Small Business Financing: Where are the Gaps?

The landscape of small business financing is far from even. Businesses operating in certain economic sectors have more difficulty accessing credit than those in other industries. Younger businesses tend to be deemed higher credit risks than older, more mature companies. Most concerning, different types of business owners—irrespective of differences in wealth, experience, credit score, or skill—enjoy greater access to financing than others. There are several facts about demographic disparities in small business financing that, unfortunately, have persisted across decades and been the object of many public and private remediation efforts. Yet they endure. Financing gaps exist between men and women as well as among racial and ethnic groups. This brief focuses mostly on the latter.

Multiple Financing Gaps

Demographic differences in small business financing occur across nearly every stage of a company’s evolution.

• At business start—Black- and Hispanic-owned businesses start their businesses with less overall capital than white-owned businesses. In part, research has found, this is because they rely disproportionately on personal and family savings rather than outside credit. This “persistent difference in funding is driven primarily by differences in the amount of bank loans and other bank credit products, which in turn are not substituted by other sources of capital.” Black entrepreneurs raise a smaller amount of bank credit when starting their business than white entrepreneurs and are unable to close the gap with other sources.

• In credit products sought and credit sources used—According to census data, Black business owners have been more likely to use credit cards for business financing. In 2019, according to the Small Business Credit Survey (SBCS), Black business owners had higher application rates for business loans, government-guaranteed loans, and personal loans for business purposes. Black business owners have also been more likely to apply for credit at online lenders and Community Development Financial Institutions (CDFIs). Similarly, in 2021, women-owned businesses were more likely to apply for credit at online lenders and CDFIs than those owned by men. (This excludes emergency relief programs.)
• In credit received—Business owners of color experience higher rates of denial when applying for credit and, when they do receive credit, usually receive less than the amount sought. Lower loan approval rates hold true even when researchers control for sector, credit score, wealth, and other factors. In 2020, excluding emergency relief programs, Black business owners reported the lowest rate (72%) of receiving all or some of the credit they requested. Rates were higher for whites (82%), Hispanics (77%), and Asians (74%). Likewise, women business owners are “more likely to report being rejected for loans or lines of credit.

The higher application rates for credit products observed in the figure above may appear to indicate an absence of financing gaps. Yet they are related to the greater difficulty Black and Hispanic business owners experience in accessing external credit, which is partly why these owners have a higher likelihood of “seeking new funding relationships.” Gaps in access to credit access lead Black and Hispanic business owners to apply for credit at more places and across more products. This carries a time cost for business owners, especially when they do not receive all or some of the credit they seek.

Financing gaps faced by business owners of color also have distortive behavioral effects, including choosing not to apply for external credit. Black business owners are far more likely to say they didn’t apply because they were “discouraged about their chances of being approved.” For other racial and ethnic groups, the main reasons for not applying are “had sufficient financing” (white, 50%), and “debt averse” (Asian, 34%). Perceptions of a financing disparity, tied to prior experience, shape financing decisions.

Barriers faced in the private market lead Black business owners in particular to turn to public programs, such as the Small Business Administration’s 7(a) loan guaranty. In 2016 and 2018, Black business owners were 10 and 11 percentage points more likely, respectively, to apply for an SBA-backed loan than white business owners. Pre-pandemic surveys by the National Community Reinvestment Coalition (NCRC) found that a larger share of Black small businesses had SBA loans than other demographic groups. In 2020, the application rate for SBA-backed loans (excluding emergency relief programs) by Black business owners nearly doubled, to 59%. Yet approval rates for SBA-backed loans were lower for Black-owned businesses (35%) than for White- (64%), Hispanic- (55%) and Asian-owned small businesses (82%).

As one researcher concluded in 2018, the “consistent finding” of research studies, dating back to the 1980s and perhaps earlier, is that Black and Hispanic small business owners “experience a higher incidence of loan denials and pay higher interest rates than whites.”

Why Do Financing Gaps Exist?

Differences in small business financing are related to, and in some cases a function of, other phenomena.

