Why Many Small Businesses Have Missed Out on Federal Loans

Initial data suggest loan size, banking relationships could limit some applications

May 26, 2020


Federal programs have set aside about $650 billion in loans to help keep small businesses afloat during the COVID-19 pandemic, which has limited their ability to operate.

But initial data from the Small Business Administration showed a notable portion of loans approved under the Paycheck Protection Program (PPP), have gone to public companies and larger-sized small businesses – companies that requested at least $2 million to cover up to eight weeks of employee payrolls that couldn’t be made due to revenue losses.

Public companies and large firms that may have other resources have been offered no-penalty opportunities to return the funds while these findings have prompted questions on how to ensure that truly small businesses – the roughly 89 percent of U.S. businesses that employ fewer than 20 people – have equitable access to the funds.

PPP data show that loans over $2 million comprised a quarter of the funding volume in the first round of funding for the PPP, and about 16 percent in the second round, so far. Looking at initial PPP data, finance professor Manju Puri of Duke University’s Fuqua School of Business says there could be several reasons many small businesses have missed out on funds.

PPP grants have been described as available on a first-come, first serve basis. But the program also gives banks latitude to process applications for existing customers first, prompting some critics to suggest banks prioritized larger loan applications to yield bigger fees.

Higher fees may be part of the story, but not the full story, Puri said. Prior research on the value of long-term client relationships suggests banks also nurture relationships with existing clients because they can generate a lot more potential revenue down the road.

“There’s a large amount of literature that suggests relationships are important,” Puri said recently on a live discussion on LinkedIn (video above). “If I have a long relationship, I’m more likely in the future to maintain this relationship, get more business and it’s more likely to be profitable.”

Puri has also published research that demonstrates that customers who use even basic products like savings accounts are more likely to get loans with the same banks and are more likely to repay them, she said.

There are pros and cons to processing applications through banks, she said. 

“On the one hand, banks are everywhere, you have good reach, good processing capability, so it makes sense,” she said. “The unintended consequence is the power of bank-firm relationships and the way that can distort the loan-giving process, which may not always be in accordance with the objective of the policymakers.”

She suggested alternatives that might help truly small businesses – such as harnessing web-based technology to centralize applications in one place where the government can see the demand for funds, can manage the distribution and decide whom to prioritize based on need, she said.

Another strategy is to approve a broader set of lenders, which is an approach the SBA took in the second round of funding, allocating $60 billion to small and community banks, she said.

“Research tells us that small banks lend to small firms,” Puri said. “And in ongoing research I am doing at the FDIC when we look at why new banks are created… this is actually one of the reasons stated by new small banks being formed  -- that there are underserved segments of the market that need serving, and these small businesses are there.”

Based on data the SBA has released so far, loan applications from these smaller banks tend to be smaller on average, and so “hopefully this means the reach is better,” she said.

PPP rules continue to evolve. One recent change advises business that receive more than $2 million loans that they are subject to audits.

Audits could address several questions about whether firms who obtain loans really needed them, and whether the funds are going to the companies that needed them most, Puri said.

“The reason for an audit is to deter companies who don’t need this funding to get it,” she said. “But the guidelines need to be clear, otherwise companies don’t know what to do. … If you have a line of credit, do you need it? If you can get a loan from somewhere else, do you need it? What if you defaulted on a loan, then do you qualify as needing it? And so with all that uncertainty, it certainly becomes a lot harder to figure this out.”

Puri said she is hopeful that as more data on federal relief becomes available, a clearer picture will emerge on how loans were used during the pandemic and whether the goals of the PPP were successful. 

This story may not be republished without permission from Duke University's Fuqua School of Business. Please contact media-relations@fuqua.duke.edu for additional information.

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