Why Banks Won't Give You a Small Business Loan

There’s a scene in It’s a Wonderful Life where George Bailey is running a small bank, fighting to keep loans going to regular people. He’s the good guy. The bank is on the side of the little guy.

Then there’s Wall Street, where Gordon Gekko is doing shady deals and doesn’t care about anyone. That’s the bad banker.

Most people have one of these two images in their head when they think about banks and lending. Either the bank is your friend who wants to help, or it’s a greedy machine that only cares about profit.

The truth is way more boring than either movie. And Chapter 2 of Charles H. Green’s book explains exactly why.

Banks Don’t Have a “Risk Appetite”

Green makes this point early and he makes it hard. The phrase “risk appetite” is basically an oxymoron when it comes to bankers. They don’t have an appetite for risk. They have an allergy to it.

Everything a bank does when it makes a loan is designed to find risk and kill it. Collateral. Personal guarantees. Covenants. Hundreds of pages of legal documents. They want to make sure that if something goes wrong, they get their money back no matter what.

This isn’t because bankers are evil. It’s because of where the money comes from.

It’s Not Their Money

Here’s the part most people miss. When a bank makes you a loan, it’s not lending you the bank’s money. It’s lending you money from depositors. Regular people who put their savings in checking and savings accounts.

Those deposits are insured by the FDIC. The federal government literally guarantees that money. So when a bank lends it out, there are a lot of people watching to make sure they’re being careful.

How many people? A lot. There are over 7,400 banks in the United States all competing for deposits. Every one of them is regulated by at least one of these: 50 state banking regulators, two federal regulators (the Federal Reserve and the Office of the Comptroller of the Currency), plus the FDIC itself.

That’s a lot of oversight. And all those regulators have one main concern. Don’t lose the depositors’ money.

So when a banker looks at your loan application, they’re not thinking “how can I help this person grow their business.” They’re thinking “if this goes bad, can I explain this to the regulators.”

Coca-Cola vs. Joe’s Deli

Green uses a comparison that makes the whole problem obvious.

Imagine you’re a banker. You can lend money to Coca-Cola or you can lend money to Joe & Sons Deli down the street. Which one is easier?

Coca-Cola has audited financial statements going back over a century. Thousands of analysts cover the company. Their revenue is predictable. Their assets are massive. The risk is almost zero.

Joe never paid for professional financial statements. He does his books on a spreadsheet. Maybe. He probably can’t read a balance sheet. His revenue depends on foot traffic and whether a new restaurant opens next door. He has no track record that a bank can verify.

The bank can lend to Coke in its sleep. Lending to Joe requires real work. And that’s where the next problem comes in.

The Scaling Problem

Making a small business loan costs almost the same as making a big loan. You still need to recruit the borrower. Analyze their financials. Underwrite the deal. Get it approved. Close it. Then service it for years.

All that work might earn the bank a few thousand dollars in interest on a $50,000 loan. Or it might earn them hundreds of thousands on a $5 million loan. Same work. Wildly different payoff.

This is why minimum loan sizes keep going up. A lot of banks won’t even look at a loan under $250,000. The math just doesn’t work for them.

Think about that for a second. Most small businesses don’t need $250,000. They need $20,000 or $50,000 or $100,000. But banks can’t make money on those deals. So they just don’t do them.

The Size Irony

Here’s something that doesn’t make intuitive sense. Smaller community banks actually handle the bigger small business loans. They know their local businesses. They have relationships. They can sit down with Joe and figure out if his deli is a good bet.

But big national banks? They handle the smaller loans. How? Not through personal relationships. Through credit cards and automated branch products. You walk into a Chase or Bank of America, and the “small business loan” you get is basically a credit card with a higher limit.

The personal touch that small businesses actually need comes from small banks. But those small banks have limited resources and limited reach. And the big banks that have the scale don’t have the interest in truly understanding small businesses.

Still Handing Out Paper Applications

Green points out something that was true when he wrote the book and is still kind of true today. Banks are not exactly technology leaders.

While tech companies were building platforms that could serve millions of users in real time, banks were still handing out paper loan applications. The underwriting process was slow. The approval process was slower. And the technology behind it all was decades old.

Banks lacked imagination when it came to using technology to make small business lending work. They could have built better systems. Faster analysis. Automated underwriting for small loans. But they didn’t. They just kept doing things the old way.

And that gap? That’s exactly where the new wave of lenders saw their opportunity.

The Bottom Line

Banks aren’t trying to screw you over. They’re running a very specific business with very specific constraints. They use other people’s money. They answer to a dozen regulators. They can’t afford to take big risks. And they can’t afford to spend a lot of time and money on small loans.

None of that is great news if you’re a small business owner who needs $50,000 to grow. But at least now you understand why the banker on the other side of the desk isn’t exactly jumping at the chance to help.

The system isn’t broken because bankers are bad people. It’s broken because the system was never really built for you in the first place.

This post is part of a series on The Banker’s Guide to New Small Business Finance by Charles H. Green, published by Wiley (2014). It covers Chapter 2: “Elusive Nature of Bank Funding.”

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