A presentation made by Dr. Brian Richard to the 44th Annual Conference of the Mid-Continent Regional Science Association on May 30,2013

1. Factors Leading to Small Business
Bank Lending
Brian W. Richard, Ph.D.
Norman Walzer, Ph.D.
Andy Blanke, MPA
Presented to
Mid‐Continent Regional Science Association
44th Annual Conference
May 30,2013

2. Small Business Bank Lending
• Small business lending is plagued by information problems
that may result in an inefficient allocation of loans
• There are a number of publicly supported programs that
attempt to correct small business lending market
imperfections
• Technical Assistance
 Assistance with developing business plans and pro forma financial
statements, financial reporting, and expansion planning
• Loan Subsidies
 Direct lending by local, state, or federal government
 Loan guarantees
2

3. Small Business Loan Subsidies
• Small Business Administration
 SBA 7a Loan Guarantees. The SBA 7a Guaranteed Loan Program
allows banks to make federally guaranteed loans to small
businesses. The guarantee encourages lenders to make loans to
businesses that might not quite meet their underwriting terms.
7a program guarantees 85 percent of loans up to $150,000 and
75 percent of loans over $150,000 (Office of the Comptroller of
Currency, 2013).
 SBA 504 Loans. The SBA loans funds to businesses through
Certified Development Companies. In a typical deal using this
program, a bank provides 50 percent of the project funding (first
mortgage), the SBA 504 loan funds 40 percent (second
mortgage), and the entrepreneur supplies 10 percent as equity
(Mihajlov, 2012).
3

4. Small Business Loan Subsidies
• Revolving Loan Funds
 An RLF is a locally managed, self‐replenishing pool of money,
utilizing interest and principal payments on old loans to issue new
loans (Council of Development Finance Agencies, N.D.).
 While RLF management practices vary from fund to fund (they are
unregulated loan funds), many operate similar to the SBA 504 loan
program, providing subordinate loans to additional bank financing.
4

5. Small Business Technical Assistance
• Business Incubators. Business incubators offer a variety of
services to small businesses including advice on business plan
development and refinement, marketing assistance, business
training, high‐speed internet access, and accounting
assistance (Knopp, 2006).
• Community Colleges. Community colleges have an active role
in local economic development which includes promoting an
entrepreneurial culture and building the human capital
required for a successful business venture (Drabenstott et al,
2004).
5

6. Small Business Technical Assistance
•
Service Corps of Retired Executives (SCORE). SCORE provides technical
assistance for small businesses through both in‐person mentoring and
through a variety of online resources designed to help small businesses
owners find and successfully apply for credit (SCORE Association, 2011).
•
Small Business Development Centers (SBDCs). SBDCs provide an array of
services for entrepreneurs including market research, business plan
development, procurement aid, and preparing businesses for loan
applications (SBA, 2013).
•
Chambers of Commerce. Chambers of commerce serve local business
communities in a variety of ways and some of them offer loan packaging, a
service where financial consultants prepare loan proposals for greater
success in loan applications to banks.
6

7. Small Business Relationship Lending
• Credit scoring and relationship lending are employed to
address the issue of unclear financial information.
Relationship lending largely bases loan decisions on
proprietary information about the firm and its owner
gathered through a variety of contacts over time (Ongena and
Smith, 2001; Giannetti, 2012).
“Small businesses consistently appear more willing to ask for credit when their
bank is a regional or community bank (and they appear to be more successful in
their requests)” (Dennis, 2012).
7

8. Hypotheses
• H1: There is a positive relationship between the frequency
banks work with the Small Business Administration and the
bank’s small business lending growth.
• H2: There is a positive relationship between the frequency
banks work with Revolving Loan Funds and the bank’s small
business lending growth.
• H3: Community banks have higher small business lending
growth than larger banks.
• H4: Banks that work with technical assistance providers have
higher small business lending growth.
8

9. Business Lending Trends
Year
2005
2006
2007
2008
2009
2010
2011
2012
Commercial &
Industrial Loans
1,085,572
1,214,728
1,439,127
1,493,934
1,213,895
1,183,962
1,345,034
1,508,400
Small Business Loans
Small Business Loans as a Percent
of Total Commercial Loans
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
334,214
28.23%
315,457
23.45%
302,224
20.04%
9

10. Survey Data
• Survey of bankers
 Illinois:
 Wisconsin:
October, 2011
March, 2013
• Dependent Variable: Indicate how your financial institution's
total number of approved small business loans has changed in
the past 12 months.
 Increased by more than 10%
 Increased by 5% ‐ 10%
 Increased by 1% ‐ 5%
 Unchanged
 Decreased by 1% ‐ 5%
 Decreased by 5% ‐ 10%
 Decreased by more than 10%
(coded as 7 for analysis)
(6)
(5)
(4)
(3)
(2)
(1)
10

11. Survey Data
• Dependent Variable: Indicate how your financial institution's
total number of approved small business loans has changed in
the past 12 months.
11

12. Survey Data
• Indicate how often your institution has worked with the
United State Small Business Administration/a Revolving Loan
Fund during the past two years in order to close small
business loans
12

