Forum on Barriers Facing Banks In Lending
to many Small & Disadvantaged Businesses
Entreprenueral Institute, 1993
- In 1993 Florida International University's Entreprenuerial Center Program (Phill Mann, director) sponsered a series of breakfast forums on the barriers faced by banks in lending to small and disadvantaged business. About 50 people attended each of three sessions. The participants were a mixture of bankers, business owners, technical assistance providers, educators, and local government officials.
What follows in an outline of the discussion that took place at the forum. In most cases where a person has been quoted, their identity has not been specifically revealed. The discussion has been broken down into categories of "barriers to bank lending" and "solutions".
- B. BARRIERS TO BANK LENDING
- FOR SOME LENDERS, THE LOCATION OF BUSINESS IN A LOW INCOME TARGET AREA CAN BE AN UNARTICULATED REASON FOR DENIAL OF A LOAN
An issue was raised during the discussion as to whether or not the location of the business can be an unarticulated reason for a denial of a loan by a bank.
All agreed that banks need to continue exercising a degree of reasonable prudence while still striving to meet community credit needs. As one participant stated:
"banking is a business of getting your money back. For this reason banks want to make good loans. (One of the main problems for banks is that they have to determine whether the loan application is for the purpose of) expanding a profitable on-going business or is this a loan to finance unprofitable operations? What often happens is that small businesses, even existing ones, don't have good books, so when they come in they say, "Yeah, I'm doing okay. Yeah, I got myself a car, and I can take out a little for groceries." And then you look at their records and the reality is that the business is really unprofitable. And a bank is not going to finance unprofitable operations. That's just like throwing good money after the bad"
But the question still lingered. Suppose you have a well-run business that meets minimal standards of credit-worthiness. Does it make a difference where the business is located? Amongst the participants there was some disagreement. One officer of a major bank said that the location of the business did not make a difference:
"banks are interested in lending money to people who are going to return it. If the business is profitable and has the track record and looks like the cash flow is there to pay us back, it doesn't matter where the business is. The key thing is, is the money going to be there to pay back our loan?"
Another banker added:
"Money is the same color, no matter where it is generated, as long as it is legitimate. . . we do our best to get small business into the mainstream of our lending.
There was, however, a strong counter-point. One participant noted that while a number of the larger banks (especially those represented at the forum) were, in fact, trying harder to make loans in low income communities, the unfortunate reality of today was that it still did make a difference from what part of town the businesses was located:
"(the location of the business) does make a difference . . . as to whether you will get the loan or not. Being a banker and being a minority and sitting on loan committees, I've definitely witnessed the fact that if a business is in a profitable area, a "yuppie area", that possibility of growth for that business, additional income, etc. is a factor. If, however, the business is in an area that is not growing and where the economic development prospects are bleak, the location of the business is definitely going to have a great deal of bearing on the decision made on that loan."
"I am a banker and I have gotten involved in what's called business lending. I have sat on a number of loan committees . . . and I know that this issue has come up. I'm not trying to account for what my banking partners say, but I think in some situations (a bias against businesses from low income minority areas) does come up. The reason I think it may make a difference is because the people on the loan committee, the people deciding, if all things are equal, (will give a preference to an applicant who they have previously known). (T)hat person is more apt to have the application go through, than (an applicant whom) no one knows anything about. Let's face it, it's not just the package that is being presented. Because you can find all kinds of reasons not to make that loan. The key is to find a reason to make the loan and if the commitment isn't there (the loan won't be made)."
A community activist, who was participating in the forum, stated:
"I had (a person come) to me. The person had an established business, established track record, and he went into a local bank. The loan officer (took the application) everything looked good and he said he'd approve it. Then one of the higher officials in the bank came through and said, 'let me take a look,' and then said, 'no, that's in Opa-Locka, we have too many problems in Opa-Locka.'"
Another participant added:
"(The) credit manager type people (are a big part of the problem). They really determine what line banking people are going to do and my experience has been that, while line banking people may want (to make loans to businesses located in the target areas), they are scared to death to make a loan to a black person if it's not picture perfect, for fear of getting their head chopped off.
- BANKS ARE NOT A SOURCE FOR START-UP CAPITAL
Most start-up businesses need financing in order to begin operations. The problem is that banks do not normally provide financing for start-up businesses. This is true in both the Anglo/white and minority communities. As one banker at the forum put it:
"Banks are not the source for start-up capital because it is not our market to be out there lending to start-up businesses. That's more the venture capital system.
