Last week, the CEO of M&T Bank (NYSE:MTB) addressed shareholders at the bank's annual meeting. But while Robert Wilmers touched on his bank's performance in 2015, he dedicated more time to talking about the decline of small business in America, what that means for job creation, and the role that lenders have played in the troubling trend.
Small businesses have long been a main driver of job creation. In the 1980s, entrepreneurs generated 58% of net new jobs, Wilmers observed. This figure, however, has since dropped. It fell to 49% in the 1990s, and is down to 31% today.
You can get a sense for the magnitude of this decline by looking at the raw numbers. From 1994 through 1999, new businesses created an average of 4.5 million jobs a year. This fell to 3.9 million from the year 2000 to the financial crisis of 2008. And since the crisis, new businesses have created an average of only 2.8 million new jobs a year.
Lost somewhere in the ether are roughly 1.7 million new jobs that small businesses used to create each year but no longer do.
Many factors no doubt play into this decline, but the availability of credit ranks at the top. It's often said that credit is the lifeblood of an economy. But even more important for small businesses, credit is the spark that brings them to life.
The problem is that getting loans has gotten harder for small businesses, which tend to fall between the cracks at the nation's biggest banks. Consumer loans such as mortgages and credit cards benefit from a standardized and streamlined origination process. Loans to big businesses offer economies of scale, which offset the individualized attention that's needed to analyze a business' creditworthiness. But loans to small business offer neither of these advantages.
Banks have thus begun to step back from the market segment. According to Community Reinvestment Act data cited by Wilmers, loans for less than $1 million are 34.9% below their pre-crisis level. That equates to a $115 billion drop since 2007. As the M&T Bank CEO went on to note:
Today, the SBA supports half as many small businesses, a decline of over 40,000, and two-thirds as many jobs, as it did prior to the recession. Instead of making small loans to small businesses, the fastest growing SBA loan segment has been for loans over $2 million—growing 91% since 2012. Now, nearly a third of the SBA's annual lending authority goes toward supporting these large loans, ostensibly at the expense of smaller dollar lending.
The solution to this problem, many believe, lies in new lending models being explored by Fintech companies. Funding Circle serves as a case in point, offering business loans of up to $500,000. Its home page promises "fast, affordable business loans for the millions of American small businesses who the banks have left behind."
But the amount of capital provided by Fintech companies has thus far been a drop in the bucket compared to the decline in conventional bank lending. Funding Circle has lent a mere $2 billion to small businesses globally. And while Lending Club, the leader among this new breed, has extended $16 billion worth of credit since 2009, only a portion of that has gone to businesses, as opposed to consumers seeking to refinance existing loans or consolidate credit card debt.
Additionally, Fintech companies can't offer the same level of individualized attention and localized knowledge to borrowers that community and regional banks like M&T Bank can. The significance of this isn't obvious now, but will be when the credit cycle takes a turn for the worse. Whereas community banks have a vested interest in supporting local borrowers, online lenders have little motivation to do the same.
"Unfortunately, not all forms of financing are created equal," Wilmers said in his address to M&T Bank shareholders.
Non-banks' virtual presence means that they are not truly of or for any particular community, and the formulaic algorithms upon which they rely to render high-speed credit decisions turn customers into mere numbers. There is no way for an "app" to understand an entrepreneur, his or her business, and its customers, suppliers and employees. Neither will an app be there to support a company if a loan is successful, nor to share in the risks and responsibilities of the loans that go bad.
The solution to the decline of small business is far from clear. However, to Wilmers' point, given the role that new companies play in job creation, it makes sense why the CEO of one of the top-performing banks over the past three decades believed it was worthwhile to discuss the topic at M&T Bank's annual meeting.