13. Survey Data
• Bankers were asked to indicate how their financial institution
was chartered, selecting from national bank, regional bank,
community bank, or savings & loan. A dichotomous variable
was created, set at 1 for community bank or savings & loan
and 0 for other responses.
 Of the 110 responses, 89 indicated that their bank was a community bank
or savings & loan.
13

14. Survey Data
• For hypothesis 4, an index was created based on responses to the
question “How often does your institution work with the following
organizations to assist in business support and development?”
 Small Business Development Center
 S.C.O.R.E.
 Chamber of Commerce
 Local Economic Development Agency
 EDA District Office
 Local University
 Local Community College
 State Department of Economic Development
14

15. Survey Data
• Control variables were included to account for
differences in local economies and banks.
 A dummy variable was created where responses in the Wisconsin survey were set to 1 (58
responses) and Illinois 0 (52 responses).
 Respondents were asked to select from a number of statements that “best characterizes
the local economic conditions in your region?” Both positive and negative statements
were included. If more positive than negative statements were selected, the local
economy variable was set to 1, else 0.
Note: Respondents from Wisconsin were much more likely (67 percent vs. 34 percent of
Illinois respondents) to have a positive view of the economy, likely because of the timing of
the surveys.
15

16. Survey Data
• Control variables were included to account for differences in
local economies and banks.
 Respondents were asked “On average what percentage of personal equity
injection does your institution require for a business loan?”
 Respondents selected an answer from the following categories:
More than 80%
61% to 80%
41% to 60%
21% to 40%
Less than 20%
(coded as 5 for analysis)
(4)
(3)
(2)
(1)
16

17. Methodology
• The data were analyzed using ordinal logistic regression.
• Ordinal logistic regression is an extension of the general
logistic regression model. It predicts cumulative logits:
ln
= ln
1
∝
⋯
Where “
represent the probability that a
1, 2, …
response falls in a category less than or equal to the jth category”
(O’Connell, 2006, p. 31).
17

18. Results
WSBA
WRLF
CommBank
AssistIndex
Wisc
ECPos
PctEquity
Estimate Std. Error Wald
Sig.
.389
.183
4.54
.228
.226
1.01
‐1.832
.499
13.50
.676
.310
4.77
.369
.408
.82
1.109
.384
8.34
‐1.307
.352
13.75
‐2 Log
Chi‐
Likelihood
Square
df
343.552
48.999
Nagelkerke R‐Square
.033
.314
.000
.029
.366
.004
.000
Sig.
7 0.00
0.369
18

19. Results
• H1: There is a positive relationship between the frequency
banks work with the Small Business Administration and the
bank’s small business lending growth.
 This hypothesis was supported by the data.
 However, some of the comments provided by bankers in open‐ended
questions indicated that they are frequently frustrated with the amount of ‘red
tape’ associated with SBA guarantees and loans.
19

20. Results
• H2: There is a positive relationship between the frequency
banks work with Revolving Loan Funds and the bank’s small
business lending growth.
 Results not significant
 Revolving loan funds are often run by city/county employees or local economic
development agencies. The loan funds are managed as a part time job for them
and they may not market them vigorously.
20

21. Results
• H3: Community banks have higher small business lending
growth than larger banks.
 The variable for community banks produced a result contrary to the
hypothesis.
 This is surprising because there is considerable literature focused on the
practices of community banks being more ‘small business friendly’.
 However, some studies are finding that this may no longer the case. In an
international study, de la Torre et.al. (2010) found that large banks are
perceived as the main player in the small‐medium sized businesses financing
market.
 Large banks are increasingly relying on more sophisticated screening
mechanisms that lower the information costs of providing small business
loans.
21

22. Results
• H4: Banks that work with technical assistance providers have
higher small business lending growth.
 This hypothesis was supported by the data.
 It is not clear from the data whether the relationship is driven by financial TA
or other TA making the businesses more viable (marketing, planning,
exporting, etc.).
22

23. References
Berger, Allen N. and Gregory F. Udell (1995). Relationship Lending and Lines of Credit in Small Firm Finance. The Journal of Business, Vol. 68.
Berger, Allen N. and Gregory F. Udell (2002). Small Business Credit Availability and Relationship Lending: The Importance of Bank Organizational Structure. Journal of
Finance. Vol. 112.
Carol, J. (2004). Going after capital. A comprehensive guide to business incubation. 2nd ed. Athens, OH: National Business Incubator Association.
Colbert, C., Adkins, D., Wolfe, C., & LaPan, Karl. (2010). Best practices in action: Guidelines for implementing first‐class business incubation programs. 2nd ed. Athens, OH:
National Business Incubator Association
Council of Development Finance Agencies (N.D.). CDFA Spotlight: Revolving Loan Funds (RLFs).
Craig, Ben R., William E. Jackson III, & James B. Thomson, (2007). SBA‐Loan Guarantees and Local Economic Growth, Journal of Small Business Management, Vol. 45.
Craig, Ben R., William E. Jackson III, & James B. Thomson, (2008a). Credit Market Failure Intervention: Do Government Sponsored Small Business Credit Programs Enrich
Poorer Areas? Small Business Economics Small Business Economics. Vol. 30, No. 4.
Craig, Ben R., William E. Jackson III & James B. Thomson, (2008b). On Government Intervention in the Small Firm Credit Market and Economic Performance. In
Entrepreneurship in Emerging Domestic Markets: Barriers and Innovation. Glenn Yago, James R. Barth, Betsy Zeidman, eds.
Craig, Ben R., William E. Jackson III & James B. Thomson, (2010). Does Small Business Administration Guaranteed Lending Improve Economic Performance in Low‐ Income
Areas? Entrepreneurship in Low‐ and Moderate‐ Income Communities Economic Commentary 55.
de la Torre, Augusto, Maria Soledad Martinez Peria & Sergio L. Schmukler (2010). Bank Involvement with SMEs: Beyond Relationship Lending. Journal of Banking & Finance.
Vol. 34.
Dennis, Jr., William J. (2012). Small Business Credit Access and the Lingering Recession. National Federation of Independent Businesses Research Foundation,
www.NFIB.com/creditpoll.
23

