Report: Subsidizing Loans For Risky Small Businesses Reduces Growth
A new report shows that the Small Business Administration, an agency tasked with providing loans to small businesses, is associated with negative income growth, as it encourages loans to risky projects.
Over the last three years, the Small Business Administration (SBA) has provided nearly $100 billion dollars worth of loans to small businesses as a way to spur economic recovery. But a study from the National Bureau of Economic Research indicates that the SBA’s program actually encourages banks to loan to risky projects, instead of more profitable and secure firms. The SBA often uses the sheer number and dollar amount of the loans as evidence of positive economic activity.
To examine the effects of the program, the study compared three decades of lending data with income growth in over 3,000 counties across the United States. Researchers found that a 10 percent increase in SBA loans is associated with a growth rate lagging 2 percent behind the normal rate. Negative effects on income also spread to neighboring counties.
The reason for the lack of income growth, according to researchers, is that the loans offered to risky businesses “come at the cost of loans that would have otherwise been made to more profitable and/or innovative firms.”
Banks loan to risky firms because the SBA insures financial institutions by providing a loan guarantee. This guarantee covers between 50 and 90 percent of the bank’s loan in case the borrower defaults. The insurance incentivizes banks to provide capital to firms who are judged unlikely to provide enough value to warrant the loan on their own merits.
Based on SBA data, Wells Fargo Bank, The Huntington National Bank, and JPMorgan Chase Bank rank among the top five banks with the greatest amount of loans. JPMorgan Chase clocks in at 2,540 loans, totaling $249,692,480 million dollars for fiscal year 2014.
Despite political favor and wide popular support for small businesses, a study in 2011 from researchers at the Census Bureau and the University of Maryland found that youngness, rather than smallness, better predicts a company’s rate of growth. Young firms generate the majority of new jobs, not small firms. And according to researchers at the National Bureau of Economic Research, the results of their study should cause lawmakers to reconsider the hype surrounding small businesses.
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