Equitable Access to Small Business Credit: Understanding the Research

Welcome back and thank you so much for joining us for the second half of today’s event. Earlier, we heard from the perspectives of small business borrowers and from our keynote speaker, Sheila Bair. We’re now going to turn to hear the perspectives of the research community, to understand what the data are revealing about equitable access to small business credit. Leading today’s discussion will be Laura Tyson, distinguished Professor at the Graduate School at the Haas School of Business at the University of California, Berkeley. Ms. Tyson is an influential scholar of economics and public policy and you can read her full bio on our event website. And with that I’ll turn things over to you, Laura.

Thank you very much, Laura. Welcome everyone. I’m honored to chair this panel and to focus on research with two outstanding colleagues: Professor Robert Fairlie, who’s a professor of economics at the University of California, Santa Cruz; Ammanuel Zegeye, who is a senior partner at McKinsey. We are going to focus on research and the framing questions for us are really, what do we know so far about the performance of PPP in terms of providing credit to small businesses and particularly to minority-owned and disadvantaged small business? But also the long-term structural barriers that we all knew about that were exposed, during this period of time, because there was a sense that the small business community always had difficulty accessing capital. The smaller the business, the greater the difficulty. The more disadvantaged the business, the greater the difficulty. The more minority-owned, the greater the difficulty. The more female-owned the greater the difficulty.

We knew that those were structural barriers. Then we had an infusion of some significant funding through PPP at a time when all of the businesses I just mentioned got very hard hit. And then there was the issue of, could we get that money to these communities and how well did we do and what did we learn? And then looking to the future, what have we learned? What should we do going forward? I think we all agreed that at the end, we should all ask ourselves a question that was raised in the panel just previously. That is, if we had Mary Daly on the phone, what advice would we give her? Because going forward, the research should give us some lessons of what policies should do in the future. With that as a start, I’m going to start with Professor Fairlie, he’s been doing extensive research on the PPP program and he can bring us up to date, I think, on what we know so far, so Robert.

Well, thank you. Thank you for the introduction also. Yes, I’ve been doing research with a colleague of mine, Frank Fossen and looking at how were the funds distributed over the three rounds. We think of there as being three rounds of the PPP program. The first round was early in 2020, right after the crisis and it’s very clear during that time that a lot of that money was going into more moderate-sized businesses. It did not go to minority communities, that’s pretty clear. There have actually been a few papers that have looked at that, and we’ve done similar work showing that first round of funds was not necessarily going to those communities. Then what we did is we were able to get all of the actual data from the Small Business Administration.

I have to give the SBA a lot of credit for providing that, making it publicly available, allowing researchers and reporters to download it and to do their own analysis. What we found is in the second round, that things actually look like they’re reversed. There was a lot of public outcry about these larger businesses. For example, the Los Angeles Lakers received a PPP loan. There was a lot of outcry about that. That’s not what the funds were targeted towards. Those companies did give money back but what we saw in the second round was this reversal that it was actually a high rate of those funds did go or a high rate of the loan numbers went to minority communities.

Then what we did is we actually got the most recent data that came out just a couple months ago to look at what happened in 2021. There were a number of different parts to the program, for example there was this two week delay where only really small businesses and disadvantaged businesses could get access to the funds. What we found looking at that overall round of funding is that also looked like it was much more evenly distributed and that it did go to minority communities. That was some promising news and that’s what we’ve heard anecdotally. What’s interesting though is in the PPP program and the data that we were able to download is: it doesn’t have race information or gender information of the owners. That’s only available in about 10% of the businesses getting loans and part of the problem is that it wasn’t required information. And so it was up to the banks to provide that information. It seems like it was mostly a few different banks that provided the information, and so it’s not a representative sample of the data that we have. We were not able to analyze that. There is some newer work that just came out recently that is trying to use names and zip codes and more detailed geographic information to try to get a handle on whether or not those loans went to Black-owned businesses. There’s some evidence of some of the patterns that we are showing and that it looks like fintech loans were one of the ones that were really helpful for Black-owned businesses in particular.

That’s interesting. Can I ask one follow up question before turning to Manny? In that distinction between rounds one, two, and three, what explains the difference? Is it that the money was being moved through different channels? Maybe in the first round was mainly being moved through banks that have big corporate clients and big business clients and that’s who they can move the money to. What was different in round two and three, that it would be a lesson in terms of thinking about the future? If you want to deal with access to capital for those kinds of business, what do you do? What channels do we need to beef up or to strengthen?

