Closing the Growing Private Business Credit Gap

Economy, FinTech

While the U.S. economy has shown its recovery from the Great Recession in most ways, small business lending isn’t one of them. In 2008 when the market crashed, all banks pulled back from business lending, but none more so than the four largest – Bank of America, Citigroup, JPMorgan Chase and Wells Fargo. Once recovery began, access to credit slowly improved. Yet today, 10 years later, access to credit is still far from where it should be, and small businesses are experiencing a private business credit gap – a reduction of credit supply – and the effects are being felt throughout our economy.

I’m happy to report that we are starting to move in the direction to right this ship: PayNet worked with Harvard University to publish a report on this very topic, and the Bipartisan Policy Center (BPC) recently hosted an event to discuss the barriers small businesses are facing when it comes to accessing capital. The BPC’s Task Force on Main Street Finance will soon release recommendations to make the financial system work better for small businesses and entrepreneurs.

In the meantime, though, how did we get here? More importantly, what are the consequences of this Main Street credit gap, and how do we close it?

By looking at small business investments along with PayNet’s database, I knew small business lending wasn’t improving as well as other areas of the economy. I wanted to validate my hypothesis – that the lack of private business lending for so many years resulted in a credit gap of which we continue to feel the effects - and approached Jeremy Stein, professor of Economics at Harvard University and past member of the Board of Governors of the U.S. Federal Reserve. I shared my hypothesis with him and he agreed to have a research team start exploring if there was actually a credit gap that opened up post-Recession.

I offered information from our database, the largest U.S. database of small business loans with more than 23 million credit contracts and totaling more than $1.4 trillion in loans. After pairing PayNet’s data with their own research, Harvard University published the report “The Decline of Big-Bank Lending to Small Business: Dynamic Impacts on Local Credit and Labor Markets,” which confirmed the decline in private business lending at the Top 4 banks in 2008 did in fact reflect a differential contraction in credit supply, opening up the gap that has had economic implications and significant impact on the local labor markets ever since.

The bottom line findings of the report: the volume of lending declined, the cost of credit rose, and small businesses looked to non-Top 4 lenders to borrow. I encourage you to download the full report, but I’ve summarized some of the key findings:

By late 2008, the Top 4 banks were facing massive losses in their core lending and capital markets divisions, threatening their solvency and leading to intense wholesale funding pressures. Executives at these banks needed to stabilize core business lines, rebuild equity capital buffers, and pass the U.S. government’s May 2009 stress test. Facing these challenges, the large banks pulled back from small business lending—a non-core unit where they were already struggling—to focus on weathering the storm.

Counties with a larger initial Top 4 bank share experienced larger increases in the cost of small business credit after 2008, and due to an array of heightened regulations, effective and new capital requirements on small-business loans, and the Know Your Customer (KYC) regulations, the Top 4 had to re-evaluate their competitive advantage in this area.

Through 2014, the Top 4 banks were slow to return to small business lending once the crisis had subsided, and there was a large contraction in the supply of small business lending, resulting in six years of a gap where there was minimal credit available to small business. 

Small banks and other non-bank lenders helped fill some of the gap left by the Top 4 banks, but it took several years for them to pick up the slack left by these large banks. And, the lenders who had stepped in to fill the gap were higher-cost credit providers than the Top 4 banks. So even though the annual flow of credit recovered, the persistent pricing difference suggests that a small business credit gap may have still existed in high Top 4 counties as late as 2014.

The report outlines the major consequences of the credit supply shock, too. The cost of credit remains elevated. Wages fell. The impact on unemployment is better, but small businesses continue to hire less in industries dependent on external finance, such as the manufacturing industry. Non-bank financing and alternative lenders grew, and continue to grow. Interest rates remain higher, so more expensive credit means many small businesses are less capital intensive. So what’s next?

Harvard’s impactful report is part of a growing body of research presenting overwhelming evidence of the private business credit gap. Academic research continues from other prestigious institutions who seek to understand the issue of frictions in the financing activity and enable better credit systems to serve small business. FinTechs are helping the effort, too. Companies such as OnDeck continue to look for ways to speed up the credit application process and take away some of the frictions associated with gaining access to capital. Others, such as Fundation, are consistently expanding technology into the banking market to help that sector shorten the turnaround time on a loan to small businesses.

And, forums are convening key industry players to develop strategic ideas to find innovative responses to the credit gap and employ the power of transformative technology. For example, Orion Capital recently sponsored the Small Business Lending Forum in Denver to bring together industry players to generate ideas. CIBC President Brant Ahrens recently spoke at a meeting of business owners about the bank’s community development efforts to help business start-ups with loans as small as $5,000. And, Tom Sullivan of the U.S. Chamber of Commerce is actively working to bring together policy makers through the Access to Capital Working Group.

We are committed to working closely with our partners to dig even deeper into what the market is doing, narrowing in on the specifics of where the credit gap exists and its true impact on the economy. Our next Pulse Post will introduce a new piece of research we’ve developed with Raddon (Fiserv) that delves into what we’ve uncovered. And, the BPC is tackling the issue from both sides of the aisle and its recommendations are forthcoming.

I look forward to continuing to share our research and how we can further ignite the market by enabling private businesses to better access capital and keep the economy healthy, vibrant and moving in a positive direction. With more than 28 million private businesses that account for at least half of the U.S. GDP, our nation’s economic wellbeing depends on it.

If you want to get involved and be a part of the growing movement to solve the credit gap, contact me at to learn how you can help.