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7 Reasons Banks Not Lending to Small Businesses

banks not lending to small business

Nobody likes to be rejected. Whether it’s a “no” from a job you interviewed for, the person you're in love with or the bank, it hurts.

And if you’re a startup or small business owner, you may be very familiar with the sting of "no" from banks not lending to small business applicants. Of the small businesses that applied for business loan financing in the first six months of 2014, only half received any loan amount whatsoever, according to a survey by the Federal Reserve Banks of New York, Philadelphia, Atlanta and Cleveland.

The cold hard fact is this... If you’re a startup or small business owner, and you walk into a bank for a loan, you’ve got around an 80% chance of getting turned down due to banks not lending to small business loan seekers.

What makes this confusing for many is that small businesses need banks and banks actually need small businesses as online lenders become a more popular option and drains their consumer revenue line. There are legitimate needs on both sides, yet still nothing.

Why Banks Not Lending to Small Business Happens

Commercial lending to big businesses by traditional banks is rising at a rate that far outpaces the loans they’re making for home equity lines of credit and mortgages, but many of the small businesses in America are left out in the cold.

We'll detail 7 very specific reasons why banks aren't lending to small businesses in our list below, but on a more general level the problem is their view of lending. Traditional banks don’t view themselves as being in the service business. Who can blame really them? Providing good service to all potential customers is far more work than cherry picking the easy loans for big businesses.

On top of that, small business lending took a hit during the recession, many thought the lack of loans was only an effect of the economic downturn and would eventually make a comeback.

But that's not what we've seen happen. The total dollar volume of traditional bank loans to SMBs has declined by 20% since the recession began. And, it's steadily trending downward. Admittedly, some small businesses share the blame in not getting funding and our list will discuss that too. So let's get to it.

7 reasons why banks not lending to small business applicants: 

  1. Increased regulation: After the 2008 recession, heightened regulation standards have caused banks to be extra-careful about the risk in their investment portfolios and drastically tighten up standards. Remember, they are making these loans with money they have in their possession but not necessarily theirs. Unfortunately, small businesses are inherently riskier than huge corporations, which makes banks hesitant about extending credit to them.
  2. Lack of preparation by some small business applicants: Some small businesses get rejected for small business loans because the owners aren’t prepared. Many businesses simply aren’t savvy about the small business loan application process and think they can just walk into a bank, fill out an application and get approved for a loan, it doesn't work like that. Before applying for a small business loan from a bank, businesses should have a solid business plan written out with financial statements or projections, bank statements and tax returns, business and personal credit reports, according to the U.S. Small Business Administration website. Small business loan applicants also need to provide copies of relevant legal documents including articles of incorporation, leases, contracts and any permits and licenses needed to operate.
  3. Traditional banks often require collateral: Unlike peer-to-peer lending personal loans, physical property is often required by banks as a collateral guarantee for business loans in case it's not repaid. This makes it hard for startups and new businesses that may not have real estate or valuable equipment to offer as collateral, and small business owners may be uncomfortable using their personal assets (family homes and automobiles) as business loan collateral. The amount a bank will lend often depends on the value of your assets. Property, automobiles and valuable equipment are the most common forms of collateral, but if you don’t own anything that banks view as valuable, you will have difficulty getting a small business loan. 

    Alternative solution:  Credible peer-to-peer online lenders have emerged over the last 15+ years that offer small business loan alternatives and help you avoid traditional banks. Online P2P lenders often don’t require collateral and offer very competitive loan rates.

  4. Bad credit or no credit: Every credit bureau determines your credit scores slightly differently, and it’s not always clear which lenders look at which scores. Generally, credit scores can be low for several reasons, including bankruptcy, missed or late payments to creditors, credit card issuers and vendors. Some startups and small businesses are simply too new to have established a decent credit history. One of the most common reasons for banks not lending to small business applicants is that they have no credit history or a low credit score.
  5. Downturn in community banking: Small businesses and startups have historically had more success getting business loan funding from community banks than from the major banks. In fact, community banks have 3 times the approval rates on small business loan funding than the major banks. Unfortunately, the number of community banks has been on the decline since the 1980’s, in turn hurting funding opportunities for small businesses. With fewer and fewer community banks to turn to, there are far fewer opportunities for small business owners to find business loans at traditional banking institutions.
  6.  Weak cash flow: Banks are very concerned that businesses have enough cash flow to make monthly loan payments in addition to covering their payroll, inventory, rent and other expenses. Unfortunately, many startups and small businesses struggle to keep enough money in their bank accounts even when they’re profitable, often because they have to pay 3rd-party suppliers upfront before they get paid for their product or service. Small business owners need to understand how much cash is coming and going through their business operations. If the margin on money going out to coming in is very slim this may cause banks to reject your loan application.
  7. Less profit for banks on smaller loans. In the majority of cases, small business owners are requesting smaller business loans than large corporations. In fact, about 80% of small businesses want loans that are less than $500,000. Such low business loan requests are perfect if you were applying at a peer-to-peer lender like Lending Club, but it doesn’t really benefit traditional banks to fund these smaller loans. Why? Because it costs banks just as much to underwrite a $1 million dollar business loan as it does a $150,000 small business loan, but they can earn much more money by underwriting the larger loans. At the end of the day, small businesses are considered too expensive to underwrite, traditional bank lenders are more eager to accommodate and fund big businesses. It's about making the most money and we can't forget that banks are businesses too.
banks not lending to startup business

Learn How To Get Small Business Loans Below.

Advantages of Applying For Peer-to-Peer Small Business Loans

The Lending Mag has come up with a list of the best peer-to-peer lending sites to get loans from, some are specifically for small-business loans and some are unsecured personal loans that you can use to meet your needs and goals. We gauged lender trustworthiness, user experience, and market scope among other factors. Peer-to-peer lending companies make the process of finding the ideal loan simple and easy, allowing small businesses to apply online, get funding quickly, and get back to growing their businesses.

There are many advantages to using P2P loans over traditional bank loans.

  • The major peer-to-peer lenders don’t use hidden fees. Unlike many banks, they are very transparent about any potential fees connected to their loans.
  • They offer loan quotes in a matter of minutes that DO NOT affect your credit.
  • Their p2p loan websites explain everything about your loan. This includes terms and rates. They work to provide small business loan funding at some of the lowest rates online.
  • You feel a lot less pressure through the quick and easy loan application process.
  • Your small business loans are funded through direct deposit quickly after approval. In comparison to most traditional banks there is very little hassle.

All of the peer-to-peer loan advantages add up to one thing for startups and small business owners: You're business getting the funding that it needs to grow and all without dealing with the unnecessary hurdles and problems that come from dealing with most major loan brokers.

It's obviously true that traditional banks are no longer lending to small businesses like they used to. In fact, banks not lending to small business applicants may have decent reasons for this such as the recession, lower profit on each loan, and a desire to lower risk to their depositors’, but it doesn't mean that your small business has to suffer. Using non-bank based small business loan options such as Lending Club's P2P small business loans and Prosper's unsecured loans up to $35,000 allows small business owners to still get the financial funding that they need.

Peer to Peer Lending and Private Lending Info