No. 234

February 2004

SMALL BUSINESS

RESEARCH

SUMMARY

The Impact of Bank Consolidation 

on Small Business Credit Availability

by Dr. Steven G. Craig and Dr. Pauline Hardee., Houston, TX 08035

under contract no SBA-HQ-02-M-0459, 2004. 39 pages 

This Small Business Research Summary (ISSN 1076-8904) summarizes one of a series of research papers prepared under contracts

issued by the U.S. Small Business Administration’s Office of Advocacy. The opinions and recommendations of the authors of this study do

not necessarily reflect official policies of the SBA or other agencies of the U.S. government. For more information, write to the Office of

Advocacy at 409 Third Street S.W., Washington, DC 20416, or visit the office’s Internet site at www.sba.gov/advo.

The banking industry has been undergoing an extensive period of consolidation, accelerated since the

federal interstate banking legislation of 1994. As

small firms are the source of most job growth, and

since the bulk of small business credit is primarily

from banks, the effects of institutional change on

small business credit is a major economic issue. 

The importance of small banks to small businesses

is shown, for example, by the fact that in 1999 small

business loans were 25.5 percent of bank assets for

institutions with less than $1 billion in assets. On the

other hand, for banks with assets of more than $5

billion, small business loans were only 7.85 percent

of total assets. This research investigates the consequences to small business credit from banking consolidation by examining two separate components of

the credit process—credit limits and credit levels,

using primarily the Survey of Small Business

Finances of 1998 (Survey).

Overall Findings

The research found that credit access had been significantly reduced for small businesses, but that actual

credit balances had fallen by less than the fall in

credit limits. These results suggest that while small

businesses are less likely to borrow from the banking

sector in markets with a greater degree of banking

consolidation, when they do so they take advantage

of improvements in pricing to borrow greater

amounts. Small businesses have increasingly turned

to non-bank sources of financing to satisfy their

credit needs. Interestingly, this non-bank option

seems to be more important for small businesses

with negative rather than positive equity.

These findings are essentially mirrored in the market for lines of credit and other loans, with some

important exceptions. Regarding total credit limits,

non-bank institutions were not able to compensate

for small firms’ reduced access to large banks’ lines

of credit. In other loans, however, it was found that

non-bank institutions do compensate for reductions

in bank credit, although the finding is stronger for

credit levels than credit limits.

Highlights

Small businesses receive less credit on average in

regions with a large share of deposits held by the

largest banks, irrespective of how debt is measured.

Details follow:

• When access to credit is measured by credit limits, reductions in lending in response to large banks’

greater market share is larger than when credit

access is measured by actual credit balances. 

• The market for lines of credit, especially the line

limits, seems to be most affected by banking consolidation. Regarding total credit limits, non-bank institutions were not able to compensate for small firms’

reduced access to credit resulting from a greater
share of large banks in lines of credit. Additionally,

non-bank institutions are not able to make up for

shortfalls in credit limit levels.

• Credit reductions appear more severe in total

when access to credit is examined through the firm’s

decision to borrow as well as the bank's decision to

grant credit, than when the amount of debt as a share

of assets is used as a measure.

• Credit reductions are found to occur for firms

with both positive and negative equity. 

• Non-bank financial institutions are making up a

considerable part of the credit reduction in terms of

the level of credit conditional on borrowing, but not

completely in the case of access to credit.

• The activity of non-bank financial institutions

appears to be especially important for firms with

negative rather than with positive equity.

Scope and Methodology

The research methodology is to use the Census regions

divided into urban and rural areas to define a banking

market, and then to use the individual firm data on

small firms from the Survey to ascertain the extent to

which credit access has changed. The analysis extrapolates from differences in the regions to changes over

time, since each region contains a different banking

market as measured by the extent to which large

banks are important, and the extent to which large

banks participate in the small business lending market.

The data for the analysis is the 1998 Survey of

Small Business Finances, combined with credit market information from the various federal regulatory

agencies. The variables employed in the regression

analysis describe two aspects of the banking market:

the share of deposits held by banks of a certain size,

and the extent to which banks are associated with

holding companies. Variables from the Survey

describing the firms are extensive, and include credit

history, industry, and other firm attributes.

The focus of the research method is to estimate

two separate regressions for a variety of credit definitions. The first regression is access to credit, measured simply by whether or not a small business is

using credit from a particular source. This regression

is estimated using a linear probability model. The

second step is to estimate the level of credit, as a

share of assets, for firms utilizing a particular credit

source. This step is estimated using weighted least

squares, to adjust the Survey data to fit the national

characteristics of small businesses. The pair of models

is estimated separately for firms with positive and

negative equity. Finally, the regression analysis is

separated to estimate the firms that utilize banks and

the firms that use non-bank financial institutions for

their credit needs.

Conclusion

The banking industry has been undergoing an extensive period of consolidation, and this process has accelerated since the federal interstate banking legislation

of 1994. With small banks providing a substantial

share of banking credit to small firms, the potential

impact on the availability of credit to small businesses

if all small banks are absorbed by large institutions

becomes a real concern to small business policymakers.

The research found that credit access had been significantly reduced for small businesses, but that actual

credit balances had fallen by much less. Small businesses have increasingly turned to non-bank sources

of financing to make up the shortfall, especially for

credit other than credit lines, which were supplied

primarily by large banks.

Ordering Information

The full text of this report and summaries of other

studies performed under contract to the U.S. Small

Business Administration’s Office of Advocacy are

available at www.sba.gov/advo/research. Printed

copies are available for purchase from:

National Technical Information Service

5285 Port Royal Road

Springfield, VA 22161

(800) 553-6847

(703) 487-4639 (TDD)

www.ntis.gov 

Order number: PB2004-102510

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