Small businesses are a critical piece of the US economy, but access to funding is a barrier that prevents many from growing – and even more from getting off the ground. According to the Federal Reserve Bank’s 2016 Small Business Credit Survey, almost half of all small businesses that sought financing were not approved. Banks typically don’t want to service loans under $250,000 because they come with higher default risks and the same underwriting costs as larger loans. But these small business loans help to create new businesses, expand existing businesses, purchase inventory and create financial stability for millions of Americans. The National Federation of Independent Businesses found that small businesses employ about half of private-sector employees and generate 63 percent to 80 percent of net new jobs annually.
While lending conditions have improved since the downturn of the great recession – thanks in large part to fintech innovations and increases to the lending rate – there are still barriers that put borrowers and lenders at a disadvantage. Some of these barriers are hard wired into federal financial policy. Congress could create an environment ripe for small business lending by making just a few critical changes.
Creating More Efficiency for Lending Processes
The most common complaint about obtaining a loan through a regulated financial institution, like a bank or credit union, is the amount of time it takes. The current business environment is one that rewards those who are nimble and quick to respond, which means many small businesses are missing opportunities while waiting for their money. There are many areas of the loan process that are ripe for change, but two in particular could have an immediate impact on lending efficiency.
First, encourage the IRS to automate the 4506T process for a third party to obtain a tax transcript, as this would reduce paperwork and the waiting period that currently burdens lenders and borrowers alike. Patrick McHenry (R-NC), Earl Blumenauer (D-OR) and Nydia Valazquez (D-NY), the ranking member of the House Committee on Small Business, have introduced H.R. 3860, the IRS Data Verification Modernization Act of 2017. H.R. 3860 would require the IRS to automate the Income Verification Express Services Process by creating an Application Programing Interface (API) that developers would be able to code against.
Second, further incentivize the U.S. Small Business Administration (SBA) to improve their technology, making the agency’s lending process more efficient and borrower friendly. The SBA doesn’t lend money directly, but works with lenders to provide small businesses with loans. The SBA guarantees the loans made through this program, eliminating a substantial amount of the risk. SBA-backed products remain a vital source of capital for small businesses – particularly newer businesses and startups – but the processes and technology used are cumbersome and deter many lenders and borrowers from participating. The private sector has developed world-class matching technology ensuring that borrowers end up approved by a lender under the most appropriate terms and conditions. The SBA should be encouraged to look to the private sector for technology solutions to improve the borrower experience in their flagship programs, SBAOne and SBA Lender Match.
Encouraging Cooperation Between Small Banks
Not all banks have the same underwriting guidelines; some are willing to take on more perceived risk than others. Unfortunately, when a small business applies for a loan at one institution and is rejected, they are forced to start the entire process over again somewhere else. Often times, the best place for a business in this situation is a Community Development Financial Institution (CDFI). CDFIs play an important role in providing capital to small businesses, often in low-income neighborhoods, that do not meet the underwriting standards of traditional lenders.
The Community Reinvestment Act is a law that was created in 1977 to reduce discriminatory credit practices in low-income neighborhoods. All regulated financial institutions that receive FDIC insurance must earn CRA credits and investing in CDFIs is one way to accomplish this. Currently, banks do not receive CRA credit from referring borrowers to CDFIs or other qualified institutions when these loans do not qualify under traditional underwriting standards. Many borrowers are unaware of CDFIs and turn to alternative online lenders that have egregious fees, high interests rates and confusing terms.
Providing banks with CRA credit for referrals would be an impactful step forward. “Referring a customer to a CDFI when they do not qualify for traditional funding already benefits the bank, as doing so allows them to help their customers access responsible financing while keeping the door open for future transactions,” says Pat MacKrell, president and CEO of the New York Business Development Corporation (NYBDC) and affiliate entity, Excelsior Growth Fund, a CDFI that works closely with a number of banks on referral partnerships. “However, expanding CRA consideration for referrals to CDFIs would notably increase the frequency at which banks refer, and would keep more people from making the regretful decision to obtain high-cost funding from online sources. If the referral results in a small business obtaining capital on reasonable terms, and that capital is put to work in the community to create jobs, how can one argue that the act that sets all that in motion is not community reinvestment?”
The collective impact of small businesses on the economy is enormous. They make up over 99 percent of all US businesses and account for 54 percent of all US sales, according to data from the SBA. By making smart changes to policy and taking fuller advantage of the latest technological efficiencies through more active partnering with fintech innovators, Congress could create the best small business environment this country has ever seen.