers were less frequently offered to schedule a future appointment (7.7 percent vs. 23.1 percent) and less likely to be offered help to complete the loan application (11.5 percent vs. 26.9 percent).

To help reduce potential bias in the lending process, the author proposes that pre-application testing using matched-paired mystery shopping by federal/state agencies should be utilized to ensure that all potential applicants are asked similar questions and receive information in the same manner as well as help to ensure the enforcement of existing fair lending laws. The authors contend that this type of testing would have three potential benefits due to the oversight of government agencies:

• Loan information provided by loan officers would not vary as greatly between applicants, regardless of the consumer’s race/ethnicity;
• Bank officers would work to impose uniform standards of scrutiny to all borrowers applying for a loan; and,
• Bank officers would provide appropriate encouragement and assistance to all potential loan applicants regardless of race/color.