What does it take to start a small business? You need an idea, a plan, and – most of all – money, and for most people that means applying for a startup loan. But who get those loans? Though many people assume that loan applications are judged objectively, startup lending actually replicates many other societal biases, and that means race and gender play a significant role in determining whose loan applications get approved. It’s important for lenders to pay attention to how they process applications to correct decades of discrimination in lending and even the playing field for new business owners.
Race And Lending
Starting a business requires determination and grit, no matter who you are, but ask borrowers like minority entrepreneur Dilla Wood and lenders will hear a clear message: it’s harder for people of color. As Wood, who took out an SBA 504 loan in 2006 for a commercial real estate project explains, as a person of color, “Minorities … tend to be greeted with subtle skepticism about being able to go through the lending process.” But not all lending bias is so subtle, as a study by Rutgers Business School reveals.
In order to objectively assess how race impacts lending, Rutgers created 26 matched pairs of white and African-American individuals to act as loan applicants. The pairs were given the same clothing, equally strong credit histories, and similar business profiles, both above average lending standards – but the African-American applicants were given slightly stronger applications overall. So what happened?
When the borrower pairs approached the same banks for a business expansion loan, the study found that African-American borrowers were asked for far more information than their Caucasian counterparts. This included being asked for more business information and for information regarding their marital status and spousal employment. They also received less encouragement and lower quality customer service overall.
The fact is, racial discrimination in lending rarely involved turning applicants away at the door, but about all the small actions that work against minority entrepreneurs. This compounds cash flow problems, which are disproportionately common among Hispanic business owners and other minorities.
The Gender Gap
Of course, racial minorities aren’t the only people who face discrimination when applying for a business loan; women are also held to a higher standard. For example, the standards for SBA loan applicants, such as Dilla Wood, are generally quite stringent. To get an SBA startup loan, applicants need to make a 20-30% capital contribution, should be able to show 2-5 years of financial projections, and must have already been in business for at least six months. It’s a hard bar to pass, but women are generally made to show an even greater degree of preparedness to secure funding, and even when they are given loans, women are consistently underfunded by a wide margin.
According to a 2014 inquiry by Democratic Senate staffers, women own 30% of US businesses. If men and women received loans at equal rates, then, men would receive about $2.50 for every dollar women receive. In reality, though, for every dollar in traditional business loans women receive, men receive $23. This disparity is part of a long history in which women are viewed as being less skilled at operating a business than men, despite there being no evidence of this bias.
Additionally, today’s startup environment is increasingly STEM-oriented, and this is another area in which women commonly face discrimination. This has resulted in women holding an unusually low number of patents – only 20% of patents list at least one female inventor, according to the Institute for Women’s Policy Research. This holds down women’s economic growth and makes it harder for them to expand what businesses they do have.
Greater awareness of lending discrimination is the first step to reducing existing disparities, but it will take more than that to stop it. In particular, without stricter legal oversight, lenders will continue to use unscrupulous means to block women and minorities from borrowing money. This isn’t about any particular business owner or lender, but about transforming our entire financial system.