FAU Study: Banks Boost Out-of-Market Lending for Small Businesses

Increased Competition Provides More Financing Options and Better Terms

MEDIA CONTACT: Paul Owers 561-221-4090, powers@fau.edu

BOCA RATON, Fla. (Jan. 13, 2021) – Banks are increasingly lending to small businesses outside of markets where the banks have offices, a geographic diversification that fuels job creation and economic growth, according to a study by a professor and a graduate student in Florida Atlantic University’s College of Business.

The findings could help influence policy decisions because access to financing is critical for small business survival during a recession, such as the one started by COVID-19, said Rebel Cole, Ph.D., professor of finance at FAU. He partnered with FAU finance Ph.D. student Jason Damm on the study for the U.S. Small Business Administration.

Out-of-market loan originations have soared over the past two decades, excluding 2008-2011, when they plunged during the nation’s financial crisis and Great Recession. These diversified loan portfolios reduce the risk for banks and lead to better terms for borrowers, the authors said.

“Technology makes it more practical for a bank to lend where it doesn’t have a physical presence, and the added competition means small businesses should have better access to credit and at better terms, particularly in smaller or rural areas,” Cole said. “Policymakers and regulators need to do more to encourage out-of-market lending because growth in small businesses drives the U.S. economy.”

Cole and Damm analyzed small business lending figures compiled by regulators to comply with the Community Reinvestment Act (CRA) of 1977. Only banks with assets above $1 billion have to report their lending data, but the analysis covers roughly three-quarters of small business loan originations.  

As the economy started to rebound from the financial crisis and housing bust, out-of-market small business loan originations rose in each year from 2011-2017, hitting new highs at the end of the period, the study showed. Large loans to small businesses ($100,000 to $1 million) in out-of-market counties grew by about twice as much as lending on smaller loans during the sample period.

Still, the study also notes the risk in relying on distance lending. It may come at the expense of in-market lending, contrary to one of the main goals of the CRA, which seeks to ensure that banks meet the credit needs of areas in which they operate.

“When the economy contracted, distance lending plummeted,” the report states. “Such a drop could leave communities dependent on distant loans without access to credit when it is most crucial, both for the survival of local businesses and for the recovery of the broader economy. Policies that preserve access to local bank branches may improve resiliency to economic downturns like the recession caused by the COVID-19 pandemic.”

 -FAU-