© Evanston Photographic
the Glen Vasel Associate Professor of Finance
information revolution in small business lending
Petersen, the Glen Vasel Associate Professor of Finance
lending to a firm or an individual, bankers must evaluate
the likelihood of repayment. Historically, the method for
evaluating the two loan applications has been different. When
an individual applies for a mortgage or a credit card, a computer,
not a loan officer, often makes the decision based on analysis
of the applicant's credit report. Automated data collection
and lending decisions make these markets impersonal, national
in scope and more competitive.
markets for small firms are quite different. Firms do not
have credit scores. Instead, a loan officer interviews the
entrepreneur, and possibly customers and suppliers, to assess
the proposed investment's merit. The lending decision is based
on the officer's judgment; information that is difficult to
computerize or automate. Historically, the small business
lending market has been a local market, based on personal
lending market of the 1950s was described in the same terms.
Lenders knew their borrowers personally, not through computerized
data. Over the past three decades, the consumer lending market
has been transformed, but has the small business lending market?
changes in small business lending, we examined the Federal
Reserve's Survey of Small Business Finances. The survey describes
firms' relationships with their banks, including loans, deposit
accounts and their purchase of financial services. It also
records the distance between a firm and their bank branch
as well as how they communicate with their bank.
the evolution of firms' banking relationships, two facts are
striking. First, the distance between firms and their lenders
has risen by 9 percent per year from the early 1970s to the
1990s; a 460 percent increase (Fig.
1). Figure 1 Correspondingly, firms' communication with
their banks has become progressively more impersonal. The
fraction of firms communicating with their banks in person
falls from 68 to 34 percent.
caused this dramatic change? Given U.S. banking history the
answer may be obvious: deregulation and consolidation. There
were more than 14,000 banks in the U.S. at the beginning of
our sample. The number dropped to less than 11,000 by 1992
2). This reduction could explain the growing distance
between firms and their lenders. This explanation, however,
is too simple.
banking consolidation begins in the mid 1980s, yet the growth
of distance and impersonal communication starts a decade earlier.
Second, we measure distance between firms and their lender's
branch; although the number of banks has been declining since
the mid 1980s, the number of branches has consistently grown.
Thus, other forces must be at work.
transforms the way we store, transmit and process information,
and the information-intensive banking industry has exploited
this technology. Using credit scoring models to make lending
decisions is an example of substituting capital for labor.
Previously, loan officers would review an application —
a labor-intensive and qualitative process. Lending decisions
based on credit reports and analytic decision rules, however,
require less of the loan officer's time. Personal intervention
has not been eliminated, just focused on the most marginal
decisions. Loan originations involve fewer people and more
that greater use of information technology has transformed
the lending market, we examined how bank employment has changed.
The ratio of bank employees to loans, a measure of the labor
intensity, drops by almost 50 percent over our sample as banks
automate the loan approval process. The reduction in employees
explains the increase in the distance we documented. In regions
where banks replaced employees with information technology
early, distance increases at the same time.
has sped up human ability to process information, it has altered
information-intensive industries such as lending. The growing
national scope of lending has the capacity to lower the cost
and expand the availability of capital for small firms. Whether
it does is an open question.
is based on Petersen and Raghuram Rajan's "Does Distance Still
Matter: The Information Revolution in Small Business Lending,"
Journal of Finance, Dec. 2002.