Elizabeth A Duke: Small business credit availability
Speech by Mrs Elizabeth A Duke, Member of the Board of Governors of the Federal Reserve
System, at the 2011 International Factoring Association Conference, Washington DC,
14 April 2011.
The original speech, which contains various links to the documents mentioned, can be found on the US Federal
Reserve System's website.
* * *
It's a pleasure to be here this morning. I appreciate the opportunity to take part in this
conference and to talk with you about credit conditions - especially conditions in the small
business lending market. Credit availability is a necessary component of economic recovery,
and factoring represents an important source of credit for large and small businesses.
Credit markets normally recover slowly following financial crises, and the most recent
episode was no exception. However, after declining throughout 2009 and much of 2010,
recent measures of aggregate credit outstanding have shown some signs of improvement.
Nonrevolving consumer credit outstanding, which includes auto and student lending, has
increased for the past seven months. Issuance of corporate bonds has been robust for
several quarters, and new issuance of commercial mortgage-backed securities picked up in
the first quarter of 2011, albeit from very low levels. Commercial and industrial (C&I) loans
outstanding have resumed growing modestly on average.
While credit availability seemed to improve for large companies throughout the past year,
small businesses still complained of difficulty in gaining access to credit. Recent anecdotes
lead me to believe that conditions are improving for small businesses, but data are scarce for
this market. Today I will pull together information from a variety of sources, including surveys
of small businesses and surveys of lenders, to paint a picture of the credit conditions
currently facing small businesses.
Sources of financing for new and existing small businesses
Small businesses are central to creating jobs and to restoring our economic prosperity. The
economic importance of small businesses is due in part to the fact that about one-half of all
Americans are employed by firms with fewer than 500 employees. In addition, business
startups are a critical component of the experimentation process that contributes to restructuring
and growth in the United States on an ongoing basis. Indeed, each wave of firm start-ups
creates a substantial number of jobs. Over the past two decades, firms less than two years
old accounted for about one-fourth of gross job creation even though such enterprises
employed less than 10 percent of the workforce.1 But, as a note of caution, these young firms
also have high job destruction rates; within five years of starting up, about 40percent of the
jobs initially created have been eliminated by the firms' exit from their market. The "up or out"
dynamics of start-ups and young firms are consistent with the innovation, learning, and
market selection that is associated with entrepreneurship.
Given the key role that start-up and established small businesses play in job creation, it is
useful to consider how start-ups are typically funded and how the owners of more-mature,
but still small, businesses tend to support their ongoing operations. To this end, the Federal
Reserve's 2010 Survey of Consumer Finances (SCF) provides some new and very
preliminary data regarding the primary sources of money used to start, acquire, or expand
closely held businesses.2 The survey was conducted largely over the second half of 2010.
In this discussion, I will focus on the responses by owners of businesses with fewer than
500 employees that were in operation at the time of our survey. For these small and nascent
businesses, more than 70 percent were initiated using personal savings or assets, about
6 percent were initiated using a personal loan from a bank or savings institution, about
3 percent were initiated using a personal or business credit card, and just 3 percent were
initiated using a business loan from a bank or savings institution. Even smaller percentages
of start-up small businesses appear to have received funding from credit unions, other
institutions, or investors. In short, our survey data suggest that the personal resources of
entrepreneurs are the most important funding source for small business formation.
The importance of personal resources in financing small businesses is supported by other
recent survey evidence. In our 2009 panel SCF, we found that families make loan
guarantees for their businesses using personal assets as collateral, and that loans between
business owners and their businesses are common in both directions.3 Moreover, according
to the most recently available data from the U.S. Census Bureau's Survey of Business
Owners, 6 in 10 small business owners use personal savings or assets to finance or expand
their businesses.
These responses highlight the role personal wealth plays in business formation. Looking
back at wealth outcomes in 2009, we found that 43 percent of families saw a wealth decline
equal to or greater than six months of their usual income, and almost one-third saw a loss
greater than an entire year of the usual income.4 Such wealth declines would, of course,
reduce the likelihood that such households would start a small business.
Over the same period, however, about one-fifth of families saw a gain in wealth that was
greater than six months of their usual income. Moreover, a higher percentage of business
owners who participated in the survey saw larger wealth gains relative to their incomes than
was the case for the overall population. These findings suggest that there just might be a
pool of potential entrepreneurs who have both the resources and relevant experience to start
successful businesses.
