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EconSouth - New technology makes small business credit more available

Although small businesses account for nearly half of all private-sector employment in the United States, historically these firms have faced significant hurdles in gaining access to credit. Financial institutions' reluctance to grant loans to small businesses stems in part from small firms' greater informational opacity compared to larger, publicly traded firms.

To address this opacity problem, many U.S. financial institutions have begun using small business credit scoring (SBCS), a lending technology that allows the evaluation of micro credits, or loans of less than $250,000. While credit scoring has been widely used for many years in consumer credit markets, its application to the small business market spread rapidly only in the last decade, when analysts discovered that the performance of these loans is correlated with the business owner's personal financial history. Today the SBCS lending technology relies on "hard" quantitative information such as the owner's personal credit history as well as business information collected either by the financial institution or, occasionally, by commercial credit bureaus.

In a recent working paper, authors Allen N. Berger and W. Scott Frame review several studies that use data from a 1998 Federal Reserve Bank of Atlanta survey to test SBCS's effects. These studies strongly suggest that SBCS has increased small business credit availability in a number of ways, including the quantity of credit extended; lending to relatively opaque, riskier borrowers; lending in low-income areas; lending over greater distances; and increasing loan maturity.

The authors also explore the implications of these findings for a number of research and public policy issues concerning bank size and industry consolidation, bank competition and appropriate antitrust market definitions, the development of secondary markets for small business credits, and the proliferation of SBCS technology.

Future research, the authors note, may be hampered by the lack of new publicly available data. They urge that new surveys be conducted to document the proliferation and the effects of SBCS technology in the United States and abroad.