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Are commercial bank lending propensities useful in understanding small firm finance?

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Abstract

We consider recent criticism by Berger et al. (J Bank Finance 31:11–33, 2007) of the use of commercial bank lending propensities (e.g., small business loans/total assets) as research tools. We use 2SLS cross sectional regressions with bank fixed effects to examine the relationship between small business lending and bank size. Our results indicate that the propensity to lend to small businesses declines as bank size increases, and the growth in small business lending does not keep pace with the growth in bank size. An increase in bank asset size from $1 billion to $100 billion reduces the ratio of small business loans to total loans and leases by 28 percentage points. Contrary to Berger and Black (2007) we find that most small business loans are made by small banks. For 1993 to 2006 as a whole, small banks (those under $1 billion) accounted for only 14.1% of total deposits and 9.7% of total banking assets, but they accounted for 28.4% of small business loans outstanding. This is consistent with the pattern shown by lending propensities. We conclude that these propensities remain very useful tools in research on small firm finance.

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Notes

  1. Berger et al. (2005) report an increase in credit scoring of small business loans. Nonetheless, DeYoung et al. (2004) and others find relationship lending remains an important part of the business plan of the small bank.

  2. The argument depends critically on how “small” and “large” banks are defined. If one were to define a large bank as any bank over, say, $500 million in assets, then most small business loans would be made by large banks. Correctly recognizing this issue, Berger and Black (2007) use the proportion of branch offices to provide an independent measure of the relative size of each group of banks in the banking system. We did not attempt to analyze branch data since the pattern shown by the other two measures, assets and retail deposits is quite clear. We use both because total assets overstates the importance of large banks since their business model involves financing a significant portion of assets with borrowed funds. We consider total retail deposits to be the best independent measure but our point is clear using either measure. The essential idea is to provide a measure of business opportunities. Berger et al. (2007) raise the point that a large bank may have a low propensity to lend to small firms simply because it has more business opportunities than small banks. We believe that total retail deposits is a measure which addresses this point.

  3. According to FDIC guidelines, the small business loans to be reported in the June Report of Condition are currently defined as “…business loans with “original amounts” of $1,000,000 or less and farm loans with “original amounts” of $500,000 or less.”

  4. Ideally, we would like the total number of small business establishments per year as reported by the Small Business Administration, but these data are only available from 2001 to 2006 which greatly shortens our sample period. Since the number of small business establishments is highly correlated with the number of total establishments (ρ = 0.636), we do not report results using small business establishments.

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Authors and Affiliations

  1. Florida Atlantic University, Boca Raton, FL, USA

    James E. McNulty

  2. North Georgia College & State University, Dahlonega, GA, USA

    Marina Murdock

  3. University of North Carolina Wilmington, Wilmington, NC, USA

    Nivine Richie

Authors
  1. James E. McNulty
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  2. Marina Murdock
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  3. Nivine Richie
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Corresponding author

Correspondence to James E. McNulty.

Additional information

We would like to thank Allen Berger, Robert DeYoung, Gregory Udell, Jonathan Scott and an anonymous referee for very helpful comments on an earlier draft of this paper.

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McNulty, J.E., Murdock, M. & Richie, N. Are commercial bank lending propensities useful in understanding small firm finance?. J Econ Finan 37, 511–527 (2013). https://doi.org/10.1007/s12197-011-9191-x

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