Turning to the funding needs of more-mature businesses, in the 2010 SCF, we asked small
business owners whether and to what extent external sources of money were used to
finance the ongoing operations of or improvements to their primary businesses in the past
year. Focusing again on only businesses with fewer than 500 employees, the preliminary
survey data suggest that for such purposes, slightly less than one-half of these businesses
did not use any external funding. Consistent with the funding information on the start-up
phase for small businesses, a significant proportion of small business owners - about
onethird - used their personal savings or assets to fund operations or make improvements. And
only small percentages of small business owners obtained credit from a bank or savings
institution for such purposes: Among these small business owners, about 5 percent used
personal or business credit cards, slightly less than 5percent used business loans, and about
3 percent used personal loans.
Taken together, these survey data suggest that many small business owners do not tap the
credit markets, but instead use their own wherewithal to start and fund their businesses.
Indeed, a bit less than 80 percent of small business owner survey respondents with fewer
than 500 employees indicated that they had not even applied for business loans in the past
five years. This is not to say that loans are not important - far from it - but that for a broad
range of businesses, personal finances may be the determining factor in starting a business,
and personal finances may also be most important in sustaining the health of a business
once started.
So what happened to the small business owners who did apply for loans? The turndown rate
was fairly modest - about 12 percent. Moreover, for those small business owners who
received credit, more than 90 percent of those surveyed actually received as much credit as
they had requested. These results are perhaps surprising given that two of the past five
years were ones with very tight credit conditions by historical standards, and anecdotal
evidence suggests that many lines of credit, for businesses and for households, were cut
during the recent financial crisis.
Furthermore, small business lending is an important part of overall bank lending, especially
at community banks. According to regulatory data, small loans to businesses, a proxy for
loans to small businesses, constituted 23 percent of total business loans outstanding at
commercial banks at the end of 2010.5 Over the past several years, this share has fluctuated
between 22 and 27 percent of banks' business lending. In addition, at community banks with
less than $1 billion in assets, the share is higher - around 66 percent - whereas at larger
banks with more than $10 billion in assets, the share is lower - 16 percent.
Small business concerns
The foregoing survey data on turndown rates and credit constraints for small business
owners are consistent with other survey evidence collected by the National Federation of
Independent Business (NFIB). In fact, over the past five years, small business owners
identified weak demand, taxes, and government regulations more frequently than interest
rates and credit conditions as their most important problem. During that period, less than
5 percent of small business respondents typically identified interest rates and credit
conditions as their most important problem. In contrast, 25 percent or more of small business
owners considered weak demand the most important concern during much of the past
threeyear period (figure 1). In considering responses to this question, however, it is important to
remember that the survey allows owners to identify only their most important problem, not a
set of problems. It is possible that financing was the second-most-important problem, but we
would not know it from this set of data.
Even if tight credit is not the most important concern, perceptions of tight credit still might
significantly influence the decisions made by current and prospective small business owners.
Among the small business borrowers surveyed by the NFIB, a fairly high net percentage -
about 8 percent in March - continues to report that credit is more difficult to obtain than it
was three months ago (figure 2). This level of self-reported perceptions of tighter credit for
small businesses is about the same as was observed in 2007 - a period prior to the recent
business cycle peak. It is also well below the 16percent of small business respondents, on
net, who perceived that credit had become more difficult to obtain in 2009.
Looking back to 2009, a Ewing Marion Kauffman Foundation longitudinal study of small
businesses that were founded in 2004 and tracked since then found that 89 percent of the
surviving firms that were denied loans in that year felt that banks' heightened requirements
played a role in their denials.6 Among the small businesses that were tracked, 21 percent
had chosen not to apply for loans for fear of being denied credit, and 5 percent also refrained
from seeking external equity financing for fear of being denied such financing. So it seems
that perceptions of credit tightness may lead some small business owners to decide not even
to try to obtain additional funding.
At this time, however, the net percentage of survey respondents telling the NFIB that they
expect credit conditions to become tighter over the next three months has come down
considerably from what small business owners reported during 2009. This decrease
suggests that, compared with the previous few years, far fewer small business owners are
expecting that credit conditions will remain tight.
Overall, what seems to matter most with regard to funding, from the small business owner's
viewpoint, is one's personal savings or assets, the internally generated funds derived from
operating the business, expected sales, and the fact that credit conditions seem to be less
tight, so money is available, if and when it is needed.
