What Role for Depository Institutions?

Historically, depository institutions, especially banks, have served as the main financial services provider and source of credit for small businesses. This is due partly to their ubiquity and widespread involvement in small business financing. In 2021, the Consumer Financial Protection Bureau (CFPB) estimated that of the 8,100 financial institutions involved in extending small business credit, nearly 80% were depository institutions.¹

Three decades ago, 94% of small businesses used commercial banks for financial services, from checking and savings accounts to lines of credit and loans.² In 2021, 90% of small employer firms used banks (large or small) as their financial services provider.³ Likewise, 30 years ago, when small businesses needed external credit, banks—especially local banks—were the primary source to which they turned. This remains broadly true today in terms of where small businesses seek credit: since 2013, on average, 43% and 41% of small businesses have applied for a loan or line of credit at large and small banks, respectively.⁴

This adds up to a sizeable market for small business credit. CFPB estimated that, as of December 2019, the value of outstanding small business balances on term loans and lines of credit from depository institutions was $580 billion.⁵ Another $60 billion in outstanding balances on small business credit cards—“mostly extended by depository institutions”—was estimated as well.⁶

Changes in the Lender Landscape

Even as depository institutions have maintained a primary role in small business financing, sectoral changes have reshaped the mix of lenders providing credit. Among banks, for example, significant consolidation has occurred: since 1983, the number of FDIC-insured commercial banks in the United States has shrunk every year, falling by 71% overall.⁷ From 1995 to 2007, the annual average number of new bank charters was 155. Since then, it has been 13.⁸ Shrinkage in the number of banks has meant closing of branches; CFPB notes that a majority of U.S. counties lost bank branches between 2012 and 2017, with disproportionate impact on rural counties.⁹

After the 2007-09 recession and financial crisis, moreover, significant new regulations on banks shaped lending behavior, especially pertaining to small businesses. Research has found that stress tests conducted by the Federal Reserve reduced small business lending at the most affected banks.¹⁰ As one small business advocate related to the Task Force, “Dodd-Frank and the Great Recession tightened the credit box, tightened the frame of small business credit.”

The most common measure of small business lending from depository institutions is a proxy measure: commercial and industrial (C&I) loans for less than $1 million.¹¹ Data reported by the Federal Deposit Insurance Corporation (FDIC) capture outstanding balances of small business loans rather than originations. Large depository institutions account for the biggest shares of the volume and value of outstanding small business loans.

In 2007, those depository institutions with more than $10 billion in assets held 48% of the total outstanding value of small business C&I loans. By 2019, that share rose to 58%. Their share of the number of outstanding small business loans increased even more, from 62% in 2007 to 84% in 2019. In fact, the number of outstanding small business loans rose only at the very largest depository institutions. Some research expresses concern that the “gradual movement to less localized small business lending,” because of consolidation could restrict credit to small businesses.¹²

Yet the effects of these changes on overall small business lending are unclear. On one hand, the outstanding value of small business C&I loans has fallen as a share of all C&I loans from depository institutions: from one-third in 1995 to 18% in 2022. On the other hand, among small business C&I loans, the smallest loans (those for less than $100,000) have grown as a share of the number and value of all outstanding small business loans from depository institutions.

Role of Small Banks and Credit Unions

By virtue of their size and branch networks, large banks account for most credit extended to small businesses from depository institutions. Smaller institutions, especially small banks and credit unions, continue to be essential financing sources for small businesses. And, at small institutions, lending to small businesses is disproportionately important. At the very smallest depository institutions, for example (those with less than $100 million in assets), small business loans represent nearly 90% of the outstanding value of all business loans.¹³ This is true even as the total value of outstanding small business loans at the smallest institutions has steadily declined.

Small banks, according to the Federal Reserve System’s Small Business Credit Survey, enjoy both high application and approval rates for small businesses seeking financing. Credit unions, too, have raised their profile in small business lending. Between 2008 and 2019, total lending to small businesses by credit unions doubled, to around $60 billion. From 2014 to 2021, credit union lending to small businesses grew, on average, 10% per year, according to the National Association of Federally-Insured Credit Unions (NAFCU). Both credit unions and small banks receive high satisfaction scores from small businesses.¹⁴

“Soft” Relationships and “Hard” Transactions

A traditional distinction in depository institution lending is between loans made based on relationships versus those that are more transactional in nature. The former is said to rely on “soft” information (tacit understanding of local markets, personal knowledge of the borrower) compared to the “hard” information (credit scores) of the latter. In small business lending, research has found that many small businesses access credit from local banks because they rely more on relationships and the local banks’ soft information about them.

The landscape of depository institutions, however, is diverse and technological changes have enabled lenders of all sizes to expand their activities, blurring the lines between relationship-transaction and soft-hard information. Since the mid-1990s, many large national banks have rapidly increased their share of small-dollar small business lending while more locally oriented banks meet small business demand for relatively larger loans.¹⁵ Diversity among depository institutions in size and scope allows them to differentiate products and serve multiple parts of the small business financing market.