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The concerns of the Congress and other policy- making bodies about small business financing largely stem from the perception that small firms have more difficulty gaining access to credit than do large businesses or other types of borrowers. The source of this difficulty may be the higher cost of lending to small firms due to greater riskiness or challenges in evaluating and monitoring credit risks, or it may be inefficiencies in markets that hinder pricing of risk or impede the effective pooling of risks. To the extent that private-market impediments or inefficiencies are the source of any difficulties for small business financing, policymakers may focus on measures that mitigate these market failures. It is important to note that no single policy prescription would likely work for all small businesses, and no single definition of small business would be appropriate for all industries. As discussed in this report, credit needs and borrowing sources differ widely among small businesses.
A credit union is a not-for-profit financial cooperative, owned and controlled by the people who use its services. Credit unions offer many of the same financial services that banks do. Like savings institutions, credit unions historically have not provided a great deal of credit to small businesses. According to the 2003 Survey of Small Business Finances, credit unions provided less than 1 percent of aggregate dollars outstanding to small businesses. However, credit unions have become a more important source of small business loans in recent years. In a 2009 National Federation of Independent Business survey, fewer than 4 percent of firms reported using a credit union as their primary financial institution. By 2010, this figure had increased to just less than 5 percent, and it was near 7 percent by 2011, the last time these data were reported. Similarly, 9.6 percent of households that owned small businesses in the 2013 Survey of Consumer Finances reported using a credit union as the firm's primary financial institution.
Support for small businesses has been a priority of policymakers for several decades, and federal, state, and local agencies have sponsored programs that assist in channeling capital to small business. Several long-standing government initiatives exist to help support credit access for small businesses, particularly small businesses owned by historically underserved groups such as women and minorities. Two such initiatives of particular importance are the Community Reinvestment Act (CRA) and various loan programs sponsored by the U.S. Small Business Administration (SBA). The CRA was enacted in 1977 to encourage federally insured depository institutions to help meet the credit needs of their local communities, particularly low- and moderate-income neighborhoods, consistent with safe and sound operations. The SBA provides financing to young and growing small firms through several channels such as the 7(a) Loan Program and SBA 504 Certified Development Companies. Among the policy objectives of the SBA loan programs are the goals of promoting entrepreneurship opportunities for women and minorities.
Securitization is the process of packaging individual loans and other debt instruments, converting the package into a security, and enhancing the credit status or ratings to further some securities' sale to third-party investors. The securitization of small business loans has the potential to substantially influence the availability of credit to small businesses, but the obstacles to securitizing small business loans are large. Securitization generally has thrived in markets in which the costs of acquiring and communicating information to investors about loans and borrowers are low. In contrast, most small business loans cannot readily be grouped into large pools that credit agencies and investors can easily analyze: Loan terms and conditions are not homogeneous, underwriting standards vary across originators, and information on historical loss rates is typically limited. The information problems associated with small business loans can be overcome, or offset to a degree, by some form of credit enhancement, as in the case of the SBA's 7(a) loans. However, the more loss protection needed to sell the securities, the smaller are both the net proceeds from the sale of the securities and the incentive for lenders to securitize their loans. Small business loans are an asset for which the high transaction costs of providing credit enhancements have made many potential securitizations unprofitable.
Aggregate nonfinancial business debt, which contracted in the immediate aftermath of the financial crisis, grew at a steady pace of nearly 6 percent per year from 2012 to 2017 (figure 1, panel A).2 As a result, the ratio of nonfinancial business debt to gross domestic product has risen over this period and remains well above historical norms (figure 1, panel B).
While there are little available data specifically on financing conditions for small businesses, measures of financing conditions in the aggregate and for large businesses suggest that conditions have largely recovered to pre-crisis levels in recent years. Default rates on corporate bonds and on commercial and industrial (C&I) loans were low to moderate over the period overall, although the rates on C&I loans moved up slightly in 2015 and 2016 (figure 2, panel A). Yields on triple-B-rated and high-yield corporate bonds remained very low by historical standards (figure 2, panel B). The spreads of yields on corporate bonds to those on comparable-maturity Treasury securities rose notably in 2015 and early 2016, reflecting in part concerns about the credit outlook of firms in the energy sector, but subsequently moved to levels similar to those prevailing in 2014. On the whole, corporate bond yield spreads remained a touch above pre-recession levels, though below the median of their historical distributions since 1997 (figure 2, panel C). Borrowing costs for shorter-term debt issued by nonfinancial firms also have remained very low since 2009, with slight increases in commercial paper rates in 2015 and 2016, as shown in figure 2, panel D, about in line with increases in the federal funds rate. As a result, the spreads of rates on A2/P2-rated commercial paper over the target federal funds rate were generally stable at low levels (figure 2, panel E).
The concerns of the Congress and other policymaking bodies about small business financing stem from the perception that small firms have more difficulty gaining access to credit sources than do large businesses or other types of borrowers. The source of this difficulty may be the higher cost of lending to small firms due to greater riskiness or challenges in evaluating and monitoring credit risks, or it may be inefficiencies in markets that hinder pricing of risk or impede the effective pooling of risks. To the extent that private-market impediments or inefficiencies are the source of any difficulties for small business financing, policymakers may focus on measures that mitigate these market failures. It is important to note that no one policy prescription would likely work for all small businesses, and no one definition of small business would be appropriate for all industries. As discussed in this report, credit needs and borrowing sources differ widely among small businesses.
Historically, and particularly in the early life of a business, lenders have had difficulty determining the creditworthiness of applicants for small business loans. The heterogeneity across small firms, together with widely varying uses of borrowed funds, has impeded the development of general standards for assessing applications for small business loans and has made evaluating such loans relatively expensive.
The cost to the lender does not end with the decision to grant a loan. Small business lenders typically have to monitor the credit arrangement with individual borrowers. For very small firms, a close association between the finances of the business and those of the owner may increase loan-monitoring costs.
Historically, the relatively elevated costs of evaluating small business loan applications and the ongoing costs of monitoring firm performance have made loans to small businesses less attractive for some lenders, especially because, when expressed as a percentage of the (small) dollar amount of the proposed loan, these noninterest costs are often quite high compared with loans to middle-market or large corporate borrowers. Financial institutions, especially commercial banks, are believed to have an advantage in dealing with information problems. Through interactions with a firm that uses its financial services, the lending institution can obtain additional information about the firm's activities, ownership, financial characteristics, and prospects that is important in deciding whether to extend credit.9 Lenders can use infor-mation gathered over time through long-term relationships with business owners and other members of the local community to monitor the health of the business and to build appropriate incentives into loan agreements.10 The role of relationship lending will likely continue to be significant, even as developments such as automated banking, credit scoring, and bank consolidation influence the competi