Should Government Become Involved in Small Business Lending?

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Now that the worst of the Great Recession seems to be in the past, economists are becoming fully dedicated to analyzing what caused the country to experience such economic disaster, as well as what can be done to prevent a recession of that magnitude from happening again. And one topic dominating the discussion is how to provide funding to small businesses without putting the banking industry in a perilous position once again.

One strategy that appears to be on the horizon is the prospect of “forcing” banks to refer businesses to alternative lenders, according to Business Secretary Vince Cable. This practice has already been put in place in the U.K., and it appears to be helping the economy run smoothly, but many Americans are still hesitant to even consider “forcing” banks in the U.S. to follow suit.

90% of all small businesses have alternative funding.
90% of all small businesses have alternative funding.

Data from the Small Business Administration shows that small business lending increased by $2 billion between 2011 and 2012, and even though about 75% of all new jobs come from small businesses — which are largely funded on loans — many investors are still hesitant to support small businesses and start-up businesses. And considering that only about 10% of all small business owners are actually given the loans they need from traditional banks — in other words, 90% of all small business owners get loans from alternative lenders — clearly, the practice of seeking loans from other lenders is already part of the small business sector in a big way. Additionally, it’s worth noting that “alternative lending” isn’t synonymous with “guaranteed lending,” and that there would still be a fair amount of competition for start-ups and small businesses.

The problem with considering forced lending, as one Forbes reporter notes, is that it’s impossible to tell at this point whether it would be successful or harmful to banks simply because they don’t know how much business they’re already losing when they turn away small business owners. Seeing that 90% of all small businesses have alternative funding, it’s still unknown whether the majority of these business owners are choosing to seek alternative lending before even approaching a bank, or whether the majority are business owners who were denied loans at traditional banks. Requiring banks to refer small business owners to alternative lenders when the bank can’t help them (but the lender can) could potentially help the economy by giving start-up businesses more opportunities; however, experts may be grossly overestimating the number of new businesses that would benefit. Although this system seems to have worked in the U.K., experts note that its success overseas does not ensure its success in the U.S. — and being willing to risk a negative outcome may be the only way to find out if success is possible.

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