Small-business lenders are getting some help from programs in roughly 20 states that backstop loans to risky borrowers.

These states, including Texas, California, and Illinois, have established funds to absorb the first losses on loans to small businesses that can't qualify for traditional loans.

Wells Fargo & Co. is pushing Arizona and Washington to adopt what is known in most states as a Capital Access Program. "It's a very effective tool to help lenders reach more small businesses," said Michael K. Gallagher, Wells Fargo Bank's manager of government loan programs.

Mr. Gallagher said state governments should establish such loan programs now so local businesses will have access to capital if the economy slumps and banks tighten lending standards.

"If you wait for a recession, given how long it takes to enact legislation, you will be 18 months into a credit crunch and there will be a lot more failed businesses than there should be," he said.

The second-largest bank lender to small business, Wells Fargo recently made the first loan under a program Texas set up this fall. The $70,000 went to a San Antonio company that installs water pumps.

More than 70 banks use the program in Oklahoma. Since Illinois established its program 10 months ago, 43 banks have funneled $7 million to 119 businesses. "It gives us an opportunity to do the riskier transactions," said Laura Lee, a commercial loan officer for Uptown National Bank in Chicago.

Although they vary from state to state, most programs follow the design established in Michigan in 1986. Typically, the state sets up the fund with an initial contribution and then the state, the banks, and the borrowers chip in a percentage of each new loan made to cover potential losses.

In Texas, the state put up $6 million and requires the second round of contributions to equal at least 8% of each loan made.

Mr. Gallagher said these sorts of programs allow Wells Fargo to issue credit lines to young, rapidly growing businesses that have recently begun to turn a profit but wouldn't meet the bank's usual lending criteria.

"We're making the decision to say yes to riskier borrowers," he said. "We would not have done this without the states' initiatives."

In most states, bankers make all the loan decisions and set the interest rates and fees. Bankers say the state programs are more flexible and require less paperwork than Small Business Administration programs. The SBA sets the terms, fees, and establishes a range of interest rates that can be charged for loans made through each of its programs.

For example, Ms. Lee said Uptown National issued a credit line to a small company that hires temporary employees to distribute food samples in grocery stores. That company had too many employees to qualify for an SBA loan, she said.

Although the loans are riskier than traditional bank loans, state officials said losses have not exceeded expectations. For example, in California losses averaged 5%. Twenty banks have made 15,000 loans for $209 million since that program was started in 1993.

"Businesses were able to expand and continue operations, when some might otherwise have had to close," said Fred Smith, an assistant state treasurer for California.

Subscribe Now

Access to authoritative analysis and perspective and our data-driven report series.

14-Day Free Trial

No credit card required. Complete access to articles, breaking news and industry data.