So my understanding is that the first round… Congress had to put this program together very quickly. They basically created the PPP program very quickly. One way that they could do it in that rapid speed was to reach out to the big banks, the national banks out there. They were the ones that were very quick to provide these loans. That’s part of what was going on is that the larger banks had their established clients that tended to be more the medium-sized businesses, and not the really small scale mom-and-pop type businesses, the ones that were owned more by minorities or by female owned businesses. What happened is, there was this real increase of awareness of what was happening to minority-owned businesses and female-owned businesses.

I was actually doing a lot of research at that time with data that was difficult to get and compile. What I was showing is these huge negative impacts in April of 2020 from the pandemic. For example, a number that was used a lot in these arguments to restructure the PPP program and the second round was that I found a 41% drop in the activity of Black business owners in April, relative to February. Whereas in comparison, if you look at white non-Latinx business owners, that drop was 17%.

All groups experienced some drop in their business activity, but clearly Black-owned, Latinx-owned and Asian-owned businesses experienced the worst. In the second round, there was this increased awareness and concern that first round of the program needed to be restructured. And so they brought in more fintech companies, a lot of more small banks, community banks and they were able to get their outreach. They had learned a lot in the first round and of course, put a lot of effort into it, and then of course the third round was a new administration. By then, we really had a lot more information about how to get these loans out there and help the communities that really need them.

Manny, I know you have been looking at PPP and barriers to capital access in small and particularly very small businesses. How do your findings compare to Robert’s? Do you have some different findings? Is that where you are in terms of summarizing where we are today?

Yeah. I’ll build on what Robert said because I agree with everything. I think the interesting thing about the point around all experience a drop in revenue. I think when we looked at it, we saw that if you look at the concentration of where Black and Latinx owned businesses are, they’re actually the sectors that were the most hit. I think we saw a 40% decline in some of the heavier hit or the majority Black-owned businesses or sectors they were in versus overall 25% across the board everywhere else. They just had an outsized effect.

I think the second point around the online lenders coming in, to Robert’s point, online lender weren’t eligible for PPP loans initially, I think until April. That also caused some further exacerbation of the problem, mainly because what you see, especially in Black neighborhoods, a vast majority of the loans actually come from maybe non large banks, but actually from some of these online sources. We found 70% of minority owned neighborhoods don’t actually even have a bank branch in many cases.

I think to your original point Laura upfront, I think we saw an exacerbation of some of the structural barriers in place, which we can get into. I think the point I would make, if we take a step back around [small and midsize businesses (SMBs)] in general, when we looked at the Great Recession in 2008, we saw large companies started to get back to their previous GDP contributions within about four years. We saw SMBs that take on average six, and so already you expect a longer recovery from all SMBs. And then when you look at the sectors which Black owned businesses are in, and then you look at the ability to actually get access to the loans, which took longer in many cases, and to the zip code data that Robert was mentioning. From the zip code analysis, you can see that in the zip codes where you have greatest proportions of White residents, there are higher approval rates than those living in zip codes which are non-White residents. We saw that all play out but again, this is just highlighting some of the structural barriers that were already in place, and we knew already, that it’s harder to get loan. I think that the question is how we move forward.

Let me ask the question going forward a bit, I think both mentioned CDFIs, certainly mentioned in fintech, certainly mentioned the fact that in these disadvantaged communities, we already had an absence of the big traditional banks anyway. One could say, “All right, maybe there’s going to be much more room for an expansion of the role of CDFIs and expansion role of fintechs.” That will deal with the structural barriers that came out of the old system. That would be a reason for optimism.

On the other hand, I think what I’d like to raise is not just access to capital, but the supply of capital and the cost of capital. Because maybe we improve the access, meaning you have a fintech company you can go to, but maybe the cost of the capital is still very high. We heard in one of the other panels, 4.25 is the rate of interest that the California Rebuilding Fund is using with the CDFIs. That’s considered to be pretty much the top end of what the CDFI community wants to do. I don’t know what the fintech community is doing in terms of lending rates, but I’d like to talk a little bit about the supply of capital and the cost of capital, as well as the channels through which the capital flows. What do you think, Robert or Manny, about that?

Yeah, maybe I can make a key point here is…

I can’t hear you, Robert, do you have your…

Yeah. I think it’s on, you should be able to hear me now. I think one of the key points here is it’s a really good point about the cost to capital. If you look at a lot of small business owners, what they use is their own personal savings or their own funds or their home equity lines, or some personally funded or family funded way to get their businesses going, way to get their businesses to whether a storm, if there’s a small recession or if there’s something that comes up unexpected, and so that is one of the big factors that puts minority owned businesses at a huge disadvantage.

