When it comes to small-business lending in Colorado, size does matter.
Small banks increased lending to small businesses, while larger institutions saw a relative decrease in loans to small enterprises during the past decade as the state went through bank deregulation, according to researchers at Colorado State University and the Federal Reserve Bank of Kansas City.
Overall, opportunities for small businesses to acquire capital were and continue to be very good, said Colorado State researchers Richard Johnson, associate professor of finance and real estate, and Ronnie Phillips, professor of economics.
The Colorado State faculty members and study co-authors Richard Sullivan and Kenneth Sprong, both economists with the Federal Reserve’s Division of Bank Supervision and Structure, examined commercial lending to small businesses from 1994-96 in Colorado, one of the last states to deregulate banks within its borders. Colorado allowed regional banks to conduct business within the state in 1988, permitted national institutions to enter in 1991 and gradually phased in branch banking from 1991 to 1997.
One of the fears about out-of-state ownership and greater concentration in Colorado banking was that loans for small businesses, which employed nearly 60 percent of all Coloradans in 1998, would dry up. They haven’t. Between 1992 and 1996, businesses with 100 or fewer employees created 65 percent of all new jobs in the state and 55 percent of new jobs nationwide.
Colorado banking was dominated during the 1994-96 period by a few, large out-of-state organizations that control nearly two-thirds of the state’s banking assets. More than 55 percent of the state’s total commercial banking assets were in the hands of five large, out-of-state banks. Numerous smaller, in-state banks, meanwhile, controlled less than a quarter of all assets. It was these small commercial lenders (each with less than $200 million in assets) that capitalized small businesses.
Between 1994-96, small in-state banks increased lending to small businesses by more than 37 percent and small out-of-state banks increased loans to Colorado small businesses by more than 30 percent. Large in-state banks (with more than $1 billion in assets) showed a 4.6 percent drop in lending to start-ups for the same period, and large non-Colorado banks posted a 2.2 percent decline. There are several reasons for that, said Johnson.
"One reason is the location of the banks," he said. "A lot of the small- and medium-sized ($300 million to $1 billion in assets) banks tend to be in small- and medium-sized communities, where there’s a demand for small business lending.
"A more important reason, probably, is that small-business lending is an area in which small institutions feel they have a competitive advantage. They can’t compete with large banks in making large loans because they lack sufficient assets, and they choose therefore to specialize in providing loans to community businesses where they can be competitive."
Phillips, meanwhile, thinks that larger, non-Colorado-based banks will get into small-business lending in a variety of ways.
"Our data was for 1994-1996, and that’s the period when these changes were just starting," he said. "When the 1998 data comes out, I expect to see more lending by out-of-state banks."
Johnson notes that for large banks, economies of scale come into play, and some have simply chosen not to compete over small business loans or else have automated the process.
"Some banks have chosen to service the small-business lending market on a uniform loan basis, scoring them automatically, say, the way Bank One has done for loans of $35,000 or less. If you have a lot of volume it costs less if you can service loans in that way, and some banks deliberately chose to specialize in that kind of lending and are not involved in more costly monitoring of non-uniform kinds of loans.
"It’s simply a different approach," Johnson said. "Some of the declines (in lending) we saw here were just a matter of choices that some banks made."
Noted Phillips, "The difference between small and large banks is principally that large institutions are using credit scoring and small banks are using the personal approach."
"With some large banks, you can apply for a loan over the Internet and never meet anyone. It’s very expensive to have a loan officer sit down with a client, so it makes more sense (for big institutions) to lend a million dollars rather than $10,000."
Nonetheless, Phillips said, both approaches add up to more small business lending.
Banks face challenges both from the shifting needs of entrepreneurial ventures and from other sources of capital, the study found. Start-ups increasingly provide a service rather than manufactured goods and may need less capital, or at least less at a given time. Meanwhile, finance companies, brokerage firms and other non-banking institutions are entering the market and have increased their share by more than 6 percent from 1987 to 1993.
"In some cases, using a non-bank finance company, in fact using a credit card, may be an easier, more efficient thing to do than going through the hassle of getting a bank loan," said Phillips. Johnson said the niche-market success of small banks loaning to small businesses is, in part, dependent on the economy solidly chugging ahead, creating demand. Given an economic contraction, large banks may become more competitive.
"The trend we’re seeing may not be permanent," he said. In addition, "the market for bank lending has changed dramatically, and some public firms that used to go to banks for lending services have migrated directly to the bond market or other capital markets."
While he feels that predictions about consolidation have been overstated, "I think we’ll eventually have a two-tiered system with 100 major, truly multinational banks and then a number, perhaps 5,000, of smaller, independent banks that might specialize in certain lines. There still seems to be a very viable market for smaller, more specialized types of banks."
As for small businesses in Colorado and elsewhere, Phillips thinks they’re like any business anywhere. The competitive ones that adapt to customer needs and take advantage of technology and capital availability will survive.
"I think small businesses are great, but the people who run them have to be willing to meet – and beat – the competition."