Is the CARD Act Hampering Small Business Borrowing?

Yera Dominguez receives a credit card from a customer for payment at Lorenzo's Italian Market in Miami, Florida. Photograph by Joe Raedle/Getty Images

In 2011, the number of small loans ($1 million or less) to businesses dropped 4.7 percent from the year before, the Small Business Administration recently reported (pdf). The number of loans is now down to about three-quarters of its 2008 peak. Why has the number continued to drop since the end of the Great Recession?

I have written before about many of the big reasons. Demand is weaker than before the economy turned south, reducing demand for credit to finance operations and expansions. The weak real estate market has made it harder for small business owners to get property loans and has dried up the home equity credit market, which many small business owners relied on to finance their businesses. And Federal Reserve efforts to toughen bank lending standards in the wake of the financial crisis have meant that fewer small businesses qualify for bank credit.

Another factor behind the most recent decline may be the CARD Act, which went into effect in February 2010 and has led small business owners to shift from business to consumer credit cards. The new law protects consumers from some of the banks’ less desirable credit-card practices. In response to the new law, banks have reduced some fees, are much less likely to raise interest rates on accounts already in place, and have made credit-card costs more understandable. Democratic Representative Nita Lowey of New York proposed the same protections for business cardholders, but Congress failed to pass her bill.

We don’t know how much the CARD Act has affected small business borrowing. But its effect could be substantive. The Federal Reserve reported (pdf) to Congress that they’re an important source of credit: In 2009, the latest year it tracked, 83 percent of small business owners used credit cards for their businesses, and 18 percent borrowed on them.

Moreover, a National Federation of Independent Business report (pdf) suggests that the difference between protections on consumer and business credit cards may have contributed to the decline in the number of small business loans. It shows that the fraction of small business owners who use personal credit cards for business increased from 42 percent in 2009 to 49 percent in 2011, while the fraction who use business credit cards declined from 64 percent to 59 percent.

Some SBA data supports the NFIB’s hypothesis. Microloans ($100,000 or less), which include credit-card loans, account for 95 percent of the drop in small loans to business in 2011, the SBA report mentioned above shows. On the other hand, the decline in the number of microloans began in 2008, two years before the introduction of the CARD Act.

Policy makers need to figure out how much of the decline in small loans to businesses comes from the shift from business to personal credit cards. Small business lending has declined to levels not seen since 1999, erasing the runup in credit during the loose financing of the early 2000s and suggesting that the small business credit pendulum has overshot its correction. But addressing the decline in small business credit requires an understanding of why it has happened, since the correct solution depends on the mix of factors that caused the decline.

More important, the decrease in small loans to businesses might simply be a benign statistical anomaly. Because the SBA data do not include personal loans, the drop might be counterbalanced by a corresponding rise in personal credit not covered by the report. In the absence of a problem, of course, there is no need for policy makers to intervene.

That brings me to the third reason policy makers need to figure out why the number of loans has dropped. Every law Congress passes has consequences, many of which are unintended. In this case, failing to pass the same protections for business credit cards as for consumer cards may have led small business owners to swap the type of cards they use, an outcome no one in Congress had intended. Swapping cards might not seem significant, but it does illustrate how crucial access to credit is and how it important it is to identify and address the factors constraining it.

Before it's here, it's on the Bloomberg Terminal.