24. References
Diamond, D. W. (1989). Reputation acquisition in debt markets. Journal of Political Economy Vol. 97.
Drabenstott, M., Novack, N., & Weiler, S. (2004). New governance for a new rural economy: Reinventing public and private institutions—A conference summary. Economic
Review. Vol. 89, No, 4.
Giannetti, C (2012). Relationship Lending and Firm Innovativeness. Journal of Empirical Finance Vol. 19.
Greenbaum,S. I.; Kanatas, G.; and Venezia, I. (1989). Equilibrium loan pricing under the bank‐client relationship. Journal of Banking and Finance, Vol. 13.
Knopp, L. 2006. State of the Business Incubation Industry. Athens, OH: National Business Incubation Association.
Lerner, J. (2009). Boulevard of broken dreams. Princeton, NJ: Princeton University Press.
Lewis, D.A., Harper‐Anderson, E., & Molnar, L.A. (2011). Incubating success: Incubation best practices that lead to successful new ventures. Ann Arbor, MI: University of
Michigan.
McFarland, C., & McConnell, J.K. (2012). Small business growth during a recession: Local policy implications. Economic Development Quarterly. published online October
8, 2012.
Mihajlov, Thomas P. (2012). SBA 504 Loans Help Improve Balance Sheets: A Micro Analysis. Journal of Marketing Development and Competitiveness. Vol. 6, No. 1.
Office of the Comptroller of the Currency (2013). Community Development Fact Sheet: SBA 7(a) Guaranteed Loan Program.
O’Connell, Ann A. (2006). Logistic Regression Models for Ordinal Response Variables. Sage Publications, Thousand Oaks, CA.
Ongena, Steven and David C Smith, (2001). The duration of bank relationships. Journal of Financial Economics. Vol. 61.
Petersen, M. A., and Rajan, R. G. (1993). The effect of credit market competition on firm‐creditor relationships. Working paper. Chicago: University of Chicago
24

25. References
Reynolds, P., Storey, D.J., & Westhead, P. (1994). Cross‐national comparisons of the variation in new firm formation rates. Regional Studies Vol. 28.
SCORE Association. (2011). Media fact sheet. Retrieved May 20, 2013 from: http://www.score.org/Media_Resources
SCORE Association. (2012). Our impact. Retrieved May 20, 2013 from: http://www.score.org/our‐impact
Sharpe, S. A. (1990). Asymmetric information, bank lending, and implicit contracts: A stylized model of customer relationships. Journal of Finance, Vol. 45.
Stiglitz, Jospeh E. & Andrew Weiss (1981). Credit Rationing in Markets with Imperfect Information, The American Economic Review. Vol. 71, No. 393.
Torres, V., Viterito, A., Heeter, A., Hernandez, E., Santiague, L., Johnson, S. (2013). Sustaining opportunity in rural community colleges. Community College Journal of
Research and Practice. Vol. 37.
United States Small Business Administration (N.D.). Credit Factors: Equity Investment.
United States Small Business Administration (N.D.). Small Business Development Centers (SBDCs). Retrieved May 20, 2013 from: http://www.sba.gov/content/small‐
business‐development‐centers‐sbdcs
United States Small Business Administration. (2013). FY 2014 Congressional Budget Justification and FY 2012 Annual Performance Report. Retrieved May 16, 2013 from:
http://www.sba.gov/about‐sba‐services/21731
United States Business Administration. (2012). FY 2013 Congressional Budget Justification and FY 2011 Annual Performance Report. Retrieved May 16, 2013 from:
http://www.sba.gov/about‐sba‐services/21731
United States Small Business Administration. (2010). FY 2011 Congressional Budget Justification and FY 2009 Annual Performance Report. Retrieved May 16, 2013 from:
http://www.sba.gov/about‐sba‐services/21731
Wilson, P. F. (1993). The pricing of loans in a bank‐borrower relationship. Working paper. Bloomington: Indiana University.
25

26. For More Information
Brian W. Richard
Senior Research Associate
brichard@niu.edu
Center for Governmental Studies
148 N. Third Street
DeKalb, IL 60115
www.cgs.niu.edu