Survey Delves into Minority-Owned Firms' Credit Challenges

October 4, 2018

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Small black-owned businesses are more likely to have difficulties obtaining credit than companies owned by whites and are likelier to feel discouraged from applying for financing, a new paper from the Federal Reserve Banks of Atlanta and Cleveland shows.

The report helps illuminate the different experiences minority-owned companies have when seeking funding for business expansion and other uses. Researchers examined financing patterns of firms with fewer than 500 workers by looking at detailed demographic and financial characteristics of the survey respondents. More than 7,900 firms in the United States responded.

The analysis—titled "Mind the Gap: How Do Credit Market Experiences and Borrowing Patterns Differ for Minority-Owned Firms?"—found that black-owned firms felt discouraged from applying for credit at higher rates than white-owned companies. "Discouraged" means firms did not apply because the owners did not think they would be approved. All types of minority-owned businesses are more likely to be dissatisfied with their lender. Companies owned by blacks and Hispanics are more likely than their white-owned counterparts to turn to online lenders for financing, the paper noted.

"Minorities are an increasing share of our population and business community," said Alisha Robb, a visiting scholar with the Atlanta Fed who is the founder and chief executive of Next Wave Impact, an early-stage venture financing company. "If they are having more trouble on average in accessing needed capital, that's going to have a negative effect on our overall economy, especially in minority communities."

The new paper follows a 2017 report by the Atlanta and Cleveland Reserve Banks that found that minority firms generally face more hurdles when accessing financing, with credit availability challenges most pronounced for companies headed by blacks. For example, among companies with low credit risk profiles that had been approved for financing, just 40 percent of minority firms received all the funds they applied for, that report noted, versus 68 percent of white-owned businesses.

"It's helpful to have current data that show there is still an issue around capital access by minority firms," Robb said. "We find some troubling patterns in these data."

Understanding the continued challenges minorities face in the credit market could open doors to possible solutions, the researchers said. Though the report doesn't seek to pinpoint the causes behind the disparities it identifies, it points to prior research and experiences by federal government officials that support minority-owned businesses. "We've heard various reasons for these disparities in financing experiences, including wealth levels, disparities in access to networks, business management knowledge, financial literacy, and language barriers for immigrant-owned firms," said report coauthor Mels de Zeeuw, a research analyst in the Atlanta Fed's Community and Economic Development Department.

Analysis helps discern differences

Using 2016 data from the Small Business Credit Survey, the researchers used a statistical process to analyze differences in credit market experiences between various racial and ethnic small business ownership groups, controlling for factors such as a firm's revenue, age, size, and credit risk profile. The process helped the researchers discern whether statistically significant differences existed among the ownership groups (see the infographic).

Minority business owners fared worse than whites on a number of fronts. For example, approval rates for loan applications were 61 percent for black owners, 73 percent for Asian owners, and 74 percent for Hispanic owners. White-owned businesses, by contrast, had the highest loan approval rates at 80 percent. Differences were more pronounced for companies that had lower revenue, were younger in age, had riskier credit profiles, and were unprofitable. The authors found that after controlling for factors such as credit risk, firm age, size, and profitability, black-owned firms were about 5 percent less likely to be approved for financing than white-owned firms.

Black-owned firms, in particular, were more likely to feel discouraged from applying for financing, the paper noted. The Small Business Credit Survey data show that 38 percent of black-owned firms reported not applying for credit because they expected they would not be approved, compared with about 14 percent of white-owned firms. Asian- and Hispanic-owned firms had discouragement rates of about 20 percent and 21 percent, respectively.

However, once variables such as firm age and revenue were controlled for, differences between Asian- or Hispanic-owned companies and white-owned firms disappeared. Still, the researchers found that black-owned firms were about 8 percent more likely to feel discouraged from applying for financing than white-owned companies.

That finding "is interesting and potentially problematic," de Zeeuw said. "Having access to capital is very important for a small business's odds of success and ability to grow. If black-owned firms are less likely to apply for credit because they don't think they will be approved, regardless of their credit profile or profitability, that means they are less likely to have the financial capital levels needed to achieve success."

Turning to online lenders

The researchers also found that firms owned by blacks and Hispanics were more likely to seek financing from nonbank online lenders for loans and lines of credit. The share of black-and Hispanic-owned businesses that turn to online financing was about 33 percent and 36 percent, respectively, compared with roughly 17 percent of white-owned firms and about 23 percent of Asian-owned companies. After controlling for specific factors, the study found that Hispanic- and black-owned firms were 5 percent and nearly 4 percent more likely than white-owned firms, respectively, to apply to an online lender.

Even so, among small companies that sought help from online lenders, black-owned firms had the lowest financial approval rates at around 51 percent, compared with 69 percent for white-owned firms, which had the highest online approval rate. Approval rates were about 68 percent for Hispanic-owned businesses and nearly 53 percent for Asian-owned companies.

Even so, among small companies that sought help from online lenders, black-owned firms had the lowest financial approval rates at around 51 percent, compared with 69 percent for white-owned firms, which had the highest online approval rate. Approval rates were about 68 percent for Hispanic-owned businesses and nearly 53 percent for Asian-owned companies.

Minority-owned businesses also had greater dissatisfaction with their lenders. Compared with white-owned firms, black-owned businesses were nearly 6 percent more likely to be displeased with lending sources, and Asian-owned firms were roughly 17 percent more likely to cite discontent, the report indicates. Hispanic-owned firms were about 10 percent more likely to be displeased with their lenders, compared with white-owned businesses.

The higher lender dissatisfaction rates among black-, Asian- and Hispanic-owned companies "indicates there is an opportunity for banks to do a better job in serving the minority business community," Robb said.

photo of Karen Jacobs
Karen Jacobs

Staff writer for Economy Matters


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