Business conditions for small businesses
Currently, expectations about future sales seem to be more important than expectations
about the availability of credit in driving business spending decisions and demand for
business loans. Recently, small business owners appear to have become more optimistic
about their outlook for sales. For example, in recent NFIB surveys, the net percentage of
respondents who expected their sales to increase rose to levels not seen since mid-2007
(figure 3).
More generally, small business owners surveyed by the NFIB indicate that they currently
expect business conditions to improve in the near future. In fact, the net percentage of small
business respondents who expected business conditions to improve six months from now
climbed in February to its highest level in several years (figure 4). Even with some
backtracking in March, this barometer of business conditions remains at a level not seen
since mid-2007.
Other survey data collected by the NFIB are also consistent with more-favorable conditions
for small businesses. The percentages of small business respondents who believe it is a
good time to expand, and who plan to make capital expenditures over the next three to six
months, have recently risen to levels not seen since mid-2007.
The bankers' perspective on lending to small businesses
Mirroring small business respondents views with respect to credit conditions are bankers'
views on credit standards and their terms of credit. To consider the bankers' perspective, I
will draw on two other Federal Reserve surveys: the Senior Loan Officer Opinion Survey on
Bank Lending Practices (SLOOS) and the Survey of Terms of Business Lending (STBL).
With regard to credit standards, we found that about 5percent of banks, on net, reported in
January that they had eased their bank's lending standards on commercial and industrial
loans to small firms in the fourth quarter of last year (figure 5).7 A similar net fraction of banks
reported having eased standards in the previous survey. This finding is consistent with small
business owners' perceptions that credit conditions have eased somewhat.
For those small business owners whose loans or credit lines were approved, the terms of
credit - the interest rate spread over the bank's cost of funds, the cost of a credit line, the
maturity, and the size of a loan - are practical measures that can be used to assess credit
availability. The January SLOOS indicates that about one-third of banks, on net, reported
that they had trimmed the spreads of C&I loan rates over their costs of funds on loans to
small firms (figure 6). Somewhat smaller net fractions of these loan officers reported that they
had lowered the costs of credit lines and lengthened the maximum maturities of loans to
small firms. Despite the fact that such terms of credit were eased for small firms, the banks
reported that the maximum sizes of C&I loans, and limits on credit lines and business credit
card accounts, remained unchanged over the past two surveys. This result means that such
lines were not being cut as they were during the first half of 2010. Easing of credit conditions
usually does not occur until banks see improvement in the credit metrics of existing
portfolios. In the January SLOOS, 77 percent of bankers reported having seen an
improvement in the quality of existing loans to small firms.
The SLOOS does not distinguish between commercial real estate loans to small firms and
such loans to others, but we know that real-estate-secured lending is an important source of
credit for small businesses. The respondents to the January SLOOS indicated that there was
little movement, on net, in domestic banks' lending standards for commercial real estate
loans over the past two surveys (figure 7). Such standards remain relatively tight even
though more than one-half of banks expect an improvement in the quality of commercial real
estate loans. And, importantly for small business owners, the commercial bank Call Reports
indicated that as of the end of last year, the loans secured by owner-occupied property had
continued to outperform other commercial real estate loans.
Information contained in the February STBL also indicated a recent easing of terms on bank
loans. More specifically, recent loan rate spreads on C&I loans at domestic banks were
lower, on average, regardless of the bank's size, and the average number of days to maturity
had lengthened.
The recent easing in banks' lending policies and banks' improved expectations with respect
to credit quality are indications that financing conditions for at least some small businesses
are likely improving.
By and large, small business owners' perceptions about the tightness of credit conditions
seem to be aligned fairly well with bankers' perceptions of late. Such perceptions are also
consistent with recent turndown statistics. According to the National Small Business
Association (NSBA), the percentage of small business owners reporting an inability to obtain
adequate financing declined to 36 percent at year-end from 41 percent in July 2010.8 These
data, of course, apply to members of the NSBA, whereas the SCF data I discussed earlier
apply in principle to all small business owners, even owners of quite small businesses who
might be unlikely to join an association. This may explain the much higher credit use among
NSBA members.
lending to Small Businesses
So far, I have discussed measures of business credit. But, as I noted earlier, small
businesses also rely on personal accounts and loans, household credit cards, trade credit
from other nonfinancial firms, and other sources, including factoring. The effect of these other
sources of funding on businesses' finances is even more difficult to determine from available
data.