Other comments from bankers on this topic included:
"There's a misconception in the community that if you need money to start up a business, you go to a bank", and,
"Banks are just not in the business of making (loans for start-up businesses)".
One participant, who was a technical assistance provider, agreed that banks do not normally finance start-ups but suggested that this was still a legitimate credit need in the community that must be addressed:
"(I am) an ex-banker and (I) understand the bank mind . . . I've got to send people to lenders to get money, so I'm sitting here trying to figure out, are there any banks in this area that are going to be willing to take any risks, that I can send my client to get some money, assuming that he has a decent business plan and he has some experience. He's done some work and education and has some minor capital. I work very closely with (the Business Assistance Center) , but they're probably not going to lend the whole amount. (The BAC is) probably (only) going to do some gap financing. (My clients will still need loans from a bank)"
A non-banker participant complained that:
"banks only lend to those people who don't really need the loan. I've seen people who have $2,500 worth of credit cards sitting in their wallets. They really don't need the (loan that they are applying for). People who have American Express Platinum cards can almost go out and buy a house with it. But the banks (always have to be) sure they're going to get their money back. However, the point here, as I see it, we have to come together, through some kind of mechanism, so we can (meet the credit needs of start-up businesses)"
A banker at the forum countered by saying:
"(community residents) see a person with prior experience in the bank getting money to start up a business. But the bank isn't giving money based on the business, but based on the previous banking experience with that client. It's a different ball game"
Another banker reinforced this point and suggested a way that a certain number of start-up entrepreneurs could obtain bank credit by using the equity in their homes:
"It looks like we're always lending to people who don't need it, but we lend to people who have a track record. We are not a source of start-up capital because of the fact that (most of) those people (do not) have a track record. But we try to look for alternatives, for a different type of capital. If you're going to start a t-shirt business and you don't have any background selling t-shirts, but if you have property we can take some equity out of, you can use that to start your business.
But many would be entrepreneurs do not have sufficient equity in their home for this idea to work. A participant who was a provider of technical assistance endorsed the idea that there still needed to be some new mechanism to overcome the legitimate barriers to making loans for start-up businesses:
"(Such a mechanism should focus on start-ups where the entrepreneur has) a good (business) idea (and has access to training and technical assistance), (perhaps) they're retired from the police department or the fire department and have saved maybe $30-40,000 and they've never been in business before. No you can't send everybody to (the Business Assistance Center). We'd like to, but (the BAC just doesn't have the capacity for that)"
- LACK OF EQUITY
Lack of equity on the part of the borrower was identified as is another barrier. Dr. Mann offered the following comment:
"People want to know what you mean by equity. Does that mean I have to give up my house? Do I have to put my car up? A lot of people come to me and say 'they asked me to put up so much stuff for so little money, it scares me'. A lot of banks . . . are asking people to . . . over collateralize. In other words, they want everything, your house, your mom's house.
There was a comment to the effect that there were a number of very good reasons for banks to demand sufficient collateralization:
"(The real issue is how much the collateral is actually) worth. As one writer said, it's what it's worth on the courthouse steps on a rainy Monday. That's what collateral is. That's how banks evaluate it. But it's more than that. If a small business person is not willing to make a commitment, a total and complete commitment, then they're probably not going to be a success in that business. In other words, a small business person has to always be running scared. Every night a small business person has to break out in a cold sweat, worrying about what's going to happen, until he gets over that critical period. And that's the only way a small business person is going to have added commitment.
