Where There Are More Local Community Banks, Rural Entrepreneurs Are More Likely to Obtain Conventional Business Loans

Decline of local banks in nonmetropolitan areas has been a challenge for small business owners, who may turn to personal savings, credit cards or contributions from family and friends, Baylor researchers say

The greater the proportion of local banks in a nonmetropolitan area, the better the chances that a conventional business loan helped start or expand a business, according to a Baylor University study. The finding suggests that a locally oriented financial sector should boost such a community’s well-being.

“It allows local business owners in nonmetropolitan America greater access to the types of capital that often prove most useful and affordable to start and maintain businesses,” said lead author F. Carson Mencken, Ph.D., professor and chair of sociology in Baylor’s College of Arts & Sciences.

The study — “Community Banks and Loans for Nonmetropolitan Businesses: A Multilevel Analysis from the 2007 Survey of Business Owners” — is published in the journal Rural Sociology.

Mencken and co-author Charles M. Tolbert, Ph.D., professor of sociology at Baylor, analyzed data from the “2007 Survey of Business Owners and Self-Employed Persons” of the U.S. Bureau of the Census. Included were 52,000 business owners in 381 nonmetropolitan commuting zones in the 48 contiguous states.

The researchers note that, over the past 40 years, rural America has contended with several major changes affecting the quality of life — among them the farm crises of the 1970s and early 1980s, globalization, factory farming, the loss of manufacturing jobs to overseas locations and the retail invasion of “big box” stores.

Just as challenging and more recent has been the sharp decline in locally owned banks in nonmetropolitan areas — down to one in five banks (20 percent), a sharp contrast to 80 percent local as recently as 1976, according to estimates from previous research by Tolbert, Mencken and Lynn Riggs, an economist with the U.S. Commodity Futures Trading Commission.

A major benefit of conventional loans — which have fixed terms and rates and are not government-insured — is that they allow businesses to be more flexible and weather sales downturns. They also do not require that business owners invest large portions of their personal savings. That enables owners to maintain a personal reserve to weather the early years of a new business, when profits tend to be small or absent, according to the study.

While large business ventures have many financial options — such as publicly traded stock, venture capital, private equity and loans from large financial corporations — local businesses in rural communities are usually smaller, with fewer employees and fewer options.

Proponents of consolidation of large banks with local ones argue that such mergers have been good for small businesses in underserved markets. They say that larger banks can provide loans at better rates because they have greater assets with less risk, and they also are less susceptible to state and regional economic shocks.

But another viewpoint is that a larger percentage of locally owned banks increases the likelihood that smaller businesses can obtain conventional loans because the banks and businesses have a symbiotic relationship. In addition, while smaller businesses may not have hard data on earning and credit scores to compete for loans at large banks, local lending institutions have access to such “soft data” as a person’s reputation and standing in the community.

Banks lend money where the potential returns are the greatest, researchers wrote. While some policy and legal lending requirements are intended to minimize that effect — such as Small Business Association lending programs — many small local businesses may struggle to find conventional financing, according to the study.

Among other study findings about nonmetropolitan businesses and loans:


  • Home-based businesses are not likely to use business loans to start or expand a business.
  • Better-educated owners have greater odds of using business loans for both start-up and expansion, with such owners posing lower risks to banks.
  • Males have 71 percent greater odds of using a business loan than females.
  • White business owners have greater odds of using a business loan to start a business than nonwhites.
  • While rural Hispanic owners have a lower likelihood of obtaining startup business financing (relative to white male owners), Hispanic owners are 40 percent more likely than white males to get expansion bank funding.


The authors contend that the paradoxical findings for Hispanics suggest that business ownership may be a pathway for Hispanic assimilation in nonmetropolitan America. They note that further research is warranted.

More examination of alternative sources of financing also should be done before discussion of long-term economic consequences of financial restructuring, the researchers said. Exploration of race, gender and ethnic differences in the use of conventional financing also could prove valuable.

Previous research by Tolbert, Mencken and their collaborators has shown that a thriving small business sector leads to stronger communities with higher levels of income, less income inequality, less poverty, better public health, lower crime and less out-migration of residents to other areas.

“In rural areas, community vitality depends in part on a thriving small business sector,” Tolbert said. “That means that community banks are key local institutions — no less important than schools, churches and government. In rural areas where there are relatively fewer of these civic organizations, community banks are far too important to fail.”

*The research by Mencken and Tolbert was funded by a grant from the Agriculture and Food Research Initiative of the National Institute of Food and Agriculture.

Baylor University is a private Christian University and a nationally ranked research institution. The University provides a vibrant campus community for more than 17,000 students by blending interdisciplinary research with an international reputation for educational excellence and a faculty commitment to teaching and scholarship. Chartered in 1845 by the Republic of Texas through the efforts of Baptist pioneers, Baylor is the oldest continually operating University in Texas. Located in Waco, Baylor welcomes students from all 50 states and more than 80 countries to study a broad range of degrees among its 12 nationally recognized academic divisions.