Can the Supply of Small Business Loans Be Increased?

By Wilkinson, Jim; Christensson, Jan | Economic Review (Kansas City, MO), Spring 2011 | Go to article overview

Can the Supply of Small Business Loans Be Increased?


Wilkinson, Jim, Christensson, Jan, Economic Review (Kansas City, MO)


Small and new businesses, widely credited as engines for job growth, have struggled during the recovery. One reason, say some analysts, is that bank lending to small businesses has declined steadily since the start of the recession. If, as many small businesses claim, the supply of credit from banks has contracted, then increasing the supply of small business loans may allow these businesses to grow and create new jobs. Understanding the factors that affect loan supply may help policymakers design policies to increase the supply of small business loans and, therefore, support further job growth.

This article analyzes the potential effectiveness of two strategies that policymakers can use to expand the supply of small business loans: increasing bank capital and reducing problem assets. A review of recent policy initiatives suggests that influencing bank capital may be easier than addressing problem assets. However, reducing problem assets may lead to a larger and more persistent increase in the supply of loans.

Section I examines the connection between job growth and small business lending. Section II reviews supply and demand factors that affect lending decisions at banks. It focuses on two supply factors-- capital and problem assets--and provides examples of policies that have attempted to influence these factors during the crisis. Section III describes the statistical analysis and data used to measure the importance of the policy variables while controlling for the influence of demand and other market factors. Section IV presents the results of the analysis and the likely effect that changes in capital and problem assets may have on small business lending.

I. JOB GROWTH AND SMALL BUSINESS LENDING

The U.S. economy lost 9 million jobs in the recent recession and initial months of the recovery. The Bureau of Labor Statistics estimates that total employment fell from a peak of 138 million in January 2008 to a low of 129 million as of February 2010. (1) Further, job growth over the next few years is expected to be anemic. The consensus Blue Chip forecast (July 2011) anticipates that the unemployment rate will fall to only 8.1 percent in 2012.

Many policymakers are looking to new and small businesses to generate jobs. Small businesses employ roughly 50 percent of all Americans (Bernanke, 2010). Small businesses are also widely perceived as engines for job growth. According to Karen Mills, administrator of the U.S. Small Business Administration, "Small businesses create 2 of every 3 new jobs each year." Recent research also suggests that new firms are responsible for job growth. (2) Of course, these new firms start as small firms.

Small businesses have struggled to retain their workers during this recovery. From 2008:Q1 through 2010:Q1, employment in establishments with less than 100 employees fell by 3.9 million or 6 percent. By another measure, establishments employing up to nine employees accounted for 22 percent of all job losses nationally from 2008:Q1 to 2009:0.2. (3)

One reason for the losses may be that small businesses are more dependent on bank credit than large businesses, and lending to small businesses has declined. (4) Although there is surprisingly little direct data on bank lending to small businesses, data are available for loans to all businesses and for small loans to all businesses (not necessarily loans to small businesses). These data show that lending to all U.S. businesses declined 22 percent from September 2008 to June 2010 and that small loans to businesses fell 8 percent over the same period. (5)

II. SUPPLY AND DEMAND FOR SMALL BUSINESS LENDING

Given the slow pace of the recovery and rising levels of problem loans, many banks have become more risk averse. Many have tightened their lending standards and moved away from loans and into securities. Falling capital levels, due in large part to losses on problem loans, have reduced the lending capacity of many banks. …

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