A banker who participated in the forum stated: "in all honesty, unless we believe that the entrepreneur has just as much to lose as we do (we will feel nervous about making the loan). We want to see at least a parity between your risk of loss and our risk of loss on a lending situation . . . we have a risk-return ratio to consider . . . (Banks are) not like a venture capitalist who could share in the equity of a business (that potentially) could boom and (be sold) off for tremendous profit. (Banks) have a relatively low return (on their loans) compared to a high risk. So we're looking for a parity. Do you have as much to lose on this deal as we do? Conversely you have much more to gain if it goes well. We of course want it to go well"
A provider of technical assistance agreed with the bankers on this point: "The reason the banks want your house, your mother-in-law's house and everything else is because of past experience. I have seen a lot of people, small entrepreneurs, come in to get loans based on good intentions. They had every intention to do good in their business (but things just did not work out). (As a result, other borrowers) following them will have a harder time in getting a loan"
- EDUCATIONAL/EXPERIENCE NEEDS FOR START-UPS
There was a consensus that lack of education and experience were barriers for start-up businesses. One participant stated that:
"when we talk about . . . the need for education and experience, we're sort of talking about the qualifications for a loan. A prudent banker or a prudent lender, wants a certain amount of equity investment, wants a certain amount of education and experience. So these perhaps are barriers to. . . making loans in these neighborhoods"
Another participant added:
"Small business people, regardless of race, creed or color, have to be educated to understand that if they go into business without the record of experience, that all the loan money can do is set them up to fail. We need to address (the educational and the experience needs) of people before they start a small businesses".
Another participant, who was a provider of technical assistance, elaborated on this point:
"based on my experience, when I talk to a client who wants to start a small business, I really don't push the capital first, I talk about the experience. Unfortunately what happens with most small business persons is that they want to go into business because something bad happened in their previous job. Let's say they're selling insurance, that's what they know. But if they lost their job selling insurance, that's the last thing they want to do, right? So, they decide, "I'm going to run a restaurant." But they have no idea of what it takes to run a restaurant, so I tell them to go work in a restaurant for six months and then come back and talk to me. How many of them come back and see me? Zero. They go and they never come back because nobody wants the pain to get the gain"
A participant who worked for a financial intermediary noted that inexperienced entrepreneurs had a tendency to want to start restaurants:
"I don't think I'll put another dime into a restaurant. I don't care if the client has 90% of what he needs. I've done five now and out of those, only two I feel comfortable are going to really survive . . . A national study . . . shows that 95% (of start-up restaurants) fail, so unless a person has lots of experience and knowledge and his house up, we shouldn't even consider it.
The discussion at the forum came around to the idea of franchising as a way that start-up businesses can overcome the lack of experience and education. As one participant put it:
"if you can qualify for many of franchises, you have met 80% of what most lenders are looking for. So that's the easiest problem we got. If all were that simple, we could make the funding work."
Another said, "in essence, you're buying a track record when you finance a franchise."
- ADEQUATE TECHNICAL ASSISTANCE FOR START-UPS
It was felt that inadequate technical assistance was a barrier. The high cost of technical assistance was one issue. Dr. Philip Mann gave an example:
"Let me just give you a situation. This is a real situation without mentioning any names. I had a young man come to me last month who went to a bank to borrow ($150,000) to expand an existing business and the bank said to him that they wanted him to do a (formal) loan application. He went to the person who does that kind of thing, a very expensive person, who wanted to charge him $20,000 to put a package together. I am mentioning a barrier because this guy came to us. He has the money, but he doesn't want to pay the $20,000 . . . There are people out there who will charge anything for a loan package if they think they can get it."
Another problem is that technical assistance providers often give an overly optimistic viewpoint. One participant who worked for a financial intermediary stated that:
"Most (technical assistance providers) won't tell people the truth and that compounds problems. If you're in the lending business you have almost no real opportunity to explain something to a client who's already misguided."
One provider of technical assistance, however, cautioned that the burden of developing the business plan in the business person himself and not the technical assistance provider:
"(Often) people come in and they want their loan package in two weeks. What good is that doing the small business person? (Once their business is operating) they're going to be putting in 60-80 hours per week. If they can't put together a loan package . . . there's a problem.
- POOR MANAGEMENT
Another barrier that is hard to quantify is poor management. Shoddy record keeping was cited by a lender as a barrier to making loans:
"Clearly in business you have to have reasonable records that can show what you've done. Then it's a whole different ball game. It's then much easier to deal with the lending process"
Another participant, a banker, summarized the problem as follows:
"Obviously, I think most of us are aware that the major reason why most businesses fail is poor management. That's nationally recognized as a major reason for business failure. So take an established business, put in brand new ownership, it may take off, it may stay the same, it may begin to die a slow death. So we would consider the owners as a major event, but obviously you do have track records - sales, product/service - and we would be looking to see how much of the management team was still in the place"
Hari Srinivas - firstname.lastname@example.org
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