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PROVO, Utah — The United States is supposed to be the land of opportunity, but troubling research out of Utah reports the business playing field is still far from level for minority entrepreneurs. Scientists at Brigham Young University say that banks are still offering Black customers inferior loan products and services. Importantly, this remained true even among highly qualified Black customers with objectively stronger financial profiles and FICO scores in comparison to Caucasian customers.
Just under a decade ago, researchers at Brigham Young University, Utah State University, and Rutgers University released a disheartening study that documented how discrimination in bank loan services was quite common at the time. This latest study, published in the Journal of Marketing Research in May 2023, suggests not much has changed since then.
“Even though a lot of time has passed and a lot of reckoning has taken place in society, we are still seeing the same discrimination patterns we’ve seen in the past,” says study co-author Glenn Christensen, a professor in the BYU Marriott School of Business, in a statement. “It hasn’t changed, it hasn’t ameliorated, and it’s still a problem.”
When applying for small business loans, Black applicants were significantly less likely to be approved compared to their White counterparts, even when their financial profiles were stronger. This disparity was particularly pronounced for sole proprietorships, where White entrepreneurs were approved for loans at more than double the rate of Black entrepreneurs (60% vs. 25.71%).
Beyond loan approvals, the research uncovered discrimination in the very fabric of customer interactions. Bank employees displayed less warmth and competence toward Black customers, offering inferior service and fewer favorable product options. For instance, Black customers were less likely to be offered Business Lines of Credit (BLOCs), which are generally more flexible and less risky for borrowers compared to Home Equity Lines of Credit (HELOCs).
On a more positive note, the study did note a silver lining: While it’s ultimately up to the financial institutions themselves to eliminate discrimination, the research team identified specific empowering approaches minority small business owners can employ to signal a certain “level of sophistication” in order to secure business loans on a more regular basis.
“Individuals may be totally oblivious that they are being treated differently,” adds study co-author Sterling Bone, a professor of marketing at USU’s Huntsman School of Business. “We don’t want to pass the burden to the consumer, but we find there are ways to turn off the bias.”
To analyze racial bias among financial lending institutions, and ultimately discover useful mitigation strategies, researchers conducted three field experiments:
Experiment one: 12 Black and 12 White testers visited 52 bank branches in the Atlanta metro area over the course of four months posing as potential customers seeking loans for small businesses. The testers were given business profiles that should have been strong enough to easily qualify for a loan, and Black testers were even given better profiles (greater business income, more years in operation, more money in the bank, and higher credit scores). Despite those superior financial profiles, Black testers were ultimately offered a business line of credit (BLOC) significantly less often than White testers.
Experiment two: White and Black testers were given either a high or low socioeconomic profile and told to inquire about small business loans with banks in the Washington, D.C., metro area over the course of six weeks. Sure enough, White customers with low socioeconomic profiles were treated significantly more favorably than their Black counterparts with the same exact profiles. That being said, the study also found that Black testers with high socioeconomic profiles received treatment generally similar to their White counterparts.
Experiment three: Researchers surveyed 266 small business owners all over the USA to see how the structures of their companies (e.g., sole proprietorship vs. LLC) impacted loan approvals. Regarding Black-owned sole proprietorships, they found loan approvals were less than half that of White-owned sole proprietorships. However, when Black entrepreneurs’ business structures were joint proprietorships or partnerships, the racial bias on loan approvals appeared to be mitigated. Additionally, when Black entrepreneurs had LLC, S corps or C corps, the racial bias was actually reversed: 75 percent of Black owners had loans approved, while only 42 percent of White owners were approved.
“There are still problems we need to root out; banks need to recognize the bias that exists,” Prof. Bone explains. “But there is some hope, as we are seeing ways to empower consumers with interventions to improve the situation from their end. There are little extra steps to signal you are more legitimate and sophisticated than what might be perceived.”
Prof. Christensen points to one specific step small business owners can take to help their case: Spend $45 to register their company as an LLC. Potential lenders see this move as an outside indicator of sophistication. He adds that the study’s findings suggest minority business owners with high FICO scores should be sure to make that fact very clear up front upon setting out to seek a loan.
“Everyone should tell their very best story,” Prof. Christensen comments. “The data backs that up: if minority loan seekers can manage the moment, the outcome will be more favorable.”
Most importantly, however, study authors are calling on financial services executives to acknowledge this troubling trend and take action to pre-empt employee biases. They suggest such firms develop policies that ensure loan product options are uniformly offered to all customers and require at least two employees independently evaluate each loan application. Moreover, firms can increase internal compliance with legal frameworks, deliberately design more inclusive products, and use self-service technologies to lower bias.
Finally, the research team also recommends policymakers step up in specific ways as well by creating standardized small business lending forms, funding programs that provide technical assistance and education for minority-owned business, and increasing overall oversight and enforcement.
“The bias training at banks is simply not working,” Prof. Bone concludes. “It’s time to do something different.”
Paper Summary
Methodology
The study employed a multi-method approach to investigate racial discrimination in financial services. Field experiments used matched-pair mystery shopping, where trained Black and White testers visited banks to inquire about small business loans. These testers followed scripted scenarios and reported on their experiences. Another field study surveyed real small business owners about their loan application experiences during the COVID-19 pandemic. Additionally, a laboratory experiment was conducted with financial service professionals, who evaluated hypothetical loan applications that varied by race and business structure. These diverse methods allowed the researchers to examine discrimination from multiple angles and in real-world contexts.
Results
The study found significant evidence of racial discrimination across various aspects of financial services. Black customers were less likely to be offered favorable loan products like Business Lines of Credit (17.35% vs. 40.43% for White customers). They also experienced less warmth and competence from bank employees and reported lower loyalty intentions. In the survey of small business owners, Black sole proprietors were approved for loans at less than half the rate of White sole proprietors (25.71% vs. 60%). However, these disparities were reduced when Black customers signaled higher socioeconomic status or had more sophisticated business structures.
Limitations
The study acknowledges several limitations. The use of matched-pair testing, while providing strong evidence of discrimination, may not capture all nuances of real-world interactions. The survey of small business owners during the COVID-19 pandemic may reflect unique circumstances not generalizable to other periods. Additionally, the laboratory experiment with financial professionals, while insightful, may not perfectly mirror real-world decision-making processes. The researchers also note that their focus on Black and White customers doesn’t capture the experiences of other racial and ethnic groups in the financial services industry.
Discussion and Takeaways
The study’s findings underscore the persistent problem of racial discrimination in financial services and its detrimental effects on both customers and businesses. The researchers emphasize the need for a multi-faceted approach to address this issue, involving financial institutions, policymakers, and entrepreneurs. They suggest that banks implement more standardized processes, increase employee training, and develop inclusive products to reduce bias. For policymakers, the study highlights the importance of stronger oversight and enforcement of fair lending laws. The researchers also recommend that Black entrepreneurs consider adopting more sophisticated business structures and seek out technical assistance to improve their chances of loan approval. Overall, the study provides a clear call to action for all stakeholders to work towards a more equitable financial system.
Funding and Disclosures
The study authors declared no potential conflicts of interest with respect to the research, authorship, and/or publication of this article. They also stated that they received no financial support for the research, authorship, and/or publication of this article. The research was conducted in collaboration with the National Community Reinvestment Coalition, which assisted with data collection.
