Small Firms Are Big on Plastic

A report issued today by the Federal Reserve highlights the importance of credit cards to small businesses.

It also gives the banking industry some ammunition in its efforts to keep business credit cards exempt from the consumer protections adopted last year for personal credit cards.

The Fed found that 83 percent of small businesses used credit cards at the end of 2009. Small-business cards, which are issued to the firms themselves instead of individuals, were used by 64 percent of small businesses, while 41 percent used personal credit cards. Some businesses, of course, used both.

Most small businesses paid off their balances at the end of each month—only 18 percent borrowed money through their credit cards.

Small businesses found that credit cards were much easier to get than bank loans last year. About 20 percent of small businesses applied for a new credit card last year, most of them business cards. Nearly three-fourths of these applicants were successful. By contrast, only one-third of small businesses were successful in getting lines of credit last year, and only one-half managed to get a bank loan.

Small-business credit cards tend to have higher limits than personal cards, the Fed found. Pricing for these cards vary with the firm’s riskiness and the credit history of the card’s guarantor, either the business owner or an authorized officer. The Fed found little information on the interest rates that small-business cardholders pay, but says it appears they’re similar to consumer credit cards.

Banks, however, say that issuing and servicing costs are higher for small-business credit cards than they are for consumer cards. Plus, loss rates on small-business credit cards historically have been 20 percent to 30 percent greater than they are for consumer cards. That could be because the most risky small businesses are the firms that are most likely to run up debt on their credit cards.

That’s where public policy on credit card terms comes in. Congress last year enacted reforms that imposed restrictions on credit card companies’ ability to change a card’s rates and terms, such as increasing rates on existing balances. Small-business credit cards, however, were not covered by these changes.

That was a gross omission, according to the National Small Business Association, which found that 68 percent of its members reported that the rates and terms of their credit cards had deteriorated over the last five years. Applying consumer protections to small-business credit cards is “a must for small business,” NSBA contends. “Why Congress would willfully neglect such a huge swath of credit card consumers is unfathomable,” NSBA states.

The Fed, however, can fathom the reason, although it was careful to see both sides of the issue. Applying the credit card protections in effect for personal cards to small-business cards would protect small businesses from harmful practices, but it also could have “the potential for adverse effects on the cost and availability of small-business credit cards.”

It’s harder to evaluate the creditworthiness of a small business compared with a consumer. That means limiting the ability of a bank to raise interest rates on a card may lead to higher initial interest rates, the Fed concluded. Credit card companies also might reduce credit limits in response to such restrictions.

The benefits of applying consumer credit card restrictions to small-business credit cards may not “outweigh the potential risk of increased cost and reduced credit card availability for small businesses,” the Fed concluded.

That’s just what bankers wanted to hear.

“Small businesses will lose access to small-business credit cards if lenders are restricted in their flexibility to manage risk,” said Kenneth Clayton, a senior vice president at the American Bankers Association.

“The ultimate takeaway from this report is that Congress should proceed cautiously when considering anything that might impact the availability of credit for small businesses,” he said.