Why do minority business owners struggle to get small business loans?

Minority business owners have been known to face rejection on their loans more often than white owners. When they do get approved, the terms of the loan are often worse.

Always favor banks that earn high marks for Community Reinvestment Act (CRA) lending.

If you can’t get financing through a traditional bank, consider crowdfunding, grant money or SBA microloans.

This post is part of a series focusing on raising awareness about the specific financial challenges that people who identify as minorities in the United States face.

A lot of what happens in America - progressing through college, buying a car to get to a higher-paying job, or starting a business - takes capital. However, data shows women and people of color, especially Black and Latino Americans, are disproportionately shut out of business lending by systemic discrimination.

According to Federal Reserve data, Black-owned businesses are denied loans about twice as often as white businesses. That does not include people who may never apply or lack necessary collateral, such as those who have been disproportionately hurt by generations of redlining, something that is difficult to measure. Minority borrowers who are approved often get less money or higher interest rates than their white counterparts.

This lack of access has led to a chasm in business ownership. In a 2019 report, the National Community Reinvestment Coalition (NCRC) reported that Black people make up 12.6 percent of the population, but own only 2.1 percent of all employer firms. For Latinos, the gap is similar: They make up 16.9 percent of the population, but own just 5.6 percent of firms.

The Paycheck Protection Program showed the same pattern of inequity.

The problem is likely to be a much longer-term project to solve. What follows are highlights on the scope of the problem and the reasons it exists - and some options that might help shrink the gap.

The gap matters because business ownership is also a way people can build generational wealth. And a way to ensure it stays in their community. It has the same effect as homeownership. Small businesses that stay put tend to contribute a lot of economic activity back into the local community in an effect called the multiplier, which means those dollars are likely to be spent where you live.

Unconscious Biases

Some lending discrimination may come from unconscious biases that many people are influenced by every day. In a study that sent mystery shoppers matched on age, gender, appearance and credit scores into banks, the NCRC found bias even from the moment they first walked into a bank.

It found a few signs of bias: People on staff introduced themselves to the white testers 18 percent more often than Black testers. When they asked for feedback afterward, white testers described their experiences as friendly much more often than Black or Hispanic testers. Lenders asked extra questions about borrowers’ finances about 32 percent of the time for Black testers and 28 percent for Latinos. White testers were given more information about fees than Black testers about 35 percent of the time.

There is a lack of data, but one place it exists shows the same trend. A 2010 Minority Business Development Agency report, from the Commerce Department, found:

• 17 percent of minority-owned firms received loans, compared with 23 percent of white-owned firms.
• The average loan among companies with high sales was $149,000 for minority-owned firms, versus $310,000 for white-owned firms, the report found.
• Minority-owned firms were rejected 42 percent of the time, compared with 16 percent for white-owned firms.

A disproportionately higher number of minority-owned firms just give up even trying to get loans. About 33 percent of them did not apply because they feared being turned down, compared with 17 percent of white-owned firms.

Interest rates are not evenly distributed, either. The average interest rate on loans for the minority-owned firms in the study was 7.8 percent, compared with 6.4 percent for white-owned firms.

That lack of data is one problem in learning about racial differences in business lending. Under the 1977 CRA, banks only report demographic information, such as loans in low-income neighborhoods, but not loan race. The SBA has reported racial data. The SBA represents a small slice of the market, though: roughly 3 to 7 percent.

What policymakers can’t see, they can’t fix. This not only makes the playing field uneven; it makes it difficult for lawmakers to make and enforce fair-lending laws. Lawmakers are looking to change that.

A 2016 SBA report noted factors that stood in the way of access to venture capital, private equity, or debt financing. One question was whether diversity at the venture capital or investing firm itself changed who got funded. Firms with racial and gender diversity on their investment boards were more likely to finance diverse ventures, it found.

Under the Dodd-Frank financial reform law of 2010, a provision called Section 1071 would require lenders to report the race, gender and ethnicity of applicants. It is not yet in effect.

