Are commercial bank lending propensities useful

in understanding small firm finance?

James E. McNulty & Marina Murdock &
Nivine Richie
Published online: 22 June 2011
#
Springer Science+Business Media, LLC 2011
Abstract We consider recent criticism by Berger et al. (J Bank Finance 31:11
33, 2007) of the use of commercial bank lending propensities (e.g., small business
loans/total assets) as research tools. We use 2SLS cross sectional regressions with
bank fixed effects to examine the relationship between small business lending and
bank size. Our results indicate that the propensity to lend to small businesses
declines as bank size increases, and the growth in small business lending does not
keep pace with the growth in bank size. An increase in bank asset size from $1
billion to $100 billion reduces the ratio of small business loans to total loans and
leases by 28 percentage points. Contrary to Berger and Black (2007) we find that
most small business loans are made by small banks. For 1993 to 2006 as a whole, small
banks (those under $1 billion) accounted for only 14.1% of total deposits and 9.7% of
total banking assets, but they accounted for 28.4% of small business loans outstanding.
This is consistent with the pattern shown by lending propensities. We conclude that
these propensities remain very useful tools in research on small firm finance.
Keywords Small FirmFinance
.
Bank Mergers
.
Commercial Banking
JEL Classification G21
.
G28
J Econ Finan (2013) 37:511527
DOI 10.1007/s12197-011-9191-x
We would like to thank Allen Berger, Robert DeYoung, Gregory Udell, Jonathan Scott and an anonymous
referee for very helpful comments on an earlier draft of this paper.
J. E. McNulty (*)
Florida Atlantic University, Boca Raton, FL, USA
e-mail: jemcnult@bellsouth.net
M. Murdock
North Georgia College & State University, Dahlonega, GA, USA
N. Richie
University of North Carolina Wilmington, Wilmington, NC, USA
1 Introduction
Businesses with less than 20 employees accounted for 79.5% of net job creation in
the United States from 1990 to 2003 (Edmiston 2007). The importance of small
business in the American economy, as well as the role of banks in facilitating small
business development, has motivated researchers to explore bank characteristics that
are conducive to small business lending (e.g. Berger and Udell 1995; Peek and
Rosengren 1998). With bank assets being consolidated even further at larger banks
as a result of the financial crisis, the ongoing issue of large banks potentially being
less willing to lend to small firms takes on increasing importance.
Many researchers examine the propensity of commercial banks to lend to small firms
and define this propensity as the ratio of small business loans to total assets (see, for
example, Akhavein et al. 2005; Berger et al. 1998; Frame et al. 2004; Laderman 2008
and Strahan and Weston 1998). However, recent studies question the importance of
lending propensities. Berger et al. (2007) suggest that the ratio of small business loans
to total assets may be lower at large banks because of greater growth opportunities
causing the denominator to expand rather than the numerator to contract. Additionally,
Berger and Black (2007) use the Survey of Small Business Finance to suggest that
most lending to small firms is done by large banks. However, this data source is
probably not representative of the population of all small firms. Very small firms (the
ones most likely to be financed by small banks) are possibly less likely to participate.
More importantly, the survey does not account for the firms that have gone out of
business, for example due to interrupted lines of credit. Based on a more
comprehensive data source, the bank call report data filed with federal regulators by
all banks, we analyze the relationship between lending propensities and bank asset size.
To address the denominator effect identified by Berger et al. (2007), we use the
ratio of small business loans to total loans and leases as the propensity of commercial
banks to lend to small businesses. This ratio excludes investment assets, trading
account assets and other assets that would be a more significant portion of large bank
balance sheets than small bank balance sheets. More importantly, we estimate a two-
stage least squares regression with bank fixed effects for 5,537 banks for 19932006
(a total of 32,215 bank-year observations) to help us understand the supply curve for
small business loans. Our results show that the supply of small business loans does
not keep pace with the growth in total assets. We also find, not surprisingly, that the
ratio of small business loans to total loans is inversely related to bank size, but also
that this relationship holds after controlling for demand shifts as well as bank capital
and liquidity. Contrary to Berger and Black (2007) we find that most small business
loans are made by small banks, regardless of how the term small bank is defined.
