Discrimination rampant in small business loans

A study by the University of Washington’s Foster School of Business released Tuesday has uncovered significant disparities in lending practices affecting businesses owned by people of color and women.

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One surprising finding was the breadth of the interest rate differential, with businesses owned by people of color and women facing interest rates two to three percentage points higher than their white and male counterparts. Additionally, while large banks have made progress in lending to Black-owned businesses, there is still a lack of progress in lending to Hispanic and Asian-owned businesses.

The study also revealed that Hispanic-owned firms continue to face significant differentials across all types of lenders, and Asian-owned firms pay higher interest rates than their white counterparts at large banks. “This information is crucial for minority business owners,” Verchot said. “It helps them understand where they might find more equitable lending practices.”

People of color, women paying more for business loans

“The study results clearly show that businesses owned by people of color and women pay higher interest rates and have higher collateral requirements than their white and male counterparts,” Michael Verchot, the director of the Consulting and Business Development Center at the Foster School, told MyNorhwest. He emphasized that these disparities persist even when accounting for all risk factors, indicating ongoing discrimination in interest rate setting and collateral requirements.

Verchot highlighted that the study, the first of its kind in 20 years, reveals two critical points: “Race, ethnicity, and gender still play a factor in interest rate and collateral differences, but we also see progress made by large and small banks in reducing these differentials across certain sectors of the business community.”

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The study, which collected nearly 2,800 responses from 44 states, found that financial institutions are potentially missing out on untapped markets. “Profit-seeking institutions with the correct information will compete for business,” Verchot explained. “Financial institutions can grab additional market share and make additional profits if they price their loans more equitably across racial, ethnic, and gender lines.”

Financial institutions losing money by not having more equitable lending practices

Verchot noted that the study serves as a call to action for financial institutions. “With this information, people who make decisions about loan policies and underwriting criteria can make different decisions,” he said. The study estimates that the interest rate differential costs businesses owned by people of color $8 billion annually in additional interest payments. Verchot said closing this gap could lead to significant job creation across the country.

The study also provides valuable insights for minority business owners. “If I’m a Black business owner, I now know where I can go for a fairer shake,” Verchot said. “I can get more equitable interest rates if I go to a big bank or a small bank versus a credit union or a FinTech firm.”

Verchot hopes the study will provoke change within the financial community. “We’re hoping that with this information, financial institutions will make changes in their policies and practices that will benefit us all,” he said.

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The findings underscore the need for continued efforts to address discrimination in lending practices and promote equitable access to financial resources for all business owners.

The study’s comprehensive approach included responses from nearly 2,800 businesses across 44 states, providing a broad perspective on the issue. Despite the national scope, Verchot noted that the number of responses from Western Washington was too small to draw specific conclusions for the region. However, he emphasized that there is no reason to believe that financial institutions in Western Washington behave differently from those in other parts of the country.

The discrimination in interest rates is significant

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“We were surprised by a couple of the results,” Verchot admitted. “One, we were surprised by the breadth of the interest rate differential. We’re looking at between two and three percentage point difference in interest rates based on the race, ethnicity, and gender of the borrower. The other thing we were surprised by is the progress that big banks have made in lending to certain segments of the business community, specifically to Black-owned businesses, but there is still a lack of progress in lending to Hispanic and Asian-owned businesses.”

Vershow pointed out that while Black-owned businesses have seen some improvement in lending practices from large and small banks, they still face challenges with other types of lenders. “When it comes to loans from credit unions, FinTech firms, and community development financial institutions, Black-owned businesses still face significant disparities,” he said.

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Verchot concluded by emphasizing the potential economic impact of addressing these disparities. “The interest rate differential costs businesses owned by people of color $8 billion a year in additional interest payments,” he said. “If we can close that gap, we can create a significant number of jobs and stimulate economic growth across the country.”

The study calls for financial institutions to reevaluate their lending practices and make necessary changes to promote fairness and equity. “This is really a call to action,” Verchot said. “Banks, FinTech firms, credit unions, and other lenders can make changes in their policies and practices that will benefit us all, both in Western Washington and across the country.”

Bill Kaczaraba is a content editor at MyNorthwest. You can read his stories here. Follow Bill on X and email him here.