Credit Scores and Credit Market Outcomes: Evidence from the Survey of Small Business Finances and the Kauffman Firm Survey

Rebel A. Cole, January 2014

Purpose

Small businesses often struggle to find available credit. Building on previous literature, this research analyzes what factors, including business credit scores, may explain credit outcomes (approvals or denials) for small businesses. It further asks what role business credit scores might play in the credit outcomes of women- and minority-owned small businesses.  

Background

Credit Scores. Statistically derived and numerically presented, a “credit score” reflects an individual or entity’s likelihood of repaying a debt. Generally, a higher credit score correlates with a lower probability of default. The consumer credit market has utilized credit scores for decades, but small business credit scores emerged only during the 1990s. Large lenders adopted small business credit scoring in subsequent years. Evidence indicates the emergence of business credit scoring may have increased credit availability to small businesses. A study of small business loan patterns indicates that banks using business credit scoring may feel able to make riskier loans at the margin and to increase their pool of available credit. Still, while this study focuses on business credit scores, evidence indicates the credit market may make use of both consumer and business credit scores in determining small business credit outcomes. For example, a study using U.S. Small Business Administration data finds that community lenders may weigh consumer credit scores heavily in evaluating small firms, often to the exclusion of business credit scores. Such findings may prove relevant to policy determinations regarding the use and transparency of all types of credit scores.

Women- and Minority-Owned Small Businesses. Pinpointing possible differences in credit access across race, ethnicity, and gender could prove important both to understanding varied credit outcomes and to policy determinations. For example, U.S. Census data indicate that minority-owned firms are smaller as measured by both sales revenues and employment, less profitable as measured by return on assets, and less likely to survive than their non- minority counterparts. In addition, women-owned firms tend to start with much less capital than their male counterparts, and Census data indicate women are also less likely to start or acquire firms with business loans from banks or financial institutions (5.5 percent of women owners versus 11.4 percent of male owners).

Several empirical studies have found evidence of disparate credit market outcomes for minority-owned small businesses. More specifically, several studies have found evidence of disproportionate loan denials to black-owned and Hispanic-owned firms, after controlling for other variables. This study confirms these findings and further asks whether business credit scores disproportionately affect access to credit for women-owned and minority-owned firms. Figures 1 and 2 illustrate business credit score distribution by race and gender.

Overall Findings

Regarding general access to credit, this study finds that small firms with lower credit scores are: (i) more likely to need additional credit because their credit needs have not already been met by past borrowings; (ii) more likely to be discouraged from applying for credit when they report a need for additional credit; and (iii) more likely to be denied credit when they need additional credit and apply for credit. Results also confirm prior findings that firm-lender relationships play a significant role in credit outcomes for small firms. Further, there is no evidence that credit scores reduce the importance of firm-lender relationships. Empirical results also confirm prior findings that the credit market disproportionately denies credit to minority-owned firms when they need and apply for additional credit, after controlling for other variables. (See Figure 3 for a distribution of credit market outcomes by race, ethnicity and gender¹). However, these results also indicate that credit scores do not disproportionately affect credit availability for either female-owned or minority-owned firms, relative to male-owned or non-minority-owned firms. In other words, the study did not find evidence that numerical credit score values were used disproportionately in credit determinations for minority-owned or women- owned firms.