If you just look at wealth levels, they’re strikingly low. Half of Black families in the US have less than $10,000 in net worth. That it doesn’t provide a lot of money, a lot of capital, that at least a person perceives it as low cost and it’s certainly easy to get access or liquid. That creates a lot of problems. If we do have this high cost of capital, you have to go to a bank, you have to go to a fintech, then that could create a problem. But on the other hand, if you are a wealthier family or an individual that has access to home equity, then you’ve got that. You’ve got this low cost to capital that you can inject into your business to get you through a struggling point or to grow it and that’s a big issue.

Yeah. I think that’s exactly right, I completely agree, Robert. I think the other point we’ve seen, two points I’d make. I’d say one is: are there alternative credit assessment methods that can be used to look at, whether it’s payment histories, whether it’s monthly utilities or rent or other bills to determine the likelihood of repayment. Maybe offsetting what we see as thinner credit histories for Black Americans, but also for Black businesses. What does that look like?

I think the second for me is also around, there’s the access to capital and the rate that it comes at, but we’ve seen a lot of this coming out of the death of George Floyd and all the corporate action around putting dollars against racial equity. There’s a push on supplier diversity, let’s push supplier diversity. But actually when you look at the crux of it, it’s not just the capital, it’s how do you actually build up those businesses in terms of funding, in terms of capability building. But also in how do you fix the company from their side, embed equity into their procurement processes, so they have inclusive sourcing, so you have equitable contracting processes that flow through. Because what we often see is that it’s very hard for some of these small businesses to get access, minority owned, but also broadly, small business to get access to some of these contracts that will help them grow.

It’s hard for them to get access to the dollars to invest in R&D. And then this only gets compounded by what we’re seeing in this new post COVID or next wave of the economy, which is digitalization, which is going online, which is automation of manufacturing, and how does that then affect these smaller businesses? And so they’re going to struggle even more. I think that it’s like, “How do you take a holistic approach to shoring up some of these businesses in addition to just the capital?” I think is what will be important.

I completely agree. A couple of observations on that, number one: I have really been very impressed by the CDFI community in many respects, but in this particular respect. They mostly have a lot of additional support for their borrowers in terms of: it’s consulting support, it’s technical support, it’s educational support, it’s networking support. They offer it and also, in the state of California and again, I was involved in this effort with the CDFIs, partly funded by the state. It’s a blended finance model, very interesting model. But one of the key things was we worked with the Chambers of Commerce all over the state, and it turns out we have a very strong network supported partly by the State of Chambers that provide technical help for small borrowers and it’s technical networking advice on getting financing, the whole thing.

These are very small scale and so the medium size firms that may be challenged by what Ammanuel is talking about, which is that robots will take over even more and that the supply chain will exclude these kinds of firms. I think that’s really has to be for pressure, whether it’s some pressure from employees, pressure from investors, pressure from regulators to get the big firms to do more on their supply chain. I don’t know if you know what you think works, Manny, but talk a little bit about that perhaps.

Absolutely agree on your point on CDFIs and MDIs in general. I think we know that CDFIs deliver loans within their…or the vast majority, 90% of the volume, goes through to borrowers living in the local community. We know it flows through properly, we know that minority neighborhoods don’t necessarily have bank branches. This helps, but I think we also know that there’s a lot more to be done with these institutions to shore them up, to give them more capital and so.

They need more capital.

Yeah, exactly. Especially minority owned banks. I think 70% of them have less than a billion dollars in assets, which is quite small. They fail at a much higher rate and so the question becomes what can be done to shore them up.

One is just increasing liquidity of them through additional cash deposits. I’ve seen some interesting corporate initiatives where some tech companies are sitting on billions of dollars of cash or tens of billions, or even hundreds of billions of some examples, and funneling cash deposits into some of those banks has been starting to be done. It’s still at quite a small scale. Even if the numbers look large, if you take it at the percentage of the overall cash, not that big. But, it starts doing things like that actually helps further capitalize those firms, which then actually gets into the community. You get increased access to capital and we also know that these institutions create strong relationships with customers and community lenders, which contributes to the strengthening trust that Black Americans will have in banks and other financial institutions. Which we know half the Black population unbanked.