• Wealth differences—In general, Black and Hispanic households in America hold much less wealth than white households. This shapes the amount of capital available for business creation. According to the JPMorgan Chase Institute, for example, “the typical Black or Hispanic founder started their businesses with much less liquid wealth than their typical White or Asian peers.”
• Age and size differences—On average, Black- and Hispanic-owned small businesses are younger and smaller, in revenue and employment, than white-owned businesses. Smaller and younger businesses, irrespective of race or gender, tend to have lower creditworthiness and are less likely to receive the financing they seek.
• Market conditions and structure—Long-tail effects of the 2007-2008 financial crisis must be considered. The crisis, among other things, severely curtailed small business lending to people of color for several years. Between 2007 and 2010, for example, the share of small business lending in minority neighborhoods fell by 50%. By 2015, that had recovered by only about 15%. Data on demographic comparisons in small business lending—whether from 2014 or 2021—will likely still reflect the effects of this decline. Market structure may also play a role. Some research has found, for example, “unequal minority access” to non-line-of-credit loans from banks yet “equal access” to “bank credit lines and to nonbank non-line-of-credit loans in highly competitive loan markets.”
• Regulatory incentives preference larger loans—Black and Hispanic business owners tend to seek smaller amounts of credit than others. Depository lenders face structural constraints, partly due to regulatory requirements, in making small-dollar business loans. Regulatory requirements play a nontrivial role in shaping those constraints. As discussed in a prior explainer, new regulatory burdens placed on depository lenders after the 2007-2008 financial crisis contributed to a drop in small business lending. Small business credit seekers who cannot access money at depository lenders may end up using a nondepository alternative such as a finance company or credit card, which have much higher interest rates.

• Discriminatory treatment—While the existence of small business financing gaps is not on its own evidence of discrimination by lenders, research suggests that discrimination does factor into financing gaps. In 2018, “mystery shopper” research by NCRC found “severe gaps” across racial groups in banks’ treatment of prospective small business credit applicants. Analysis of large-scale survey data from the 1990s found that racial gaps in small business credit could not be explained by “observable differences“ in [Black-owned businesses’] creditworthiness, suggesting causation that would “traditionally be attributed to discrimination.” Concerningly, the SBCS found that, even among those small business borrowers deemed to be “low credit risk,” there are racial and ethnic gaps in the amount of credit received.

Efforts to Close Financing Gaps

There has been no shortage of public and private efforts to address demographic gaps in small business financing, with varying levels of success. In the 1960s, SBA provided Economic Opportunity Loans to “disadvantaged” business owners. The program “floundered” and was shut down two decades later. In the 1970s, another SBA program, the Minority Enterprise Small Business Investment Company initiative, achieved few successes and ended in 1996. In the 1990s, SBA established programs focusing on “microenterprise development.” Initial efforts “produced high costs (relative to benefits) rooted in low loan volume, steep administrative costs per loan, and high default rates.”

Subsequent public programs appear to have enjoyed moderately better success although, as outlined above, significant gaps in credit access persist. Lenders in the Community Advantage Pilot Program, established in 2011, “have consistently and significantly outpaced lending to Black, Hispanic, and women-owned businesses as well as Veteran-owned businesses and startups.” Compared to the “regular” 7(a) program, small businesses run by women and people of color enjoy greater access to government-guaranteed loans through Community Advantage. The program, however, is small, with just over 700 loan approvals in fiscal year 2022 compared to over 47,000 across all other 7(a) programs.

In one sense, however, the entire 7(a) program could be seen as “inherently a mission program” since any guaranteed loan must meet the “credit elsewhere” requirement. From this perspective, “every (a) loan serves a borrower that would otherwise be left behind by banks’ conventional lending practices, whether that loan is reported as having been delivered to a certain demographic or not.”

The SBA Microloan Program supports small business loans that are, on average, around $15,000. According to SBCS data, a quarter of Hispanic and Black small business owners and 15% of white business owners seek less than $25,000 in financing. This indicates that the Microloan Program meets an important need.

In the private sector, many financial institutions have embarked on efforts to close financing gaps. The Diverse Community Capital (DCC) program, launched by Wells Fargo in 2016, provides capital to CDFIs to expand lending to diverse small businesses. Evaluation has found that, for CDFIs, DCC “proved important in increasing lending volume, capacity to lend, reach into new markets and clients, and proximity to the diverse small businesses in their communities.” Additionally, by donating all gross processing fees from PPP loans made in 2020, Wells Fargo fulfilled its $420 million Open for Business Fund commitment to support an inclusive economic recovery for small businesses affected by the COVID-19 pandemic. Grants were awarded to more than 200 CDFIs and nonprofits serving small businesses. In the Goldman Sachs 10,000 Small Businesses program, 37% of program graduates are people of color—by contrast, people of color own just 16% of small employer firms nationally. Likewise, while women own one-fifth of small employer firms in the U.S. economy, half of program graduates are women.

Addressing small business credit disparities offers an important rationale for government intervention. As discussed in the next explainer, however, such intervention is not without controversy over its existence and effects.