Why Banks don’t lend to Small Business – Part I

Most of us know that if you are a small business, it is a challenge to get funding.  There are a number of reasons banks are not seen as more readily providing finance here.

First, how big is small? At whatever size, a small business is characterized by not having a lot of capital relative to sales, they basically live day to day on the cash they get that day. A bird has to eat half its body weight each day to stay alive. Cash is food to a business. A small business eats like a bird.

Why bankers don’t like to lend to small business

From my experience, there are several reasons bankers are hesitant to fully embrace Small Business lending:

  1. You don’t make your bonus on small business loans - It is not reasonable to expect a banker making a mid six figure salary to justify that salary making five and six figure loans to small business.
  2. Monitoring costs are high - In an economic downturn, when sales are going down, and business is waiting longer to get paid, it is not reasonable to expect a banker to be optimistic about the reality of getting paid back if they do make a loan.
  3. Loans to the service sector are risky.  Service sells the intellectual output of people. People go home every night. People quit. The inventory is brains. How does a banker value brains?
  4. How do you value inventory in the goods sector?  For a banker, the question is how do value inventory?  For example, what is the value of last year’s dress   If the dress is this year’s hot product, it has value, if it is last year’s and still in inventory, it is “under water”. So what banker wants to lend on inventory that may be next year’s soggy dress? And to add a level of complication, what banker wants to lend on the goods in process that are neither raw materials, nor finished goods, but that once in process can only make a soggy dress.  Because the pace of change has increased dramatically in both consumer and industrial goods, the accumulation of soggy inventory is sooner not later. Change this year is wonderful until you, the banker, own it from last year.


Look at the problem from the banker’s perspective. Consider the phrase from the housing market: “under water”.  Five years ago, nobody knew what that phrase meant, or how it was determined. Now we know that if the value of a house is less than the mortgage, it is “under water”. And we also know that if the house next door to yours, which was similarly valued, sells at a low price, your house gets marked down to keep it comparable to the one next door, and you go “under water”.

To put the problem in perspective, in Europe, more than 92% of SMEs actually fall into the category of micro enterprises where the majority of their credit history was found in consumer credit bureaus rather than in commercial credit databases.  These small businesses trade on a cash or credit card basis.

In our next post, we will discuss what a banker can lend against with a reasonable expectation of repayment.

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