Student Loan Debt and Business Start-ups

ON his blog, Darren Fishell has a very interesting preliminary study from Penn State and the Philly Fed regarding the negative correlation between student loan debt and small business start-ups.  He writes:

The study found that in counties where student debt increased its share of the total consumer debt — mortgages, credit cards, car loans — the number of businesses started with one to four employees dropped. It factored in county-level differences in population, demographic makeup and other local economic conditions. The study attributes that to smaller businesses relying more heavily on personal debt to get started, whereas larger firms have access to other financing.

In short, would-be business entrepreneurs have a fixed amount of debt they can hold, and with tuition and student loan debt consuming more of that amount, the less debt capacity there is to take on further debt to start-up a business.

The study looks at the years 2000 to 2010 to compare student loan debt growth and small business start-up activity to arrive at these conclusions, and while it controlled for some elements (i.e., demographics), it did not seem to account for two essential elements impacting small business growth; the recent economic downturn and the tightening of lending standards.

As the study notes, entrepreneurs require capital to start up a business, and the authors suggest that student loan debt is driving down demand for the capital.  However, while the rise is student loan debt can certainly be argued to have a negative impact on the growth of small businesses, there are a confluence of other factors (some of recent vintage, some with roots in changes in the credit markets dating back to the 1990s) that have helped suppress small business growth.

One of the big reasons is that lending standards have tightened in general, and more specifically lending to small businesses and business start-ups has been fading over the past decade and a half.  The following is from a 2011 Economic Brief published by the Richmond Fed:

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The graph reveals that the demand for credit is cyclical.  Interestingly, however, while the demand by small businesses for credit is cyclical, the demand for credit by business start-ups is counter-cyclical.  The report suggests this is because as economic conditions weaken, non-traditional channels of credit (family and friends) dry up and require entrepreneurs to head to more formal channels such as banks.

Two problems exist here. First, as Ann Marie Wiersch of the Cleveland Fed wrote in 2013:

At the same time that fewer small businesses are able to meet lenders’ standards for cash flow, credit scores, and collateral, bankers have increased their credit standards, making even fewer small businesses appropriate candidates for bank loans than before the economic downturn. According to the Office of the Comptroller of the Currency’s Survey of Credit Underwriting Practices, banks tightened small business lending standards in 2008, 2009, 2010, and 2011.

. . . 

Moreover, while banks have loosened lending standards for big businesses during the recent economic recovery, they have maintained tight standards for small companies. Figure 1 shows the net tightening of lending standards (the percentage of banks tightening lending standards minus the percentage loosening them) for small and large customers from 2003 to 2012. As the figure indicates, net tightening was slightly greater for small businesses than large businesses in 2009 and 2010. However, in 2011 and 2012, there was a net tightening of lending standards for small businesses, despite a net loosening for big businesses.

Second, Wiersch notes that there has been a decade and a half long trend by banks away from small business lending and into other sectors in the credit market:

The 15-year-long consolidation of the banking industry has reduced the number of small banks, which are more likely to lend to small businesses. Moreover, increased competition in the banking sector has led bankers to move toward bigger, more profitable, loans. That has meant a decline in small business loans, which are less profitable (because they are banker-time intensive, are more difficult to automate, have higher costs to underwrite and service, and are more difficult to securitize).

And the downward trend in lending to small businesses is occurring at smaller banks as well as the larger financial institutions, according to 2011 research from the San Francisco Fed:

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While student loan debt is not mentioned in the above research, there are logical reasons why the rise in debt held by recent graduates looking to start up a business would be a barrier to starting a business.  As Wiersch wrote:

Lenders see small businesses as less attractive and more risky borrowers than they used to be. Fewer small business owners have the cash flow, credit scores, or collateral that lenders are looking for. 

Obviously the rise in student loan debt can make loan applicants less appealing to lenders.  Also, the rise in student loan debt might also deter some from even inquiring about a loan because they believe they do not have access to credit.  However, neither Wiersch nor the Penn State/Philly Fed study investigate whether student loan debt deters would-be entrepreneurs from inquiring about a start-up loan.

There is also the cyclical component to the small business lending decline.  A report issued by the New York based non-partisan policy research and advocacy organization Demos together with Opportunity Maine highlight the impact of the credit crunch on small business lending.  From the report:

Now more than ever, the future of Maine’s middle class depends on the health of our small businesses. Yet the engine of a thriving small business economy—affordable credit—has stalled in our state since the financial industry set off the Great Recession in 2008. While Maine has lost 30,000 jobs, the largest banks have returned to profitability after taxpayer bailouts, and many of these same banks have yet to restore lending to small businesses and consumers to pre-crisis levels.

For example, in 2007, one of our largest out-of-state banks made only 29 Small Business Association 7(a) loans—the flagship program for small business lending—in Maine.  In 2009 and 2010, the same bank made zero SBA 7(a) loans—a 100 percent decline that has pushed Maine small businesses either out of business or onto higher-interest credit cards. The average business card interest rate is 16 percent, but quality SBA 7(a) loans average seven to nine percent. In 2009, 97 percent of the bank’s small business loans in Maine were on credit cards.  According to a May 2011 Maine Small Business Coalition survey, 68 percent of small businesses in Maine experienced deteriorating credit terms during the recession.

The large bank lending cutbacks have had a disproportionate impact on the Maine economy due to high bank consolidation in the state. Just three large national banks currently control 50 percent of all deposits, up from 37 percent before the crisis


One of the proposals from that report to overcome the decline in lending is the creation of a state bank, which would keep tax dollars and the state and .  As noted above, the demand for loans to start a business are counter-cyclical, but lending standards tighten and access to credit for small businesses declines during these periods of high loan demand.  As the report notes, the Bank of North Dakota increased the number of loans it participated in with local banks by 35% during the recession.

This proposal is supported by a 2011 study published by the Maine Small Business Coalition and Alliance for a Just Society.   Noting that loans from large banks to small businesses declined, the study, which surveyed 109 small businesses, also found that an overwhelming number of the business owners surveyed (96%) preferred to bank with a local/community bank.  Moreover, 72% of respondents supported the creation of a state bank like the Bank of North Dakota.  Creation of such a bank in Maine has been on the legislature’s agenda, but has met opposition from the mainstream banking industry.

Obviously the barriers to credit for would-be entrepreneurs is multifaceted, and Fishell’s post highlights another potential element to those barriers.  The issue of the student loan–damping of business start-up activity nexus becomes more nuanced, and questions as to how student loan debt impedes access to credit need to be investigated.  This investigation needs to take place against the backdrop of tightened lending standards, as well as the trend by some lending institutions away from providing credit to small businesses and start-ups.


John Haskell

About John Haskell

John graduated from the University of Southern Maine with a degree in Political Science, and from the University of Maine School of Law. He has worked in both the public and private sectors, and currently, works with a small business services company in the Mid-Coast area.