Our study has implications for researchers and for policy makers. We suggest
that lending propensities contain valuable information and should continue to
be used as a research tool to investigate the supply of loans. For policy makers,
the findings suggest that bank consolidation may adversely affect the supply of
small business loans, particularly as large banks impose their lending
technology on the small banks that they acquire. Legislators should consider
measures to promote, or at the very least protect, small business relationships
with their banks during bank mergers as bank relationships are vital to the
survival of small businesses and the jobs that they create. This would be
512 J Econ Finan (2013) 37:511527
consistent with the recommendation of Carow et al. (2006) who suggest that
banks that acquire other banks be required to maintain existing target bank
relationships with small firms.
2 Lending propensities in the literature
Berger et al. (1998) use lending propensities to look at the short run, or static, effects
and the long run, dynamic effects of bank mergers on credit availability to small
firms. The short run effects occur from a melding of bank balance sheets after the
merger. They consider that small banks specialize in relationship loans, a lending
technology suitable for small firm finance (e.g., Berger and Udell 1995). As a result,
the ratio of small business loans to total assets is lower for large banks. Extrapolating
the large bank ratio to the merger partner necessarily results in a reduction in small
business credit. This effect is estimated to be 16% of aggregate small business loans
outstanding, or $26 billion in 1994 dollars. They find, however, that over time the
static effects are ameliorated by an increase in small business lending by other banks,
as well as the competitive reaction of the new, larger bank. Dynamic effects include
the effects of possible restructuring, other direct effects of a merger or an acquisition
and an external effect. External effects include competitors in the geographical area
of the target picking up the residual small business lending that the resulting bank
rejects. They also find evidence of negative effects on small business lending when a
large bank acquires another bank, whether large, medium or small.
Peek and Rosengren (1998) also analyze bank lending propensities before and after
a merger based on data for all banks, including 872 acquirers, for the period 1993
1996. They combine the pre-merger balance sheets and then compare the small
business lending propensities of the resulting institution before and after the merger.
They find that an acquiring bank tends to impose its business model on the target, in
effect reconstructing the target bank in its own image. Their results show that the ratio
of small business loans to total assets for the consolidated institution converges
toward the pre-merger ratio of the acquirer. Not all cases result in declines in small
business lending because in many cases the acquirer is small and has a ratio similar to
that of the target. But when the acquirer has over $300 million in assets and is not
active in small business lending, there is a decline in such lending in two thirds of the
cases. When they regress the change in the small business loan share of total assets
from before to after a merger on bank size and a number of control variables, the size
effect is negative and statistically significant at the 1% level. Strahan and Weston
(1998) also use these propensities in their analysis of small business lending.
In a recent paper, Berger et al. (2007, p. 13) make an interesting argument about
lending propensities: The previous approaches using the small-business-loan-to-
total assets ratio do not account for the possibility that a large bank or recently
consolidated bank may have a low small business loan ratio not because the
numerator is contracted but because the denominator of the ratio is expanded. They
argue that this may happen because large banks have more business opportunities
than small banks. They conclude that the likelihood of a small firm having a line of
credit from a bank in a given size class does not decline as bank size increases and
emphasize new lending technologies such as asset based lending, leasing and credit
J Econ Finan (2013) 37:511527 513
scoring as ways that large banks lend to small firms.
1
They do not directly analyze
lending propensities, but nonetheless, a careful reading of their paper suggests that,
in their view, bank willingness to lend to small firms does not necessarily decline as
bank size increases. Their results are based on matching firm data from the National
Survey of Small Business Finance and bank data from the call reports and the
Summary of Deposits. There are 648 matched bank-firm observations. In contrast,
we look at virtually all small business loans made by banks by considering all usable
call report data.
3 Are lending propensities important?
As noted, Berger et al. (2007) question the use of the small-business-loans-to-total-
asset ratio to evaluate bank willingness to lend to small firms. They suggest that
perhaps large banks have lower ratios because the denominator is expanded (i.e.
growth opportunities) and not because the numerator is contracted. Berger and Black
(2007) suggest that most small business loans are held by large banks. Prompted by
this comparison, we also evaluate the distribution of total small business loans by
bank asset size based on call report data.
Figure 1 shows the sum of total loans and leases outstanding for all banks for
each peer group from 1993 to 2006. This chart shows clearly that large banks
dominate the overall lending market. By 2006, banks with greater than $50 billion in
total assets (peer group 1) held more than $2.6 trillion in total loans and leases while
banks with less than $1 billion in total assets held just over $600 billion.
