Nearly ten years ago, a group of researchers from Brigham Young University, Utah State University, and Rutgers shed light on a disconcerting phenomenon: discrimination within the realm of bank loan services, which cast a shadow over the American Dream for minority entrepreneurs.
Regrettably, as we enter the year 2023, it appears that little progress has been made. In a recently published paper authored by the same group, it is revealed that banks continue to provide Black customers with inferior loan products and services, even when these customers possess objectively stronger financial profiles and FICO scores compared to their white counterparts.
“Even though a lot of time has passed and a lot of reckoning has taken place in society, we are still seeing the same discrimination patterns we’ve seen in the past,” the researchers explain. “It hasn’t changed, it hasn’t ameliorated, and it’s still a problem.”
Racial bias
In order to evaluate the persistent racial bias prevalent within financial lending institutions and, ultimately, to identify potential remedial measures, the researchers undertook three distinct field studies:
Study 1 involved a group of twelve Black testers and twelve white testers who visited 52 bank branches across the Atlanta metro area ovefour monthsod. These testers assumed the role of potential customers seeking loans for small businesses.
Equipped with business profiles that exceeded the criteria for loan qualification, the Black testers were furnished with even stronger profiles (including higher business income, longer operational history, greater funds in their accounts, and superior credit scores). Surprisingly, despite their superior financial profiles, Black testers were offered business lines of credit (BLOC) significantly less frequently than their white counterparts.
Study 2 employed both Black and white testers, each assigned either a high or low socioeconomic profile. These testers were instructed to approach banks in the Washington, D.C. metro area ovesix weeksan to inquire about small business loans.
The researchers discovered that white customers with low socioeconomic profiles received significantly more favorable treatment compared to their Black counterparts with identical profiles. However, intriguingly, the study also revealed that Black testers with high socioeconomic profiles received comparable treatment to their white counterparts.
In Study 3, the researchers conducted a survey encompassing 266 small business owners from various locations across the country. The purpose was to examine how the structure of their businesses, such as sole proprietorship versus LLC, influenced loan approval rates. The findings demonstrated that loan approvals for Black-owned sole proprietorships were less than half the rate of those for white-owned sole proprietorships.
However, when the business structures of Black entrepreneurs shifted to joint proprietorships or partnerships, the racial bias in loan approvals was mitigated. Additionally, when Black entrepreneurs operated under the structure of LLC, S corps, or C corps, the racial bias was reversed: 75% of Black owners had their loan applications approved, in contrast to 42% of their white counterparts.
Ongoing problems
“There are still problems we need to root out; banks need to recognize the bias that exists,” the researchers explain. “But there is some hope, as we are seeing ways to empower consumers with interventions to improve the situation from their end. There are little extra steps to signal you are more legitimate and sophisticated than what might be perceived.”
One step that small business owners can take is to register their company as an LLC, which would help to persuade lenders that the business is more sophisticated. What’s more, minority business owners with a high FICO score should also ensure that this is made clear when they look for finance.
“Everyone should tell their very best story,” the authors continue. “The data backs that up: if minority loan seekers can manage the moment, the outcome will be more favorable.”
Accepting the problem
Significantly, the researchers underscore the need for financial services executives to acknowledge the existence of persisting challenges and to proactively address employee biases. To this end, the study’s authors propose the implementation of robust policies aimed at ensuring the equitable provision of loan product options to all customers.
They recommend the requirement for independent evaluation of each loan application by at least two employees. Additionally, firms are encouraged to enhance internal compliance with legal frameworks, deliberately craft more inclusive product offerings, and leverage self-service technology as a means to mitigate bias.
Furthermore, the study emphasizes the role of policymakers in taking decisive action. It suggests the creation of standardized small business lending forms, which would contribute to a more consistent and equitable application process.
Policymakers are also urged to allocate funds towards programs that offer technical assistance and education specifically tailored to minority-owned businesses. Moreover, increased oversight and enforcement measures are deemed necessary to ensure fair practices and promote accountability within the lending industry.
“The bias training at banks is simply not working,” they conclude. “It’s time to do something different.”
