Why Small Business Is Still Getting the Short End of the Credit Stick

In its 2010 Year-End Economic Survey released Thursday, the National Small Business Association reported a "slight thaw" in credit markets -- when it comes to bank loans specifically, 45 percent of small firms were able to score one, up from 43 percent last July.

Any increase in lending is a positive step, but a stat in the Federal Reserve Senior Loan Officer Opinion Survey [pdf download] released earlier in the week makes it all too clear just how hard it still is for small businesses to get bank loans. According to the report, about 14 percent of all banks have eased their lending standards for small firms, while about 30 percent have loosened them for larger companies. A frustrating discrepancy, to say the least.

It's no wonder that a full third of small businesses say they cannot get the financing they need.

So what, exactly, is the problem?

Obviously, small business loans are riskier for banks to take on. But there's more to it, according to Tufts University Professor and author Amar Bhidé in an interview for the February issue of Inc. The problem lies in the mechanics of loans. Many loans -- particularly home loans -- are approved based on a formula. If a mortgage application meets certain criteria, it gets approved. This kind of lending is quick and requires little manpower, making it easy for banks to scale up their lending rapidly.

But small businesses really don't fit into this model. Instead, bankers need to go sit down with potential borrowers -- a time-consuming and decidedly low-tech process. "Analysts can pretend that all housing loans are the same, but with small business, the pretending completely defies belief," he tells Inc. "So small business gets the short end of the stick." And it's not going to get much better anytime soon.

To ease the problems with loans for small businesses, Bhidé says that all depositories with liabilities backed by the federal government should be required to make a case-by-case examination of the risks of a loan. Small business loans won't get less risky -- but decisions based on algorithms make it a lot more dangerous.