Figure 2 shows the sum of small business holdings by peer group from 1993 to
2006. We see that small banks, those under $1 billion in total assets, have a
combined small business loan portfolio that exceeds the total small business
portfolio held by the largest banks, those over $50 billion.
2
These data show,
contrary to Berger and Black (2007), that small banks make many more small
business loans, relative to their size in the banking system, than large banks. The
largest banks, the ones that do the large mergers and acquisitions, do the least
amount of small business lending relative to their size in the banking system.
Table 1 reports the sum of total deposits, total assets, and small business loans for
our sample of banks within each peer group from 1993 to 2006. The data show that
1
Berger et al. (2005) report an increase in credit scoring of small business loans. Nonetheless, DeYoung et
al. (2004) and others find relationship lending remains an important part of the business plan of the small
bank.
2
The argument depends critically on how small and large banks are defined. If one were to define a
large bank as any bank over, say, $500 million in assets, then most small business loans would be made by
large banks. Correctly recognizing this issue, Berger and Black (2007) use the proportion of branch offices
to provide an independent measure of the relative size of each group of banks in the banking system. We
did not attempt to analyze branch data since the pattern shown by the other two measures, assets and retail
deposits is quite clear. We use both because total assets overstates the importance of large banks since their
business model involves financing a significant portion of assets with borrowed funds. We consider total
retail deposits to be the best independent measure but our point is clear using either measure. The essential
idea is to provide a measure of business opportunities. Berger et al. (2007) raise the point that a large bank
may have a low propensity to lend to small firms simply because it has more business opportunities than
small banks. We believe that total retail deposits is a measure which addresses this point.
514 J Econ Finan (2013) 37:511527
the group of largest banks, those over $50 billion in assets, account for 41.2% of
total deposits and 51.1% of total assets but only 23.3% of total small business loans
from 1993 to 2006. On the other hand, the peer group consisting of the smallest
banksthose under $1 billion in total assetshold 14.1% of total deposits and only
9.7% of total assets but hold 28.4% of all small business loans. Additionally, the
average ratio of small business loans to total loans and leases is only 0.0647 for peer
group 1 but is 0.3125 for peer group 5. Similar conclusions follow from comparing
peer group 2 with the larger groups. If the definition of small business loans were
different, this pattern may be different; but under the regulators current definition,
this is the pattern.
3
It is possible that the Survey of Small Firm Finance used by Berger and Black
(2007) is not fully representative of the population of all small firms with
commercial bank loans found in the call report data, due to the reasons outlined
earlier, namely possible survivorship bias and probable exclusion of very small
firms. In our call report data, we consider all small business loans made by all
commercial banks, which almost certainly explains the difference between their
interpretation of the data and ours.
The reasoning behind the numerator-denominator argument is, of course, that a
lower percentage of a much higher number could be a higher number. For example,
comparing a bank with $100 million in assets and a small business lending
propensity of 50% with a $100 billion bank with a lending propensity of 5%, the
hypothetical large bank makes more small business loans.
There are two practical problems with this argument. One is that there simply are
not that many medium-sized and large banks. For example, Table 1 shows that, out
of 5,537 banks in our sample (all banks with at least four years of data) there are 6
banks in peer group 1, 40 banks in peer group 2, and 54 banks in peer group 3. Most
banks are small banks. The second problem is even more important. We noted the
point made by Peek and Rosengren (1998) that in a bank merger the small business
loan ratio of the resulting institution tends to converge to that of the acquirer. In other
words, with respect to small business lending, the acquirer imposes its business plan
on the target. Karceski et al. (2005) find the same pattern in Norwegian data, and
3
According to FDIC guidelines, the small business loans to be reported in the June Report of Condition
are currently defined as business loans with original amounts of $1,000,000 or less and farm loans
with original amounts of $500,000 or less.
0
500
1000
1500
2000
2500
3000
1
9
9
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$

B
i
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o
n
s
Year
Peer Group 1 (Total
Assets > $50 billion)
Peer Group 2 (Total
Assets $10-50 billion)
Peer Group 3 (Total
Assets $5-10 billion)
Peer Group 4 (Total
Assets $1-5 billion)
Peer Group 5 (Total
Assets < $1 billion)
Fig. 1 Sum of total loans and
leases by bank peer group
J Econ Finan (2013) 37:511527 515
they suggest the results might be representative of what would happen in the United
States. Clearly, lending propensities are important because lending propensities are a
reflection of major differences in the business models of large and small banks.
