Access to Credit: Small Business Loans

What is debt refinancing? What is a refinance loan?
BY Steve Tanner
Jul 31, 2020
Key Takeaways:
  • Research shows minority small business owners are less likely to be approved for business loans and are offered less attractive terms than white business owners.
  • Choose banks with good Community Reinvestment Act (CRA) ratings.
  • Crowdfunding, grants, and SBA microloans are good options for minority businesspeople.

As our contribution to the ongoing discussion America is having around racial inequality, here is another post in our Financial Discrimination, Access, and Equality series. We will continue to share information about how to recognize and help combat financial discrimination, so please come back to read future posts.

Upward mobility relies at least in part on the maxim that “it takes money to make money.” Whether financing a college degree, purchasing a car to commute to a better-paying job, or starting a business, data from multiple sources suggest that women* and people of color (particularly Black Americans and Latinos) tend to be disproportionately shut out by systemic business loan discrimination.

Black business owners are turned down for loans at roughly twice the rate of white business owners, according to data from the U.S. Federal Reserve. However, it’s difficult to quantify the number of would-be minority entrepreneurs who either don’t have enough collateral for a loan (in part a result of “redlining” or other types of discrimination with a multi-generational reach) or are discouraged from applying in the first place. Those who do get approved often may receive less funding or pay higher interest rates.

The legacy of business loan discrimination has resulted in a landscape where only 2.1 percent of businesses with employees are black-owned, despite making up 12.6 percent of the population, according to a 2019 report by the National Community Reinvestment Coalition (NCRC). Similarly, Latinos make up 16.9 percent of the U.S. population, but account for just 5.6 percent of businesses with employees.

Minority-owned businesses also had a difficult time securing funds through the Paycheck Protection Program (PPP) meant to help businesses impacted by the COVID-19 crisis, according to available data. Complicating matters is the lack of official government data showing the racial gap in small business funding, although that may be about to change.

The various and complex reasons why small business loans for minorities and women are so elusive will not be easily solved. We hope the following information will help you understand the breadth of the problem, some of its causes, and what minority entrepreneurs can do to clear these hurdles to business ownership and wealth creation.

Understanding the scope of business loan discrimination

Just as buying a home may help create wealth that may be passed down to future generations, entrepreneurship can help families get ahead financially and socially, allowing them to realize a better future for their children. Small businesses also have the potential to prime the pump within their communities through the multiplier effect, generating chain reactions of economic growth.

To understand the breadth of discrimination in business loans, the NCRC study used “mystery shoppers” (controlled for factors such as age, gender, appearance, and credit scores), which revealed how even unconscious racial bias can hinder the chances of being taken seriously as a worthy borrower right from the start.

For example, in the test, bank employees introduced themselves to white testers 18 percent more often than they did to black testers, with white testers reporting much friendlier service. African American and Latino testers were also asked to provide more financial information than their white counterparts 32 percent and 28 percent of the time, respectively. White testers were given more information about loan fees than their black counterparts 35 percent of the time.

The limited amount of government data tracking the demographics of business borrowers tells a similar story. A 2010 report by the Minority Business Development Agency from the U.S. Department of Commerce found that, compared to white-owned small businesses, minority-owned small businesses:

  • Are less likely to receive loans. Just 17% of minority-owned firms received loans, compared to 23% of white-owned firms.

  • Receive lower loan amounts. Average loan amount for high-sales, minority-owned firms was $149,000, less than half of the $310,000 average loan amount for high-sales, white-owned firms.

  • Are more likely to be denied loans. Minority-owned firms had a 42% denial rate, compared to a 16% denial rate for white-owned firms.

  • Are less likely to apply because of rejection fears. While 33% of minority-owned firms decided not to apply for loans out of fear of rejection, only 17% of white-owned firms held back.

  • Pay higher interest rates. Minority-owned firms paid an average interest rate of 7.8%, compared to an average rate of 6.4% for white-owned firms.

Small business loan discrimination: enforcement and progress

Similar to car loans, the federal government doesn’t track the demographic data of business loan borrowers in any broad sense. The Community Reinvestment Act (CRA) of 1977 required banks to track lending data by neighborhood, shedding light on underserved, low-income neighborhoods, but not by race. The Small Business Administration (SBA) does track lending by race, but SBA loans only account for an estimated 3 to 7 percent of small business lending activity.

This clouded view of minority access to small business loans makes it difficult for lawmakers and other policy makers to adequately address the problem and enact changes that could help level the playing field. It also makes it difficult to enforce existing laws. However, efforts are underway to make a change.

SBA findings

SBA started an initiative in 2016 to get a better understanding of the barriers to small business financing to minority-owned businesses, including venture capital (VC) and private equity, as well as debt loans. What they found is that the racial and gender diversity (or lack thereof) of investment boards has a direct impact on how funds are doled out. Simply stated, diverse investment boards are more likely to invest in diverse business ventures.

