Financial Update (October-December 1997)

How Does Bank Consolidation Affect
Small Business Lending?

D uring the 1990s many local and state banks were acquired by regional or national banks. Banking industry analysts predict this trend toward consolidation will continue over the next several years. The trend raises a number of questions about how bank consolidation will affect the type of services banks provide.

In a recent presentation to the Atlanta Fed's Advisory Council on Small Business, Agriculture and Labor, Atlanta Fed Senior Economist Aruna Srinivasan and Whitney Johns, a member of the council and chief executive officer of a Nashville, Tenn., mergers and acquisitions firm, provided background on bank consolidation's impact on small business lending.

Does Consolidation Affect Small Business Lending?

According to Srinivasan, the new structure of the banking industry may not have the negative impact that many small business owners once suspected. In fact, some small businesses may realize benefits by working with larger institutions.

Larger banks, for instance, have higher loan-to-debt ratios. Larger institutions also are generally more diversified, with loans and deposits from many areas, and are thus better able to grant credit during downturns in a particular local economy. Larger banks also have a bigger customer base to spread costs for new technology.

All of these factors are good news for small businesses, but many business owners are concerned about how relationships with lenders may suffer since small business loans generally require more oversight than other loans. Traditionally, local community banks have more closely and efficiently monitored small business loans.

But the evidence is mixed on whether or not small businesses' lending relationships suffer because of consolidation, according to Srinivasan. In fact, some experts believe small business lending may actually increase through the use of new loan methodologies, such as credit scoring, that are more likely to be provided by larger banks.

Credit scoring is a method of assigning a single quantitative measure, or score, to a potential borrower that reflects the borrower's relative chance of going into delinquency or default. Through credit scoring, large banks can lend more money more economically to small businesses. Srinivasan said that credit scoring may make small business lending more like mortgage lending, similarly opening small business loans to a national savings pool through securitization.

With credit scoring providing a cost-effective way to lend to small businesses, large banks have the profit incentive to increase their number of small business loans.

Options for Small Businesses

There are options other than traditional bank financing to make up the difference in small business lending that may be lost through bank consolidation, according to Johns.

Many business owners, she said, particularly those who do not have a long track record, must depend on personal financing through credit cards or other options, such as family, friends or "angel financing." Angel financiers are wealthy individuals who provide loans to small business owners, typically by pooling their money with others to invest in start-up companies or companies looking to expand.

Once business owners have a track record, they can utilize more sophisticated options such as venture capital, which may lead to a small business being transformed into a publicly held company by selling stock.

While there has been considerable consolidation in banking, this trend does not necessarily mean that small businesses may have a smaller lending pool to utilize for start-up or expansion, particularly given the use of new lending methodologies and the availability of financing through less traditional sources.

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