These differences determine the effect of specific mergers on individual small
business borrowers at individual banks.
Discussion: what we are not saying We are not saying that the much higher
percentage of assets in small business loans for small banks (the lending
propensity) necessarily means that more small business loans are made by small
banks. This would be equivalent to the line of thinking that Berger et al. (2007)
correctly warn against. We are saying that in an economy such as the United States
where there are relatively few large banks, the practical consequences of the
Berger-Rosen-Udell argument are limited. Ignoring lending propensities and
Table 1 Distribution by peer group
Peer group 1 2 3 4 5 Total
Total deposits ($ billion) 15,899 8,800 3,382 5,086 5,449 38,616
Peer group deposits as a proportion of all
peer groups deposits
41.2% 22.8% 8.8% 13.2% 14.1% 100.0%
Total assets ($ billion) 35,469 15,264 5,073 6,965 6,706 69,477
Peer group assets as a proportion of all peer
groups assets
51.1% 22.0% 7.3% 10.0% 9.7% 100.0%
Small business loans ($ billion) 1,004 914 398 765 1,225 4,307
Peer group SBL as a proportion of all peer
groups SBL
23.3% 21.2% 9.2% 17.8% 28.4% 100.0%
Average SBL to TLL ratio 0.0647 0.0998 0.1263 0.1837 0.3125 0.189
Number of banks in peer group 6 40 54 243 5,194 5,537
Distribution of total deposits, total assets, and total small business groups in $ billion by peer group for the
total sample period of 19932006. Also presented is the proportion of the total sample assets, deposits,
and small business loans that are held by each peer group. Peer group 1 includes banks with >$50 billion
in total assets, peer group 2 includes banks with total assets between $10 and 50 billion, peer group 3
includes banks with total assets between $5 and $10 billion, peer group 4 includes banks with total assets
between $1 and $5 billion, and peer group 5 includes banks with less than $1 billion in total assets
0
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B
i
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o
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s
Year
Peer Group 1 (Total Assets
> $50 billion)
Peer Group 2 (Total Assets
$10-50 billion)
Peer Group 3 (Total Assets
$5-10 billion)
Peer Group 4 (Total Assets
$1-5 billion)
Peer Group 5 (Total Assets
< $1 billion)
Fig. 2 Sum of small business
loans by bank peer group
516 J Econ Finan (2013) 37:511527
simply looking at which types of banks make small business loans, we find that,
relative to their share of retail deposits, small banks make many more small
business loans than large banks. This pattern is precisely what we would expect
from looking at lending propensities.
4 A model of small business loan demand and supply
Our primary research question centers on the effect of bank size on supply curve for
small business loans. Traditional models of supply and demand face an identification
problem when both quantity demanded and quantity supplied are specified as
functions of a single, common explanatory variable, namely price. We identify the
supply curve of small business loans by introducing shift variables in the demand
and supply functions.
Prior studies on the determinants of bank loan rates suggest that banks operate in
an oligopolistic market where they can set prices based on profit maximization (see
Santomero 1984 and Gambacorta 2008). The prime rate is a key benchmark rate for
loans and, though many high-quality borrowers can borrow at rates below the prime
rate, most loan rates will change together (Dueker 2000). Peek et al. (2003, p. 932)
attempt to isolate loan supply shocks from loan demand shocks. They argue that a
firms demand for loans depends crucially on the demand for its products and that
the ability to account for aggregate demand is essential to controlling for loan
demand.
Our model specifies that loan demand by businesses (Q
Di
) will be an inverse
function of loan rate or price (P
i
) and a direct function of the economic factors that
drive a firms productivity (ECON
i
). We specify the demand function in structural
form as:
Q
Di
a
0
a
1
P
i
a
2
ECON
i
e
Di
1
To control for aggregate demand, we introduce three different estimates of
the economic factors that drive a firms demand for loans: (1) the number of
establishments in the banks county of domicile, (2) the unemployment rate in
the county where the bank is headquartered, and (3) the year-end value of the
index of industrial production reported by the Federal Reserve Board. By using
three different demand shift variables, we are capturing demand that varies by
county and year and by year alone. We follow previous studies in using
economic data for the bank headquarters location (see, for example, Graddy
and Kyle 1979; Gajewski 1988; Cebenoyan et al. 1995; Akhigbe and McNulty
2003, 2005). Arguably, the use of the county-level macroeconomic data to
estimate demand for loans is most meaningful for smaller, community-based
financial institutions. However, as the bank grows in size, the headquarters
county should continue, for most banks, to account for a very important
component of total loan activity.
