Financial Update (Third Quarter 2007)

For Underserved Areas, Borrower-Lender Distance Increasing

calculatorSmall business lending has long been considered a local affair—and especially so for borrowers located in historically underserved areas. In recent years, however, the physical distance between bank lenders and their small business borrowers has markedly increased, and today borrowers in historically underserved areas—such as low-income and minority areas—actually tend to be farther away from their lenders.

Bank lenders have increasingly expanded the geographic footprint for small business lending, and this greater entry helps explain the longer lender-borrower distance, according to a recent Atlanta Fed working paper.

Geographical shift coincident with new credit scoring models
The paper’s authors—Robert DeYoung, W. Scott Frame, Dennis Glennon, Daniel P. McMillen, and Peter J. Nigro—used a large, random sample of Small Business Administration loans to study changes in distance between small businesses and their bank lenders. They found that between 1984 and 2001, borrower-lender distance increased, with a rapid acceleration in distance beginning in the late 1990s.

This structural change, the authors determine, began taking place around the same time as the widespread adoption of credit scoring models that rely on automated lending processes and quantitative information. Just as home mortgages, auto loans, and credit card receivables have essentially become financial commodities, produced and traded without regard to the geography of borrowers and lenders, small business lending has increasingly moved from a relationship-based business to a transactions business.

Working Paper 2007-11a

One result of this transformation has been improved household access to credit made possible by advances in information technologies, innovations in financial markets, and geographic banking deregulation. The authors find evidence of similar changes emerging in the production of small business loans.

Soothing concerns about reduced credit
The authors indirectly link the implementation of small business credit scoring models to above-average increases in lending distances for borrowers in low-income and minority neighborhoods. These findings, the authors say, should allay fears that the growth of transactions-based lending processes—which make arms-length credit decisions based on hard information rather than on bankers’ personal information about individual borrowers and local markets—will lead to reduced credit availability in underserved markets. Their findings of longer borrower-lender distances are consistent with increased competition to lend to these small businesses.

July 24, 2007