Nationwide in the U.S. over the past 15 years, small businesses generated 64 percent of the net new job growth. Small businesses with fewer than 500 employees, a definition used by the Small Business Administration (SBA), represent 99.7 percent of all employer firms, and employ more than half of private sector employees in the United States. Firms with fewer than 50 employees represent 95 percent of all employer firms. Since the recession that began in late 2007, large bank lending to small businesses has fallen by more than 50 percent.
A combination of forces have contributed to this decline: devalued collateral, especially of real estate, damaged credit reports stemming from financial hardship, reduced cash flow due to diminished sales, and general economic uncertainty. Tight standards on home equity loans have precluded a widely used financing method for small companies. Eroded balance sheets and declines in revenue have increased the possibility that bank loan applications will be denied, and some businesses that once qualified for bank loans no longer qualify. Further, banks have been tightening underwriting standards in an effort to manage risk, leading to reduced options for those businesses still seeking credit. Nevertheless, banks remain the largest source of small business credit, including term loans, credit cards, credit lines, commercial mortgages, and capital leases.
Given this environment, it is interesting to take a closer look at some of the entities that are filling the credit gap for small businesses. While many business owners have become more cautious about seeking credit, and may be more concerned about the strength of their sales than access to credit, some business owners have turned to a variety of non-mainstream credit sources. Depository lenders held about 60 percent of the total loans to small business borrowers from traditional sources of credit (excluding owner loans) in 2010. The remaining 40 percent came from finance companies, brokerage firms, family, friends, and other businesses.
In this article, we explore the expanding role that nonbank, often mission-driven, lenders are playing in a period of constrained lending to small businesses by regulated depository institutions. We present key themes from discussions with over a dozen providers of small business credit products and services and other small business experts, and include data from Accion Chicago, a certified Community Development Financial Institution (CDFI) and microlender, that provides evidence of a shift in borrower credit profiles at a nonbank provider. We find that:
- many community development business lenders are “anti-recessionary” as they become a viable alternative when banks tighten lending standards;
- different underwriting metrics used by these nonbank organizations expand the meaning of the term creditworthy borrower;
- while community development lenders always play a key role in redeveloping areas, the shift by borrowers from banks to nonbank entities demonstrates the complementary role of nonbanks when bank credit is very scarce.
The implication of these findings is that investment in the capacity – organizational and financial – of these nonbank providers, and the expansion of a nonbank infrastructure – virtual or physical, can be especially valuable during times of tight credit.