Prior studies examine loan supply by bank size (see Berger et al. 1998; Kishan
and Opiela 2000, among others). Kishan and Opiela (2000) extend prior studies by
adding bank leverage as an additional explanatory variable. Peek et al. (2003) isolate
J Econ Finan (2013) 37:511527 517
bank loan supply shocks by using confidential bank supervisory information about
bank health. They use CAMEL ratings as their indicator of bank health, and find that
this measure is independent of bank loan demand. Slovin and Sushka (1983)
investigate whether banks become loaned up when they face a binding liquidity
constraint in the absence of sufficient demand deposits.
Following prior research, we specify a structural model of loan supply as:
Q
Si
b
0
b
1
P
i
b
2
SIZE
i
b
3
CAPITAL
i
b
4
DEPOSITS
i
e
Si
2
where quantity supplied (Q
Si
) is a function of the loan rate or price (P
i
), bank size
(SIZE
i
), bank capital, (CAPITAL
i
), and bank deposits (DEPOSITS
i
). We expect that
quantity of small business loans supplied will be directly related to loan price and
bank deposits but inversely related to bank size. In terms of bank capital, the
relationship can be direct if higher bank capital indicates greater capacity to lend.
However, it is also possible that the relationship can be inverse if lower bank capital
indicates a greater willingness on the part of the bank to accept risk by extending
risky loans to boost profits.
5 Empirical estimation
We compile the call reports for all FDIC-insured commercial banks from 1993 to
2006. To avoid the effects of the recent financial crisis, we do not include the years
20072009. The data on small business lending comes from the June call report
provided through the Federal Reserve Bank of Chicagos website (http://chicagofed.
com). Banks are only required to report the amount and the number of their small
business loans (SBL) outstanding in the June report. Small business loans include
business loans of $1,000,000 or less and farm loans of $500,000 or less. In contrast
to some studies, we include agricultural loans because agriculture is a business.
Those loans do not include loans secured by residential property, unless the property
is part of improvements of farmland. The figures understate the amount of small
business lending because loans with larger amounts than one million are often made
to relatively small firms.
To be included in our final sample, a bank is required to have at least four years of
balance sheet data available. Our final sample is an unbalanced panel of 5,537 banks
with an average of eight years of data per bank giving us a total of 32,215 bank-year
observations.
Table 2 presents the summary statistics of the commercial banks in our sample.
The average bank has $2.157 billion in total assets, $1.199 billion in total deposits,
and $134 million in small business loans. As expected, the distribution of banks is
clearly not a normal distribution with the median bank size being $217 million in
total assets, $175 million in total deposits, and $39 million in small business loans.
The average ratio of small business loans to total loans and leases (SBL/TLL) is
0.189 while the median ratio is 0.176. The capital ratio is 0.10 on average with a
median value of 0.09.
We use a two-stage least squares regression with bank fixed effects to estimate the
supply function given in Eq. 2. The reduced form equations for price and quantity
518 J Econ Finan (2013) 37:511527
are expressed as:
P
i
p
01
p
11
ECON
i
p
21
SIZE
i
p
31
CAPITAL
i
p
41
DEPOSITS "
1i
3
Q
i
p
02
p
12
ECON
i
p
22
SIZE
i
p
32
CAPITAL
i
p
42
DEPOSITS "
2i
4
The first-stage regression of Eq. 3 incorporates the following specifications:
P is the price of loans and is represented by the prime lending rate reported by the
Federal Reserve. ECON is the demand shift variable representing the economic
variables that drive the demand for a firms products. We use three different
estimators of ECON: the natural logarithm of the number of business establishments
in the county of the banks headquarters as reported by the Bureau of Labor
Statistics
4
(lnANNESTAB), the unemployment rate in the county where the bank is
headquartered (UMEMP_RATE) as reported by the Bureau of Labor Statistics, and
the natural logarithm of yearend industrial production as reported by the Federal
Reserve (lnINDPRO).
