3.8 Challenges for banks
3.8.1 Impact of the recession on small business lending
Variables: Individual lending credit scoring model
No. of days since credit card opening.
Utilization rate in bank loan commitment.
Amount of the largest loan.
Utilization rate in card loan commitment (preceding 12 months).
Debt payment ratio (total debt/total income).
Debt ratio (debt/available debt).
Duration of credit.
Source: Authors own compilation
It is important to note that in South Africa, the NCA regulation does not allow for any unfair discrimination in the scorecards. Irrespective of what type of model, it is clear that it is not a simple procedure to develop a model. Sufficient and quality data is needed, together with the expert knowledge to implement. Other than continuous testing, it is also important to apply the most relevant variables. It is also important to custom make models for a relevant bank.
According to Beck et al. (2008) a ‘cut and paste’ of a competitors credit scoring model will not work. The motivation is that a powerful scoring model is highly personalized to a given bank – it should take into account the organizations’ tacit knowledge, brand perception, customer base, product lines, and history.
Due to the specialist nature of this field, it can be assumed that there must be many challenges faced by the banks to grant credit to small businesses (Beck et al., 2008). This aspect will be further explored.
Wiersch and Scott (2013) agree that small business lending has dropped substantially since the recession. While the crisis may not have impacted the South African banking sector as deeply as in the United States of America (USA) and Europe, banks in South Africa experienced a drop in earnings and some stress. However, according to Job (2013), the Minister of Economic Development, Ebrahim Patel stated that the tighter lending criteria adopted by mainstream lenders in South Africa in the wake of the recession had a negative impact on SMMEs and an overall reduction in credit extension over a period. For example, growth in credit extension during 2011 was the lowest in over 50 years (Job, 2013). It was a concern by policymakers that since the recession businesses are not getting the credit needed. Different views have emerged about the reasons for the scarcity of small business credit since the recession. Bankers say that the main reason small business lending is lower now than before the great recession is that demand has fallen. Bankers say the problem rests with small business owners and regulators. Banks argue that there is a drop in business expansion due to the drop in demand for products and services which reduces the demand for credit (Wiersch & Scott, 2013).
An analysis of data from the Federal Reserve Survey of Consumer Finances revealed that the income of the typical household headed by a self-employed person declined by 19% (in real terms) between 2007 and 2010 (Wiersch & Shane, 2013). Similarly, Census Bureau figures indicated that the typical self-employed household saw a 17% drop in real earnings over a similar period. Effectively lower earnings and sales mean that fewer small businesses are seeking to grow. Reduced small business growth translates into subdued loan demand. In support of this, the National Federation of Independent Businesses (NFIB) reported that businesses who borrowed once every three months fell from 35% to 29% between June 2007 and June 2013 (Wiersch & Shane, 2013).
On the other hand, the Wells Fargo/Gallup Small Business Index survey, in the second quarter of 2007, reported that 13% of small business owners expected that credit would be difficult to get in the next 12 months. By the second quarter of 2013, the figure had increased to 36%.
By contrast, 58% of small business owners said credit would be easy to get during the next 12 months when asked in 2007, compared to 24 % six years later (Mills & McCarthy, 2014).
Based on this, it can be argued that the drop in demand could also be influenced by the perception of the small business owners that credit may not be readily available (Wiersch &
Shane, 2013).
In addition to this, the banks advise that the regulators are compelling the banks to tighten lending standards which are adding to the reason for the decline in credit to small businesses.
Tighter credit policies reduce the number of creditworthy small business owners (Wiersch &
Shane, 2013).
According to the latest Wells Fargo/Gallup Small Business Index, 65% of small business owners said their cash flow was "good" in the second quarter of 2007, compared to only 48%
in the second quarter of 2013 (Wiersch & Shane, 2013). The Federal Reserve's Survey of Small Business Finances also indicated that small business credit scores are lower now than before the Great Recession.
To make matters worse, the decline in value of both commercial and residential properties since the end of the housing boom has made it difficult for businesses to meet bank collateral requirements according to the banks. Small business owners, in turn, say the problem rests with bankers and regulators. Bankers for increasing collateral requirements and reducing the focus on small business credit markets, and regulators for making loans more difficult to obtain (Wiersch & Shane, 2013).
While bankers, small business owners, and regulators all point to different sources for the drop in small business credit, Wiersch and Shane (2013) state that a careful analysis of the data suggests that a multitude of factors explain this decline in credit, however, these factors must not be seen as the sole cause of the decline in small business credit. The results revealed that fewer small businesses are interested in borrowing than in past years, and at the same time, small business financials have remained weak, reducing small business loan approval rates.
In addition, collateral values stayed low, as real estate prices declined, limiting the amount that small business owners can borrow.
Furthermore, increased regulatory scrutiny has caused banks to tighten lending standards, lowering the number of creditworthy borrowers. Finally, shifts in the banking industry also had an impact. Bank consolidation reduced the number of banks focusing on the small business sector, and small business lending has become relatively less profitable than other types of lending, reducing bankers' interest in the small business credit market (Cornett et al., 2011).
Considering these varying factors impacting on the decline in small business credit, Wiersch and Shane (2013) propose that all the possible multiple factors affecting small business credit must be researched and taken into consideration. In order to further research the challenges for small business credit, the 5C’s of credit framework will be used as a guideline. The most common challenges faced by credit managers when assessing credit applications for small businesses will now be further explored.
3.8.2 Challenges for credit managers when assessing small business credit