Federal Reserve Board Governor Edward M. Gramlich warned Monday that many rural banks may soon find themselves unable to fund small-business lending.

"Small banks experience a great deal of competition for deposits from money market funds and other deposit-taking institutions," he said. "As they lose these low-cost, lendable funds, many rural banks are finding it more difficult to serve the credit needs of their customers."

This deposit drain is worsened by the transformation of rural America, he said. As farmers die, their heirs are increasingly liquidating the estate rather than continuing to work the land, he said.

"In many cases, the funds on deposit at a local bank move with the new owners and these heirs frequently live and work in metropolitan communities located far from their original homes," he said.

The rural bank comments were part of a wide-ranging speech given at a Fed-sponsored conference on small business lending. Mr. Gramlich also strongly endorsed credit scoring, saying it can eliminate many of the barriers small businesses face in obtaining credit.

"Credit scoring increases the consistency, speed, and often the accuracy of credit evaluations," Mr. Gramlich said. "It also lowers the cost of gathering relevant information."

Small businesses benefit from credit scoring because it reduces waiting time on loan approvals to "minutes or hours" from "days or weeks," he said.

Mr. Gramlich, however, warned banks to regularly check scoring models for fairness. "Bank regulators must continue to ensure that the bank's credit scoring models are accurate and nondiscriminatory," he said.

The Fed governor dismissed concerns by some that bank consolidation will hurt small business lending. Though large banks make a lower percentage of their loans to small businesses, he said credit unions, thrifts, finance companies, and insurers more than pick up the slack.

Consolidation among smaller banks actually boosts lending, he said. "When small banks buy other small banks, the new entities tend to be more active small business leaders than the banks that were purchased," he said.

At the conference, several researchers presented studies showing that banks make fewer loans in minority neighborhoods than in white communities.

Fed economist Glenn Canner found that a 10% increase in minority population in an urban area results in a 1% decline in small business lending. "Predominately minority census tracts get somewhat fewer loans," he said.

Yet Mr. Canner cautioned against overreacting to the finding, noting it is based on the Community Reinvestment Act's small business data collection requirement. The CRA data does not include information on credit demand or credit quality, and only 20% of all banks are required to file this information, he said.

Malcolm Bush, president of the Woodstock Institute of Chicago, found that banks made an average of 15 small business loans per census tract. Yet predominately black census tracts had 2.6 fewer loans per tract and Hispanic areas 5.8 fewer loans than average.

Income also affects lending, he said. Lower-income communities receive about 50% fewer small business loans than upper-income areas, while moderate-income communities get 14% fewer loans than upper income areas, he said.

"While there is not direct evidence of discrimination ... the results are generally consistent with other research showing discrimination," Mr. Bush said.

These studies were harshly criticized by Anthony Yezer, a professor at George Washington University, who said the CRA data is so flawed that it should not be used as the basis for any research. The data ignores business growth rates, competition among lenders, and credit supply, he said.

"Just because you have numbers and you yell them loudly does not mean you have anything," Mr. Yezer said.

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