We specify quantity (Q) two ways: (1) the natural logarithm of small business
loans (lnSBL) to represent the percent change in the level of small business loans on
a banks balance sheet and (2) the ratio of small business loans to total loans and
leases (SBL/TLL) to represent the propensity to lend to small businesses. The supply
shift variables are SIZE, CAPITAL, and DEPOSITS and are all balance sheet
variables gathered from the call reports. Bank size is estimated using the natural
logarithm of total assets (lnTA). Bank capital is represented by the ratio of total
equity to total assets (CAPRATIO). Finally, bank deposits are represented by the
natural logarithm of total deposits (lnDEP).
To control for omitted variables that differ across our panels of banks, we estimate
the regressions with bank fixed effects. The F-test that all dummy parameters less
one are equal to zero is rejected (results not reported) so we conclude the group fixed
effects is appropriate rather than pooled OLS regression. We test for random effects,
Table 2 Descriptive statistics
Variable N Mean Median StdDev Minimum Maximum
Ratio of SBL to TLL 32,215 0.189 0.176 0.133 0.000 0.978
TA 32,215 2.157 0.217 21.288 0.004 1,160.260
SBL 32,215 0.134 0.039 0.596 0.000 23.769
DEP 32,215 1.199 0.175 9.762 0.000 576.962
CAPRATIO 32,215 0.100 0.090 0.040 0.008 0.875
Summary statistics are presented for the bank related variables used in the empirical analysis. TA is total
assets, SBL is small business loans, DEP is total deposits, CAPRATIO is the ratio of total equity to total
assets. TA, SBL, and DEP presented in $ billion
4
Ideally, we would like the total number of small business establishments per year as reported by the
Small Business Administration, but these data are only available from 2001 to 2006 which greatly
shortens our sample period. Since the number of small business establishments is highly correlated
with the number of total establishments (=0.636), we do not report results using small business
establishments.
J Econ Finan (2013) 37:511527 519
and the results of the Hausman test indicate that fixed effects are appropriate rather
than random effects.
We expect that a banks propensity to lend will be inversely related to the size of the
bank, all else being equal, but we expect that the size of a banks SBL portfolio will be
directly related to the size of the bank. The expected sign on the CAPRATIO variable
may be positive or negative. Healthier banks may have a greater capacity to lend, so we
expect that the CAPRATIO may be directly related to both the propensity to lend and to
the size of the SBL portfolio. However, if banks with declining asset values are willing
to pursue risky loans, then we may see negative coefficients on the CAPRATIOvariable
indicating declining bank capital is related to increased small business lending. Finally,
since banks are likely to require small business owners to maintain checking accounts
with minimum balances, we expect total deposits to be directly related to both the
propensity to lend and to the size of the SBL portfolio at banks. Moreover, as deposits
increase, banks will have more funds available to lend, so once again, we expect that
deposits will be directly related to our dependent variables.
6 Results
The results from the two-stage least squares regression to estimate the supply of
small business loans are presented in Tables 3 and 4. The first stage regressions are
not reported, but the t-statistics and the F-statistic in the reduced form equations
indicate that the shift variables are statistically different from zero.
Table 3 presents the regression results where SBL supply is specified as the
natural logarithm of total small business loans. Panel A presents results using
lnANNESTAB as the demand shift variable. As expected, the coefficient on lnTA is
positive and statistically significant in all four models. The coefficient on lnTA in
model 1 is 0.703. This finding that small business lending increases less than bank
size holds after controlling for bank capital and bank deposits in models 2 through 4.
(We recognize the obvious high correlation between loans and deposits across banks
by specifying models both with and without both variables.) These results
demonstrate that as banks increase in size, their total volume of small business
loans increases as well. However, a coefficient less than 1.0 indicates that as banks
increase in size, the increase in their small business loans does not keep pace with
the growth in bank size. Models 2 and 4 show that the coefficient on lnDEP is
positive and significant, indicating that an increase in total deposits is associated
with an increase in small business lending, as expected. Nonetheless, the total
increase from both variables is less than proportional to bank size. The coefficient on
the capital ratio is not statistically significant.
A coefficient less than 1.0 on the lnTA variable lends support to the conclusion
that as banks increase in size, their propensity to lend to small businesses declines.