The Consumer Financial Protection Bureau announced a settlement to a suit over the issue from plaintiff groups representing small business owners, women, African American and Latino people. The deal is expected to speed the roll-out of Section 1071, including timelines and deadlines. The bureau must publish a proposal for collecting the data.

Greater transparency would mean regulators could more effectively enforce anti-discrimination laws and protect the public. It would also be easier to see and understand the full scope of the inequities, in order to provide help where most needed.

Misallocation of PPP Funds

The Paycheck Protection Program, a federal $659-billion loan program, was to bridge small businesses through the downturn with money to help pay employees and other expenses. While the PPP money was a big boon to small businesses, it was found to disproportionately support white-owned firms over Black and Latino firms. One survey, cited by Forbes, found 38 percent of white applicants were fully funded versus 12 percent of Black and Latino applicants.

One report that drew similar conclusions, from the Center for Responsible Lending (CRL), found the program was so badly designed it underserved the minority small businesses that most needed it. Some of the inequality came from the program design itself.

The program’s fees to lenders gave them a monetary incentive to prefer bigger loans - while smaller businesses often could not use that much within the eight-week forgiveness period.

On average, minority-owned firms tend to be smaller than white-owned firms, according to the CRL, making them less attractive to banks that make money by making loans.

Before PPP, minority small firms were much less likely to have a recent loan. And prior loans proved to be a key predictor of PPP loan approval.

Another factor in PPP was the connection between the business and the bank. Getting a loan was easier for those already in the bank door. Some minority borrowers did not have established relationships with banks.

PBS Newshour interviewed a Black man who owned a barbershop in a mostly Black neighborhood in Chicago. When the barbershop owner applied to PPP, he never heard back from the bank, the same bank that denied him a business loan earlier.

This misallocation of PPP funds is a sign of the still-tenuous relationship between banks and minority business owners. Later PPP changes intended to help small firms did not improve results. Whether there will be another round of PPP or similar stimulus loans to small businesses is a murky question.

To improve the situation long-term takes more work that needs the help of lawmakers, lenders and regulators to create initiatives that use carrot-and-stick incentives that enforce anti-discrimination laws for lending. Some of the problems go back generations. An enduring, racially unequal wealth gap, reinforced by generations of redlining, means people in communities of color often lack a key asset often required for financing: collateral.

Steps to Start With

While laws could force change in lending, you can’t wait for change to happen to get funding for your business. Here are some steps to start with.

• Look at minority-owned lenders, including small online lenders. A rising number of online lenders are minority-owned, and some focus on minority businesses.
• Learn the bank’s CRA rating. The Community Reinvestment Act exists to keep banks serving lower-income communities and it rates them on their performance. Go with banks that have good ratings, meaning Outstanding or Satisfactory.
• Do a search for grant money. There are groups that have set aside money for small, minority-owned business applicants. Local businesses and wealthy donors do this, too. The best part is that this is money you never have to pay back.
• The SBA has an 8(a) Business Development program where you get expert advice and access to loans.
• SBA microloans offer up to $50,000 in money available to small businesses and nonprofit child care centers.
• Join a trade or professional group, either online or in real life. A supportive group can do a lot to help you, from tips on how to find financing, to sharing ideas about good lenders.
• Use crowdfunding sites like Kickstarter or Indiegogo, both popular means of raising money to start a business that also do your marketing for you and link you with people who like what you are trying to do.

At any bank you go to, pay attention to how staff members treat you: Do they listen to you, ask you questions, or do they treat you as a bother and rush you out? If you get treated badly, you are probably in the wrong place. Go where they want you. Running a business is not easy for anybody. And wherever you go, be patient. Getting business financing may take persistence and time.

No one entity has every answer to discrimination or every idea on shrinking the finance gap, and it will take time to see which options have the most promise. This is a subject that won’t go away. Look for more articles to come that focus on financial challenges people from minority groups face.

Another population that has traditionally been affected by lending discrimination is women. Women face their own challenges in getting funded, but that is beyond the scope of this article in a series on the financial challenges people of color face in America.