The Evolution of Bank Lending to Small Business

authors thank Peggy Gilligan for providing valuable research assistance. L ending to small firms traditionally has been a business served primarily by the banking industry. Banks have specialized in assessing and monitoring borrowers, particularly companies too small to access the bond and equity markets directly. In addition, because banks provide a variety of transactions services such as checking accounts , payroll operations, and cash management services, they may have had informational advantages in monitoring and advising small businesses. Recent changes in the banking industry are likely to have a significant impact on the way banks provide services to their small business clients. The industry has undergone substantial consolidation, in part stimulated by the relaxation of barriers to interstate mergers and interstate branching. As many banks grow in size and focus more on national and international markets, it is possible that some lines of business, including small business lending, may be less profitable for them than other activities that exploit more fully the advantages arising from economies of size and scope. The revolution in information technology has stimulated a second major change in the banking industry pertinent to small business lending. Credit-scoring models, based on relationships identified using historical data to ascertain risks associated with potential borrowers, have altered the way some banks evaluate and monitor many loans. These models enable banks to offer credit on more favorable terms to borrowers with significant assets and good credit histories, as the banks can assess the risk of the loan at far lower cost compared to the use of traditional underwriting standards. This article examines how these two developments may be reflected in recent patterns of small business lending by banks. Both appear to be strongly reflected in the data. Subsequent to a bank merger, roughly one-half of acquirers have increased and one-half have decreased the share of small business loans in their asset portfolios. However, the pattern is sensitive to the size of the