Changes in personal wealth during the downturn were not uniform across households, and
there were some big winners and losers. While the households that disproportionately
increased their wealth are more likely to start businesses, those that disproportionately lost
wealth are less likely to do so. In particular, the recent housing downturn has made it more
difficult to use cash-out refinancing or home equity lending as a funding vehicle for small
business formation. It has also made it more difficult for some small business owners to fund
the purchase of equipment or to cover business operating expenses.
Even though our survey data suggest that only 3 to 5 percent of small business owners tend
to rely on personal or business credit cards, the decline in bank credit card outstandings over
most of the past two years indicates that this source of credit may still be quite limited.
While balance sheet data for financial institutions are readily available, the relative
contributions to changes in outstanding balances of new lending, paydowns, and
writedowns and the levels of line usage are not available. To focus on the link between lending
and new business activity, we need measures of loan originations. Indeed, a loan or lease
origination is what typically generates an investment in equipment and signals business
growth.9
To explore recent loan and lease originations to small businesses, we can look at the
PayNet/Thomson Reuters Small Business Lending Index (SBLI). For inclusion in this index, a
loan or lease must be originated to a business borrower who has total loan outstandings
across all qualifying lenders of less than $1 million at both the start and the end of the month
in question. While some such loans and leases may be to established firms that employ
more than 500 workers, small businesses are generally viewed as much more likely to
borrow in these relatively small loan denominations. The lenders that provide the data used
to construct the index are banks and finance companies.
The year-over-year changes in the SBLI are consistent with a view that loan originations are
a pro-cyclical indicator (figure 8). Strikingly, such year-over-year changes were mainly
positive, but smaller through time, until the recent business cycle peak in December 2007.
During the recession, however, the year-over-year changes in the SBLI were increasingly
negative until the business cycle trough, which occurred in June 2009. Then, shortly after the
recent business cycle trough, the year-over-year negative changes in the index became
smaller until they turned positive in early 2010. In February, the most recent month for which
data are available, the SBLI measure of business loan and lease originations rose 15 percent
from a year earlier.
The seasonally adjusted index, which is normalized to 100 in January 2005, provides a
different take on small business originations (figure 9). This measure of lending, which allows
comparisons across different months, has not yet rebounded to its level in mid-2007 even
though many of the measures of small business owners' and bankers' perspectives have
returned to their pre-recession levels. Despite the magnitude of the rebound, there has been
an apparent turnaround in loan and lease originations using the seasonally adjusted SBLI
measure. These data add to the evidence that credit availability to small businesses is
gradually improving.
While at first glance stronger demand for bank loans by large and medium-sized firms may
seem irrelevant for analyzing credit to small businesses, that perception would ignore the fact
that such demand may signal that larger firms are becoming more willing to provide trade
credit to smaller firms that are their suppliers or customers. In the most recent SLOOS, the
net percentage of respondents reporting higher loan demand by large and medium-sized
firms rose above 20 percent for the first time since 2005 (figure 10). That said, banks report
that loan demand from smaller firms remains fairly weak. Only a small net percentage of
banks reported stronger demand from such firms.
Conclusion
To sum up, the financial conditions that would be necessary for small businesses to start up
and thrive would include positive conditions for personal wealth building and a full range of
consumer and business credit availability. In the wake of the financial crisis, small business
owners and potential small business owners likely experienced a substantial reduction in the
personal resources necessary to start or sustain a business. At the same time, small
business loans became harder to get, and when they were available, both price and nonprice
credit terms were likely quite restrictive. Many small business owners were so convinced that
their requests would be denied that they did not even apply for credit. Despite this restricted
credit availability, small business owners, by a large margin, still considered their most
significant problem to be weak sales. Although no definitive data source exists, the
combination of a variety of recent survey results paints a picture of increasing optimism
about future sales and business conditions and a corresponding easing of credit availability
for small businesses.

Figure 4. Outlook for general business conditions
6 months from now (net)*
(Monthly data, 1990-2011)
Figure 5. Change in standards for commercial
and industrial loans to small firms
(Quarterly data, 1990-2011)
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Figure 6. Change in spreads of loan rates
over cost of funds to small firms
(Quarterly data, 1990-2011)
Figure 8. PayNet/Thomson Reuters
SBLI percent change vs. year prior
(Monthly data, 2006-11)
SBLI Small Business Lending Index.
Source: PayNet/Thomson Reuters.
Figure 9. PayNet/Thomson Reuters
Small Business Lending Index
(Monthly data, 2005-11)
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