Of course, one could argue that this is demand driven, rather than supply-driven. Our
model controls for demand by specifying three alternate demand shift variables.
Panel B specifies that demand is driven by the county unemployment rate where the
bank is headquartered while Panel C specifies that demand is driven by the natural
logarithm of industrial production (lnINDPRO). In all cases, the coefficients on lnTA
are similar in magnitude and sign, confirming the results of Panel A.
520 J Econ Finan (2013) 37:511527
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J Econ Finan (2013) 37:511527 521
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522 J Econ Finan (2013) 37:511527
T
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524 J Econ Finan (2013) 37:511527
Table 4 shows a model for the supply of small business loans expressed as the
ratio of small business loans to total loans and leases (SBL/TLL). Panel A presents
the results of the model where lnANNESTAB is specified as the demand shift variable
in the reduced form equation. The SBLTLL ratio is an alternative indicator of SBL
supply in Table 3. As noted, it shows the proportion of the loan portfolio dedicated to
small business loans. In all four models, the lnTA coefficient is negative and
statistically significant at the 1% level. The negative coefficient indicates that as
bank size increases, the propensity to lend to small businesses decreases. Again, this
finding holds after controlling for bank capital and bank deposits in models 2
through 4. Using the coefficient from model 1 of 0.061, we estimate that an
increase in total assets from $1 billion to $100 billion is associated with a decline of
approximately 28 percentage points in the propensity to lend, which is economically
very significant.
Panel B of Table 4 presents the same results using the unemployment rate in the
county where the bank is headquartered as the demand shift variable and Panel C
uses the natural logarithm of industrial production (lnINDPRO) as the demand shift
variable. The results are qualitatively similar with the coefficient on lnTA that is
negative and statistically significant. In Panel B, the lnDEP variable is positive and
significant at the 10% level, indicating that an increase in total deposits is associated
with an increase in the banks propensity to lend.
7 Summary and implications
We use a two-stage least squares regression with bank fixed effects on an unbalanced
panel of banks for 19932006 to estimate the supply curve of small business loans as
a function of bank size and other variables. We specify three different demand shift
variables for the reduced form equation for price in the first stage regression and
control for other supply shift factors in the second stage regression. Our results show
that the supply of small business loans, when specified as the natural logarithm of
small business loans, is directly related to bank size, but that the increase in small
business loans does not keep pace with the increase in a banks total assets. The
results further show that our estimate of a banks propensity to lend, specified as the
ratio of small business loans to total loans, is inversely related to bank size, and that
this relationship holds after controlling for loan demand, bank capital, and total
deposits. We find that other things equal, an increase in asset size from $1 billion to
$100 billion reduces the ratio of small business loans to total assets by an
economically significant amount28 percentage points.
The results suggest a possible clientele effectsmall banks lend to small firms and
large banks lend to large firms. Regulations restrict national banks to lending 25% of
their total capital and surplus to one borrower (10%of which must be secured by readily
marketable collateral) and similar limits exist for state-chartered banks. A banks
business model is, of course, closely shaped by these regulatory limits.
As noted, many small business loans are over the one million dollar limit used in
the call reports. If we were able to include these loans in our regressions the results
may have been quite different. The definition of such loans has not been modified
since the regulators introduced this reporting in 1993. Regulators should consider
J Econ Finan (2013) 37:511527 525
changing this definition to facilitate more informed analysis of small business
lending patterns and potentially adverse effects of bank mergers on the supply of
small business credit.
Despite recent criticism of lending propensities (e.g., Berger et al. 2007), we find
that lending propensities have important explanatory power. Small banks have high
lending propensities and, consistent with this, they account for a much larger
proportion of small business loans than their relative size in the banking system
would suggest. Despite the new lending technologies discussed by Berger et al.
(2007), we do not find evidence that large banks provide economically significant
amounts of credit to small firms relative to their size in the banking system. The
banks that do the large acquisitions, those over $50 billion, do the least amount of
small business lending relative to their size.
This research has important implications for both researchers and policy makers.
For researchers, the findings suggest that lending propensities are important
descriptors of loan supply. For policy makers, these findings suggest that bank
regulators should consider protecting small business relationships during bank
mergers. To avoid disruption of small business credit and hence job creation, these
regulators might require banks involved in mergers to maintain the target banks
relationships with small firms.
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