Newswise — Approximately ten years ago, a group of researchers from Brigham Young University, Utah State University, and Rutgers University conducted a disheartening study that shed light on the detrimental impact of discrimination in bank loan services on minority entrepreneurs, tarnishing their pursuit of the American Dream.
Regrettably, even in the year 2023, the situation remains largely unchanged. A recently published paper authored by the same group of researchers reveals that banks continue to provide Black customers with inferior loan products and service, despite the fact that these customers possess objectively stronger financial profiles and higher FICO scores compared to their White counterparts.
According to Glenn Christensen, a co-author of the study and a professor in the BYU Marriott School of Business, despite the considerable passage of time and societal reckoning, the patterns of discrimination observed in the past persist. He emphasizes that discrimination in loan services has neither changed nor improved, highlighting that it remains an ongoing problem.
However, the new paper published in the Journal of Marketing Research does provide a glimmer of hope. While financial institutions bear the responsibility to eradicate discrimination, the study identifies specific empowering approaches that minority small business owners can utilize to signal a higher level of sophistication. By implementing these strategies, they can increase their chances of obtaining business loans on a more consistent basis.
Sterling Bone, a co-author of the study and a professor of marketing at USU's Huntsman School of Business, noted that individuals may be completely unaware that they are being subjected to differential treatment. He emphasizes that the burden should not be placed on the consumer, but the study has identified ways to mitigate bias and counteract discrimination in loan services. The aim is to provide strategies that can effectively neutralize bias and create a fairer lending environment.
To examine the persistent racial bias within financial lending institutions and identify strategies for mitigation, the researchers conducted three field studies:
Study 1: Twelve Black and twelve White testers visited 52 bank branches in the Atlanta metro area over a four-month period. They posed as potential small business loan customers with strong business profiles that easily qualified for loans. Interestingly, the Black testers were provided with even better profiles, including higher business income, more years in operation, greater funds in the bank, and higher credit scores. Despite their superior financial profiles, the Black testers were offered a business line of credit (BLOC) significantly less frequently compared to the White testers.
Study 2: White and Black testers, both with high or low socioeconomic profiles, approached banks in the Washington, D.C., metro area over a six-week period to inquire about small business loans. The results showed that White customers with low socioeconomic profiles received significantly more favorable treatment compared to their Black counterparts with the same profile. However, the study also revealed that Black testers with high socioeconomic profiles received similar treatment as their White counterparts, indicating a leveling of bias based on socioeconomic status.
Study 3: The researchers surveyed 266 small business owners nationwide to investigate how the structure of their companies (e.g., sole proprietorship vs. LLC) influenced loan approvals. They discovered that loan approvals for Black-owned sole proprietorships were less than half of those for White-owned sole proprietorships. However, when Black entrepreneurs operated as joint proprietorships or partnerships, the racial bias in loan approvals was mitigated. Moreover, when Black entrepreneurs utilized LLC, S corps, or C corps as their business structures, the racial bias was reversed, with 75% of Black owners obtaining loan approvals compared to 42% of White owners.
Sterling Bone emphasizes that despite the existing problems that need to be addressed and eliminated, it is crucial for banks to acknowledge the presence of bias. However, there is some hope, as interventions are being discovered to empower consumers and improve the situation from their perspective. By taking additional steps to signal legitimacy and sophistication, individuals can counteract potential biases and enhance their chances of fair treatment from financial institutions. These interventions provide avenues for consumers to navigate the lending process more effectively and overcome potential biases based on perceptions.
Christensen highlights a specific step that small business owners can take, which involves registering their company as an LLC for a cost of approximately $45. This registration acts as an external indicator of sophistication, which potential lenders may perceive positively. Additionally, the study findings suggest that minority business owners with high FICO scores should explicitly communicate this information upfront when applying for a loan. By proactively emphasizing their strong creditworthiness, these entrepreneurs can increase their chances of receiving fair consideration from lenders.
Christensen emphasizes the importance of effectively conveying one's best story when seeking a loan. He suggests that all loan seekers, particularly minorities, should make a conscious effort to present their strongest case. The data supports this approach, indicating that if minority individuals seeking loans can skillfully manage the loan application process and effectively communicate their story, they are more likely to achieve a favorable outcome. By highlighting their strengths and unique value proposition, loan seekers can enhance their chances of receiving a more positive response from lenders.
In a more critical vein, the researchers urge financial services executives to recognize the need for action and address the issue of employee biases proactively. The authors of the study propose that companies establish policies to ensure equal offering of loan product options to all customers, and mandate that each loan application be independently evaluated by at least two employees. Additionally, the researchers suggest that firms enhance their internal compliance with legal frameworks, purposefully design more inclusive products, and employ self-service technology to mitigate bias.
Lastly, the study also recommends specific actions for policymakers to take. These include the creation of standardized small business lending forms, the implementation of funding programs that offer technical assistance and education specifically targeted at minority-owned businesses, and the enhancement of oversight and enforcement measures to ensure compliance. By adopting these measures, policymakers can play a crucial role in addressing the biases and disparities in the financial services industry.
“The bias training at banks is simply not working,” Bone said. “It’s time to do something different.”
The study's lead author is Maura Scott, a marketing professor from the Rockwood School of Marketing at Florida State University. The co-authors of the study include Anneliese Lederer from the National Community Reinvestment Coalition, Martin Mende, a professor of marketing and business administration at Florida State University, Brandon Christensen, a doctoral student from the University of Colorado, and Marina Cozac, a doctoral candidate from the Rockwood School of Marketing at Florida State University.
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