Human bias skews small business relief lending, study finds

Automated loan vetting improves approval rates for Black businesses.

From the very start of the Paycheck Protection Program last year, it was clear that minority entrepreneurs, especially Black business owners, struggled more than white borrowers to find a willing lender. A new research project indicates that the problem was particularly pronounced at smaller banks — and human bias appears to be the main reason.

The majority of Black borrowers who received aid from the $800 billion relief program got their loan from a financial technology company, not a bank, according to an economic working paper released Monday. The skew toward those so-called fintechs was far sharper among Black borrowers than any other racial group.

“I was taken aback by the striking disparity — it was a surprising and unexpected fact, and we wanted to figure out why,” said Sabrina T. Howell, an assistant professor of finance at New York University’s Stern School of Business and the lead author of the paper.

It turned out that the automated loan vetting and processing systems used by the fintechs, as well as some of the nation’s biggest banks, significantly improved approval rates for Black borrowers, the researchers found. They didn’t find such stark gaps for any other racial group they examined, including Asian and Hispanic applicants.

The findings come amid growing scrutiny of how algorithmic systems can inadvertently perpetuate biases. Regulators like the Consumer Financial Protection Bureau are examining whether lenders using such systems run afoul — even inadvertently — of fair-lending laws.

But Howell said her new research helped illustrate how technology could also help level the playing field.

“The human brain is a much scarier black box than any machine-learning algorithm,” she said. “You can constrain an algorithm to meet fair-lending standards and you can ensure the data it trains on isn’t biased. That may be hard to do, but it’s a clear and objective possibility. Whereas when you have a human loan officer who is in front of someone and making a decision, you can never do that.”

A trade group for small banks, the Independent Com

munity Bankers of America, defended its members, saying that community lenders had “outperformed the rest of the banking industry in serving minority-owned, women-owned, and veteran-owned businesses.”

In particular, the group criticized the steps the researchers had to take to determine the race of applicants. Collecting data on borrowers’ ethnicity was optional for lenders, so Howell and her colleagues used Census Bureau data on business owners’ locations and surnames to project what race they were likely to be. The banking group said those methods turned the research into “an unreliable guessing game.”

But Sergey Chernenko, an associate professor of finance at Purdue University’s Krannert School of Management who was not involved in Howell’s research, said the new paper aligns with his own findings on race-based gaps in Paycheck Protection Program lending. At an economic conference next month, he is presenting a paper that concluded that Blackowned

businesses were disproportionately left out of the relief program.

“This fits very well with and complements our finding that minority-owned businesses were less likely to get loans because of racial bias, and to the extent that they do get them, they’re more likely to get them from fintechs than banks,” Chernenko said.

The government designed the Paycheck Protection Program to be virtually riskfree for lenders: They would advance small companies up to $10 million — the size of the loan was based on the company’s head count and payroll — and the government would then pay off the loans in full for business owners that followed the rules. If the borrower defaulted, the government would still repay the lender. In theory, any lender should have been willing to lend to any qualified applicant.

It didn’t work out that way. Many banks limited their loans to their current customers, which was a hurdle for owners who lacked business checking accounts or loans. But even Black owners who had accounts were noticeably more likely than those of other races to end up with a fintech loan, Howell and her co-authors found.

NYT At large financial institutions like Bank of America, Blackowned businesses appeared just as likely as any other to get a loan, after researchers adjusted for variables.