Better data is key to beating bias in small-business lending

Enjoy complimentary access to top ideas and insights — selected by our editors.

After nearly a decade of business ownership gains for both women and identifiable minority business owners, the recession following COVID-19’s arrival is set to devastate that growth. Manufacturing, food services, construction and accommodation services have been hit hard — 20% of businesses in immediate-risk industries are run by Asian or Black owners and 39% are female-owned.

Current reports indicate that nationally, people of color represent roughly 40% of the population, but only 20% of the nation’s 5.6 million small-business owners with employees.

With the onset of COVID, vulnerable business owners felt the crushing blow of forced closures and many were already in a precarious financial position. The Federal Reserve Banks reported that small businesses owned by underrepresented groups were significantly more likely to show signs of limited financial health, with large banks reportedly approving 60% of loans sought by white small-business owners, 50% of those sought by Hispanic or Latinx small-business owners, and a minuscule 29% of those sought by Black business owners.

These statistics aren’t a product of 2020. Research carried out in 2016 by Sarah Harkness suggested that lenders assess borrowers based on cultural stereotypes and determine the borrowers’ status based on those perceptions. In an eye-opening experiment, Harkness evaluated a series of loan applications whose race and gender were tampered with. Despite the applicant’s having identical financial histories, the results frustratingly show that race and gender “significantly affect lenders’ funding decisions because they alter lenders’ status beliefs about the applicants,” making the pursuit of a small-business loan for underrepresented borrowers an uphill battle.

When it comes to the race and/or ethnicity of a given applicant, at the end of the day, it really has no impact on a candidate’s viability for a loan. Alternative lenders are of a new, modern class of business, using methods that are changing the nature of the industry — for the better. Companies that have embraced the digital world reduce the need for face-to-face interactions and are working to eradicate the “issue” of race regarding loan approvals. Business owners should be provided with an equal opportunity based entirely on the health of their business.

If one of the most consistent realities in the lending market is the differential treatment of Black, Hispanic and female borrowers, it begs the question of what can be done to better serve marginalized groups and increase their chances of receiving the funding they deserve. There are a growing number of grants available for women and minority business owners, signaling a step in the right direction, but these grants don’t address underlying issues that plague the lending environment. As we continue to move away from face-to-face interactions and transition to online and digital applications, we inevitably eliminate inherent and systemic bias. A computer algorithm does not increase or decrease fundability according to a last name, a skin tone, or an accent, and it can review data holistically to create a full picture of fundability faster and more efficiently. The answer is simple — look toward technology.

In the digital lending landscape, underserved business owners can attain equal footing with their cohorts. Using a tech-powered marketplace that’s 100% online is a timely solution for providing business loans for underserved communities and a step that guarantees funding based on the health of one’s business alone.

In the past we’ve seen how the data used to assess fundability is incomplete and in some respects a product of systemic racism and ingrained bias. However, through the increased use of technology, along with holistic data points, racial and gender disparity in lending can be eradicated and fintech leaders can usher in a more equitable era for small-business lending.