Are ethnic minorities entrepreneurs discriminated against when seeking credit in the small business finance market?
Latest press releasesA Warwick Business School research paper recently published by Dr Stuart Fraser has examined the small business credit market using data from the UK Survey of Small and Medium Finances (UKSMEF) where summary comparisons have shown that there are much poorer credit outcomes for Ethnic Minority Businesses (EMBs) than for White owned businesses, with the poorest outcomes for Black and Bangladeshi owned businesses.
At face value, these results would seem to be an indication of discrimination, however, analysis of loan denials and interest rates points to differences in creditworthiness rather than ethnic discrimination as an explanation for poorer EMB credit outcomes. In particular, Black African firms are more likely to miss loan repayments or exceed their overdraft limits which appear to account for their higher loan denial rates.
Dr Fraser notes that the increasing use of credit and behavioural scoring systems, which do not allow transactions to be tainted by dubious judgements based upon ethnic perceptions by loan officers, is the main reason for the lack of discrimination in the UK. The report also compared the UK with previous findings for the US in the 1990s, when these 'arms length' measures were not as prevalent, and notes that there was measurable ethnic discrimination in the US loans market at that time.
The research found that Black Caribbean firms in the UK are less likely to apply for loans than White owned businesses due to fears of rejection based upon discrimination. Whilst the 'arms length' scoring systems have been successful in eliminating racial bias, ironically, they may also be responsible for these misperceptions since the reasons for rejection are not usually made clear to the applicant in these cases.
Improvement in information flows between finance providers and businesses about the criteria used to make credit assessments including providing the reasons for rejection would help tackle the misperceptions of discrimination, the research indicates. Particularly, finance providers should make it more clear that defaulting on a loan or exceeding an overdraft limit could have adverse consequences for future credit.
The research has highlighted a number of factors which need to be addressed in order to reduce ethnic variations in loan denial rates: lack of financial skills and advice; poor financial performance; and ethnic and cultural differences. Targeting EMBs for assistance with skills advice may help reduce delinquency rates and improve access to finance. This, together with finance providers investing more in their relationships with Black firms could cause significant reductions in dissatisfaction.
At face value, these results would seem to be an indication of discrimination, however, analysis of loan denials and interest rates points to differences in creditworthiness rather than ethnic discrimination as an explanation for poorer EMB credit outcomes. In particular, Black African firms are more likely to miss loan repayments or exceed their overdraft limits which appear to account for their higher loan denial rates.
Dr Fraser notes that the increasing use of credit and behavioural scoring systems, which do not allow transactions to be tainted by dubious judgements based upon ethnic perceptions by loan officers, is the main reason for the lack of discrimination in the UK. The report also compared the UK with previous findings for the US in the 1990s, when these 'arms length' measures were not as prevalent, and notes that there was measurable ethnic discrimination in the US loans market at that time.
The research found that Black Caribbean firms in the UK are less likely to apply for loans than White owned businesses due to fears of rejection based upon discrimination. Whilst the 'arms length' scoring systems have been successful in eliminating racial bias, ironically, they may also be responsible for these misperceptions since the reasons for rejection are not usually made clear to the applicant in these cases.
Improvement in information flows between finance providers and businesses about the criteria used to make credit assessments including providing the reasons for rejection would help tackle the misperceptions of discrimination, the research indicates. Particularly, finance providers should make it more clear that defaulting on a loan or exceeding an overdraft limit could have adverse consequences for future credit.
The research has highlighted a number of factors which need to be addressed in order to reduce ethnic variations in loan denial rates: lack of financial skills and advice; poor financial performance; and ethnic and cultural differences. Targeting EMBs for assistance with skills advice may help reduce delinquency rates and improve access to finance. This, together with finance providers investing more in their relationships with Black firms could cause significant reductions in dissatisfaction.
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