So just shoring up some of those things and then also provide, to your point Laura, the resources around financial education and support that these additional programs, education, training, assist borrowers on how to effectively use credit and access capital. I think on a positive note, you’re seeing a shifting focus on this and you’re seeing on corporate social responsibility to look at this, there’s a long way to go. But there are certain things to your point, which can help accelerate them and get capital into the hands of people in an equitable way.

Robert, do you have any observations based on your own work, or any observations about this general notion? I think it’s about how to increase the supply of capital that somehow gets channeled in this direction. And then all of the supporting mechanisms for those who become the borrowers. The wealth gap is incredibly important and it is, I think, a real focus of the Treasury, of the Fed, I mean it’s a huge issue. That’s one, but then there’s just the issue of what are the best ways we might imagine of trying to increase the supply of capital for these kinds of borrowers?

Yeah. I think that’s definitely going to be important. I think that the more localized lending institutions like the CDFIs and other community banks are really crucial in trying to increase capital into those areas. If we can get more funds to those types of lending organizations, if that’s through increased deposits or increased whatever other types of funds.

I also think we haven’t talked as much about the customer side. I think that’s also really important is this idea that we’ve really seen a big increase in awareness. One thing that’s happened is if you notice around most of the US, localities have a list of Black-owned businesses or minority-owned businesses where you can shop. In some cases, female-owned businesses and it provides you this awareness like, “If I really want to support this type of business, maybe I should go eat at this restaurant. I’ll try a new restaurant.” Get out of your comfort zone in the places that you typically go to. Some large retailers that are also doing this, so if you go for example, to the Target webpage. They have a section that’s like any other section that says, “Shop Black-owned businesses.” It creates this avenue for small businesses that are owned by different groups that you would not normally see at a big retailer to be highlighted. So customers all of a sudden say, “Wow, that product looks really interesting. I’m going to try it.” If we can increase that awareness, if we can get for example, search engines to provide more local information on small businesses, instead of just the large ones that are paying a lot of money in ads. That’s going to help in the long run because once they have those sales, then as Manny was mentioning that, that’s really important to look at what are the expenditures that a business has in looking at their application for a loan. Their revenue sources also are extremely important in looking at their loan application.

I love that observation about the customer awareness and I’m delighted to hear that. I know that in my community, it’s the case that we’re seeing more and more of that, but to have some of the big organizations like Target that are moving massive amounts of goods and services around, that’s really good news. I would say that’s another way of thinking about the supply chain to some big companies are saying, “I’m looking for, I want to have more in my supply chain of minority-owned business.” Again, it’s a way of thinking about the revenue side and I think that’s really important.

I think we only have about five minutes left and I think I like very much the idea of the way the last panel ended with our advice to Mary. Mary Daly is asking for advice. We’re not giving it unsolicited, she said, “What would you tell us at the Fed, if there’s anything we can or should do?” The Fed, they have incredibly great research capabilities and so some of the questions we are raising, I think they’re already working on research. Clearly we can help inform their research, but anything else in terms of, what can the Fed do in its capacity as the overseer of the financial institutions of the United States? What can and should it do? Why don’t I start with you Rob, and then we’ll go to Manny.

Yeah. I think that’s a good point. I think we need more information, more data would be great. The Fed has a number of different efforts there that are great, but it would be great to get maybe the banks to provide some more of that information. I think it was truly a great thing when the SBA was able to provide all of that loan data. It was public information and they provided it and it allowed this incredible amount of research to be able to look at this program that’s close to a trillion dollars and analyze it and look carefully at where the money went and to which types of businesses it went. Also, the fact that early on it went to these businesses that we just don’t think of as small businesses.

I think is a really important thing and then also, just as we mentioned before, just somehow getting the ability for more funds to go to these more localized things, I think is crucial. I think they’re the ones that create the relationships with the local communities and similar to almost everything else, that if it’s more localized, then it really helps the people that live there instead of it being more national. And then it’s harder to target those areas.

Manny.

Yeah. I agree with everything said. I think at a high level, I talked a little bit about how we think about small businesses and small businesses broadly at that and the role they play, the importance in the US economy, but also the disruptions they will be undergoing. I think it’s going to take collaboration across the economy to keep them afloat, that’s from academia, that’s from regulatory and that’s from the private sector as well. This question of how, and then incorporating equity into that is another added layer, but that should be central to everything that’s done. So, what role can the Fed play in bringing people together to shine light on some of these issues and push some of the innovations around CDFIs and others which can help I think is important. So that’s at a high level, I think, important.

