Why Banks Failed to Serve Small Business in Most Countries
On March 27 I spoke at an OECD conference in Italy on the subject of credit availability in the current “crisis” for small and medium enterprises (SME). After listening to the presentations of representatives from 20 or so countries, it became clear that one major problem is that there is no bank competition in most countries. Credit flows are managed by just a few large banks and these banks were all impacted by the global financial crisis due to decisions made about the composition of their investments. In simple terms, if a country has one bank with 1000 branches, all branches suffer the fate of the large bank and SME finance is affected. In the U.S., mega banks abandoned programs to finance new fast food franchises for example. But if there is one large bank with 500 branches and 500 independent small banks, the entire banking systems is not fully impacted by troubles at the large bank. In the U.S. small banks refer to the large bank problems as the “goose that keeps laying golden eggs” as good large bank customers shift their business to them.
In the United States, where small business owners did not report a sudden “freezing up” of capital flows, there are 8000 or so commercial banks (plus other financial institutions including credit unions). In simple terms, these banks are SMEs, competing for the business of other SMEs (there are 6 million employers in the U.S., 90% have fewer than 20 employees and another 10 million “one person enterprises). This is not the case in most other countries. In the U.S., the largest banks have experienced (caused?) the most severe financial problems. However, on “main street”, banks were not engaged in financial engineering, but were doing simple basic banking, collecting savings in their markets and lending to consumers and businesses in their market. Their capital was not impaired by the credit market collapse, although it has been impaired by reductions on the yield on their assets imposed by the Federal Reserve rate cuts and by increased insurance premiums changed by the FDIC to cover the losses incurred by the largest banks.
As further evidence of the benefits of competition, decades ago states had differing rules about branch banking, ranging from unit banking states (only 1 branch) to state wide branching. SMEs always reported (1) the highest degree of customer satisfaction), (2) the best loan terms and (3) the lowest refusal rates in states with unit banking laws.
Much discussion revolved around what the government could do to alleviate the credit issues currently experienced. One good answer is to develop a competitive banking system (diversify the risk of large bank failure). But the discussion focused primarily on the usual role of government – provide subsidies, guarantees, below market rate loans, loans to firms that don’t qualify for a loan from banks etc. These may reduce the pain today, but are not the kind of policies needed to foster the long term growth of the SME sector (in the U.S,, half of private GDP and well over half of private sector jobs). SME finance will still suffer from the lack of competition among banks and will remain vulnerable to the next big financial market problem.
Bill Dunkelberg, Chairman Liberty Bell Bank, Chief Economist, National Federation of Independent Business
