For small companies, loan approval often hinges on the personal relationship between a business owner and a bank manager or loan officer. That's one reason the ongoing wave of bank consolidation is hurting small-business owners' ability to get credit, according to a May paper published by University of Houston professors Steven C. Craig and Pauline Hardee.
Using data from the Federal Reserve's 1998 Survey of Small Business Finance, the two economists examined business owners' ability to get credit given the size of the banks in their region. They found that entrepreneurs were up to 25% less likely to get loan approvals in areas with a strong presence of large banks -- defined as those with more than $5 billion in assets -- than in regions with lots of smaller banks. Small businesses that had total debt exceeding assets were most vulnerable: They were the ones most in need of a personal relationship -- more common at a small bank -- to get loans. In addition, credit lines offered by large banks were typically less generous than those offered by smaller lenders.
Although larger banks may offer lower interest rates than small lenders, the overall cost of borrowing for many small businesses still appears to be rising. That's because businesses without a small-bank option that can't get a loan from a big bank often turn to more expensive sources of money such as venture capitalists or subprime lenders. Craig and Hardee found that even access to those pricier funds isn't fully offsetting large banks' tightfistedness.
By James Mehring