The Value to Banks of Small Business Lending

Abstract

By estimating the market premium placed on the small business loan portfolios of banking organizations, this study provides direct evidence on the value to banks arising from relationship lending. Using data from the small business loan survey contained in the June bank Call Reports, we find that small commercial and industrial (C&I) loans do, in fact, add value, both in absolute terms and relative to the value contributed by larger C&I loans. The value-enhancing effect of small business loans is observed primarily at community banks, and it is present not only during normal economic conditions, but also during the Great Recession of 2007-09. Furthermore, the value creation emanates primarily from the smallest, relationship-based CI loans with original values of $100,000 or less. In contrast, small commercial real estate loans (CRE), being relatively more transactional than C&I loans, do not contribute additional value to banking organizations.

Keywords: relationship lending, small business loans, value of banks, community banks, financial crisis

JEL Classification: G21, G28, G31