FRBSF Economic Letter
97-02; January 24, 1997
Changes in Small Business Lending in the West
Western Banking Quarterly is a review of banking developments
in the Twelfth Federal Reserve District, and includes FRBSF's Regional
Banking Tables. It is published in the Economic Letter on
the fourth Friday of January, April, July, and October.
Over the past year, big banks have made a highly visible push into small
business lending. Several large banks have been using new technology to
reduce the cost of originating small business loans and speed the approval
process. For example, at some banks businesses can apply for loans by
mail using simplified forms, and credit analysis has been automated and
streamlined through the use of "credit scoring," a method of
evaluating potential borrowers using sophisticated statistical analysis
to estimate the probability that they will repay as promised.
The most recently available small loan data show that these changes
may be having a sizable impact in the West, as reflected in relative growth
rates of small loans at banks of different sizes. This issue of Western
Banking discusses the emerging trends in the Twelfth District.
A superficial evaluation of the success of the big banks' expansion
efforts might divide banks into several size groups and calculate whether
the small loans of the largest size group (such as the top 20) increased
relative to those of smaller banks. Based on data that federal banking
agencies collect each June on banks' small business loans, the 20 largest
banks in the District reported 19.8% more in small business loans for
June 1996 than did the top 20 a year earlier. (The term "small business
loans" here refers to commercial loans with original amounts of $1
million or less, excluding those secured by real estate.) If accurate,
a growth rate of nearly 20% would be remarkable, since overall small business
loan growth was 5.7% for banks in the District and 6.5% for banks nationwide
over the same period.
Unfortunately, calculations like this are misleading. There have been
many recent mergers and acquisitions in banking, including a large number
of mergers between affiliated banks as holding companies react to changes
in interstate banking laws. One artifact of this merger wave has been
consolidation of regulatory reporting, with banks that formerly filed
separate reports filing only a single, combined report after they merge.
These consolidations distort any size-based comparisons by artificially
boosting the reported loans of the surviving banks.
To adjust for mergers, the 14 companies that control the 20 largest
banks in the District were identified. Changes in consolidated small business
loans for the twelve months ended June 1996 at these "Top 14"
were adjusted for the effects of mergers by taking the June 1995 reports
and combining the numbers for banks that merged during the year. Comparing
these adjusted loan figures to the June 1996 totals isolates loan growth
that occurred for reasons other than consolidation of regulatory reporting.
After these corrections, the data show that small loans at these largest
banks actually grew more slowly during the year than at their smaller
competitors: Small business loans increased by only 5.2% for the largest
banks, compared to 6.2% for other banks in the District. The contrast
with the unadjusted figure of 19.8% cited above demonstrates the importance
of correcting for mergers.
However, growth in total small business loans may not be the right measure
of success of the larger banks' expansion strategies, since some of the
innovations in business lending are not applicable to loans of all sizes.
Credit scoring is a notable example: Scoring models, originally developed
for consumer lending, use statistical techniques to relate information
about a borrower (such as credit history or current financial position)
to the probability that he or she will default on a loan or other debt.
Lenders have found that business loans below a certain size are analogous
to consumer loans, and therefore are candidates for very similar credit
scoring; the analogy breaks down as the business loans get larger. Because
scoring can reduce the costs of lending, several of the larger banks have
focused their efforts on the smallest of the small business loans.
The loan reports break the small business data into three loan-size
categories, and within these categories significant differences between
large and small banks are evident. The largest banks in the District (as
defined above) increased their holdings of business loans with original
amounts under $100,000 by an astonishing 26.2% during the year, while
other banks increased these smallest of business loans by only 3.1% (Figure
1). The strong growth in the smallest loans at the largest banks is
consistent with an emphasis on automated loan application and evaluation.
As a result of this growth, the largest banks as a group increased their
share of these small commercial loans by about 5 percentage points during
the year, to 58% of the District total.
This shift at the largest banks apparently was accompanied by a retreat
from loans that are not amenable to the new technology: Large banks actually
reduced their holdings of smaller business loans (in the $100,000
to $1 million range) by more than 5%. Their withdrawal seems to have left
room for competitors to expand: Smaller banks increased such loans by
7% in the $100,000 to $250,000 category, and 8.4% in the over $250,000
category. However, expansion by smaller banks was barely enough to offset
the contraction by the larger banks: Overall growth within these two loan
categories was near zero for the District, compared to 5.5% for such loans
The push by big banks into small business lending has been more than
just cheap talk. The top banks in the District have strongly increased
their commercial loans of less than $100,000 and have taken market share
from smaller banks. However, they appear to have retreated from small
business loans that are slightly larger and therefore not good candidates
for new automated lending processes. Smaller banks have moved into this
gap left by the big banks, but have not kept small business loan growth
at Twelfth District banks from lagging the rest of the country.
Mark E. Levonian
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or of the Board of Governors of the Federal Reserve System. Editorial
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