Section 1071 of Dodd-Frank

To solve the broader visibility problem, lawmakers included a provision in the Wall Street Reform and Consumer Protection (Dodd-Frank) Act of 2010 that would have required lenders to collect additional details about business loan applicants, including race, gender, and ethnicity. However, the provision that would amend the Equal Credit Opportunity Act, Section 1071, has yet to be implemented.

CFPB settlement on Section 1071

Currently, the settlement of a lawsuit filed by plaintiffs representing Latino, African American, and women business owners against the Consumer Financial Protection Bureau (CFPB) has fast-tracked the implementation of Section 1071. Among other provisions, this settlement requires the CFPB to outline its proposals for how this demographic data will be collected and used, negotiate with various stakeholders, and stick to established deadlines until Section 1071 is implemented.

The hope among minority-owned businesses and their advocates is that broad visibility into lending practices by race, ethnicity, and gender will help with enforcement and identify areas that need improvement.

Business loan discrimination during a global crisis

The $659 billion federal PPP loan program was intended to help small businesses weather the extended shutdowns in response to the coronavirus pandemic, but very little of that money went to black and Latino-owned businesses. One survey cited by Forbes shows that 38 percent of white applicants received what they asked for in PPP relief, but just 12 percent of Black and Latino applicants did.

Many of the minority small businesses that needed the most help were the least served by the PPP program because of inequities that were built into it, according to a report by the Center for Responsible Lending (CRL). Some of the inequities cited include:

  • A fee structure that incentivized large loans that the smallest businesses typically couldn’t use within the eight-week window required for loan forgiveness.

  • Minority-owned businesses were likely to have fewer employees and lower revenues, making them less attractive to participating lenders.

  • Minority-owned small businesses were much less likely to have gotten a loan from a bank in the past, an indicator of whether a business would be approved for a PPP loan.

Another report (also cited by Forbes), echoing CRL’s third point, found that decisions on whether a given company received aid often were based on “how and where it banked.” Many black and Latino businesses owners who applied for PPP funds had never applied for a bank loan before, although banks that participated in the program often considered applications from existing customers only, according to the report.

One illustration of how these stats played out in the real world: An African American barbershop owner based in a primarily black neighborhood of Chicago told PBS Newshour reporters that he didn’t get any response to his PPP application, adding that it was the same bank that had previously denied his business loan application.

Given the historically tenuous relationship between traditional banks and minority business owners, these dynamics underscore the broader obstacles that minority-owned businesses face. Updates to the original rollout of the PPP program didn’t improve matters, but additional relief in response to the economic fallout from COVID-19 may come later.

Improving access to small business loans for minorities

Many of the solutions to business loan discrimination involve larger actions by lawmakers, other policymakers, and financial institutions. Understanding the problem and enforcing existing nondiscrimination laws is a start, as is incentivizing loans for minority-owned businesses and entrepreneurs. Other obstacles maybe more generational in nature, such as the reliance on home ownership as collateral for business loans.

But in business time is money, and minority-owned businesses can’t simply wait around for these broader dynamics to change. Here are some proactive steps minority businesses can consider to help secure the small business funding they need:

  • Seek out minority owned lending institutions. There is a growing number of smaller, online lenders that are minority-owned, and some (including Balboa Capital) specifically cater to minority businesses.

  • Check the bank’s CRA rating. The Community Reinvestment Act (CRA) encourages banks to address the needs of the communities in which they do business, assigning them CRA ratings based on their practices. Look for a bank with an “Outstanding” to “Satisfactory” rating.

  • Apply for grants. A number of corporations, organizations, and wealthy benefactors set aside grant money for minority-owned businesses. The best thing about grants is that they don’t have to be repaid.

  • Apply for the SBA’s 8(a) Business Development Program. The SBA’s 8(a) program provides better access to small business loans through expert advice and assistance.

  • Apply for a microloan through the SBA. These are smaller loans, up to $50,000, that may be used for very small enterprises and non-for-profit child care centers.

  • Join networking groups. There is strength in numbers, and networking with other minority business owners and professional organizations can help you get the funding you need.

  • Try crowdfunding. Many small businesses have been started up through crowdfunding platforms such as Kickstarter and Indiegogo, which have the added benefit of helping you market your new product or service.

If you’re seeking a loan from a traditional bank, be aware of how you’re being treated and trust your instincts. If you don’t believe you’re receiving the respect and attention you deserve, go elsewhere. Starting and running a business is a difficult endeavor for anyone; with some extra patience and perseverance, you should be able to access the financing you need.

Don’t give up your dream, and get assistance if you need it

We don’t have all the answers or solutions to the discrimination that affects so many entrepreneurs of color. However, Freedom Debt Relief is dedicated to doing our part to help. We will continue to provide information about financial challenges to help you understand money and your right to equal access, so you can better protect yourself and your financial future. Please come back to our blogs for additional updates and information with this series and other posts.

*While discrimination against women seeking small business loans is an important issue that impacts a large segment of the population, it is beyond the scope of this particular series, which is focused on racial discrimination.

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