Maybe I’ll say more broadly, what are some ideas or what can be done more broadly by just the regulatory institutions in general to think about impact on the fairness of the financial system, which will impact underrepresented groups. I think on frameworks, and these are all just examples, not recommendations, but, thinking about can you tailor regulations to the size and type of bank? What are the [Assets Under Management (AUM)] ratios to CDFIs, what does that look like? Does that change and how does that change behavior? I think on some of the oversight and monitoring, just again, looking at racial equity in private insurance and look at where some of the disparities are. And making sure we’re monitoring the services and products that are going into those communities to ensure that one, they’re driving change but two, they’re not predatory.

I think three, there’s the question around, can we work with financial institutions to develop more nontraditional data sets to augment credit scores? We talked a little bit about that, and that could be an interesting way to think about how you look at some of the risk to reward profiles. We talked a lot about fintech and I’m no expert in fintech, but there is a lot of innovation going on. Are we ensuring that or making it easy for innovators to pilot and launch alternative models that could increase equity? I think that’s brought excitement around the topic and so how do we enable and ensure those versus hold them back, I think will be important. We’ve seen examples of that in other countries, which have really accelerated that like Brazil, where you’ve seen acceleration of the unbanked population through new disruptive models and shaking things up. Those are some ideas at least I had around.

By the way I was told we had five extra minutes. I want to start with, play off of the fintech comment you just made, Manny. There is now, I would say, a growing interest by some of the big fintech companies in fintech for good or fintech for inclusive growth. And there’s a whole bunch of things going on now, just on the Berkeley campus with funding from some of the big traditional financial institutions and a couple of the fintech ones. To think about, what kinds of tech, what kinds of products and services do we need to have for this inclusive growth agenda? A lot of that’s also focused on international, around the world, so you’re trying to find unbanked communities. They’ve never been banked, they’ve never had access to credit at all, and you’re trying to jump them to the frontier through fintech.

I’m optimistic. There’s lots of innovation going on at fintech and a lot of it’s for really big bucks and scaling high-income individuals to play the stock market more and things like that. That’s different, but I’m enthusiastic or optimistic that there’s a growing interest in fintech for good, I guess is what I would say.

There’s one thing I wanted to just raise with you again, both of you. In the supply of capital, so one of the things that I really had the pleasure of working on was this California Rebuilding Fund. One of the key things here is the partnership. It’s the partnership, this is an attempt to bring in private money and public money. The public money leverages the private money by taking more of the risk, taking some of the risk off. So the risk resides more with the state than it does with the private money going into this blended fund. I wondered if you have some sense about this notion of a partnership where the public money could be used as leverage and whether you know of other examples. I think there are some other examples in other states of this, but it is a leveraging opportunity, I would say. Either Rob or Manny.

I don’t know a huge amount. I’ll defer to Rob if he does.

Yeah. I don’t know much about it either. Sorry I mean, it sounds very interesting and promising.

Maybe I can end on that score because it’s something that Bulbul said in the last panel… Again, it goes to the price of this capital and the need to find funders who are interested in impact and may be willing to accept a lower return to have the impact. And the notion of the public private partnership is essentially, and I know there’s some of this going on in New York, the public money comes in to take off some of the risk of loss to the private impact money. But the private impact money still is money that’s coming in, not seeking at an interest rate return which is the going market interest rate return. It’s a blend here, is public money and impact money in a fund to create additional money. If you put in some of the additional funding for the CDFIs coming through the federal government, that’s part of the public money. We’re trying to build a pool of additional funds.

Yeah. I like the idea and I think what people are starting to realize more broadly, even outside of financial services, is that embedding racial equity into your strategy creates a bigger pie, it’s not delusive. When you talk about the fintechs, I’m excited and I’m optimistic about them being able to figure out areas which actually grow the access to credit and build the pie. I think we’ve seen that. We’re starting to see that across the board, and we’re starting to see companies finally recognize that it’s been a long time coming.

Very exciting. [crosstalk] Rob.

Yeah. From the customer side, it’s been this huge gain. People are buying a more diverse set of products because they got out of their habits and said, “Wow, I like this.” It could be a win win.

Those are fantastic optimistic notes on which to end. We see some change, it’s just beginning. It’s really important. Wonderful. Thank you so much, Robert. Thank you so much, Manny.

Great. Thank you, Laura, Robert, and Manny for just really a rich discussion. In our next session we’re going to hear directly from different types of small business lenders. I invite the audience to join us, you can click on home to find the next panel. Thanks so much.

Thank you.