Earlier this week, the Federal Reserve published a second report based on its first nationwide survey of small business credit conditions which reports evidence of very tight credit conditions to startups (small businesses with 5 years or less). The first report found credit conditions to be tight for small businesses, irrespective of their age.
The second report provides valuable insights into an important sector of the economy. Startups account for about one-third of small businesses and play a key role in U.S. innovation and productivity. As pointed out in a recent paper by Chen, Hanson and Stein (2017), it is likely that the weak productivity growth in the decade since the crisis may be due to declining small business vibrancy driven by the contraction in bank credit supply to small businesses. As reported in a previous TCH blog post, large banks originate a sizable share of small business loans. According to the Community Reinvestment Act data, large banks originated 54 percent of small business loans in 2015 by dollar amount and 86 percent by number of loans. As discussed in another TCH blog post, the heightened capital standards imposed on large banks via the U.S. supervisory stress tests and the capital surcharges for systemically important banking organizations are likely key factors explaining the withdrawal of credit supply of large banks, especially for small business loans.
According to the results of the second report on the Federal Reserve’s Small Business Credit Survey (SBCS), approximately 50 percent of startups reported not having all of their borrowing needs satisfied. This number is 40 percent higher than the share of small businesses that were reported not having all of their borrowing needs satisfied in the first report and 12 times higher than the often-cited share indicated by the responses obtained from the National Federation of Independent Business (NFIB) small business survey. In addition, credit conditions to startups are tighter at larger banks, which are the ones subject to more stringent capital regulation.
The results of the second report can be summarized as follows:
- 72 percent of startups indicated that they faced financial challenges over the past 12 months.
- Approximately 60 percent cited lack of credit availability or ability to secure funds for expansion as a reason.
- About 80 percent of startups with financial challenges said they used owners’ personal funds to address the problem.
- 52 percent of startups applied for financing over the past 12 months (the large majority was for a loan or a line of credit).
- Of those that applied for credit, 28 percent received none of the funds requested and 41 percent received only some portion of what they would like.
- Of the remaining 48 percent of startups that did not apply for financing, about one-quarter did not apply because they thought they would be turned down (discouraged firms).
- Credit conditions to startups are tighter at large banks.
- Approval rates at large banks were just 26 percent for medium/high credit risk startups.
- Online lenders and small banks reported having approval rates of 45 percent and 35 percent for medium/high credit risk startups, respectively.
These results highlight the importance of reviewing all data available describing the credit conditions facing small businesses, instead of relying only in the results of the NFIB survey – which includes larger and more mature small businesses –and erroneously reach the conclusion that credit remains widely available to small businesses. In particular, this second Fed report increase the dissonance between the Fed’s own data and statements from the Fed Chair, based on an earlier, less comprehensive NFIB small business survey, that “small businesses don’t by-and-large report in surveys when they’re asked that lack of access to loans or credit is one of the significant problems that they face.”
Disclaimer: The views expressed in this post are those of the author(s) and do not necessarily reflect the position of The Clearing House or its membership.
 The 50 percent is not reported directly in the Federal Reserve’s Small Business Credit Survey. It is derived as the sum of applicants that received none or some of the funding requested and non-applicants that were classified as discouraged firms.