Who you know counts, even when applying for PPP loans


Newswise – In the chaotic first weeks of the COVID-19 pandemic, the Paycheck Protection Program (PPP) was a lifeline for many struggling businesses. It provided government-guaranteed, repayable bank loans to businesses with fewer than 500 employees to cover payroll costs, utilities, mortgage, and rent.

There was a mad race for the first round of P3 loans, and the $ 349 billion fund was used up in less than two weeks. Many small businesses were shut out while large corporations and franchises received millions in forgivable loans.

Now new to research conducted by researchers at Washington University in St. Louis, Boston College and the University of Geneva shows how, with little oversight or accountability, lenders have prioritized PPP loan applications from companies with relationships previous loan or personal ties with bank executives in the early stages of the program.

“Collectively, our results provide some of the most accurate estimates to date of the role of connections in promoting patronage in lending by financial institutions,” said Xiumin martin, professor of accounting at the Olin Business School at the University of Washington. “In addition, they highlight the conflicts of interest resulting from the design of the paycheck protection program and the importance of oversight and aligned incentives in financial intermediation.”

The latest round of PPP loans opened in January 2021 with $ 284 billion available, although some rules have continued to undergo changes after the difficult launch last year.

The researchers – including Martin and Ivy Wang, a doctoral student at Olin, as well as Ran Duchin from Boston College and Roni Michaely from the University of Geneva – focused their analysis on publicly traded companies, because the accounting data of these PPP beneficiaries were more accessible than private ones. companies. Public companies also offered a natural sample to detect favoritism as they are less likely to qualify for P3 loans due to their size.

In the sample, they found: the average loan size was $ 3.2 million; 5.8% of beneficiaries had a past lending relationship with their PPP lender; and 36% of recipients had personal connections to senior executives at the lending financial institution, such as shared education, previous employment, and nonprofit background.

Researchers found that having a previous loan relationship increased the likelihood of getting a P3 loan by 57%. In particular, 75% of relational borrowers obtained a PPP loan compared to 18% of non-relational companies. Likewise, a personal connection between the borrower’s senior management and the lender increased this probability by more than 7%.

Obviously, the favoritism had an impact on the requests that were approved. But did these connected businesses deserve as many PPP loans as stated in the program criteria?

Borrowers with past lending relationships were 24% more likely to repay their PPP loans than their unconnected counterparts. Likewise, borrowers with personal relationships were 10% more likely to repay their loans.

In the end, some companies chose to repay PPP loans either because the program would not meet their needs or because they did not meet the criteria. For some large companies, such as Shake Shack and Ruth’s Chris Steakhouse, the public reaction was too strong.

The researchers found that borrowers with previous lending relationships were 24% more likely to repay their P3 loans than their untied counterparts. Likewise, borrowers with personal relationships were 10% more likely to repay their loans.

“Not only does our research provide unequivocal evidence of favoritism in bank lending in the first round of PPP funding, but it also suggests that banks have deviated from the program’s stated goals for their connected borrowers,” said Martin.

For many reasons, banks have been the biggest winners from P3s. They played an important role in granting loans and prioritizing borrowers. Their incentives were different from those of the government.

Since the loans are fully guaranteed by the Small Business Administration (SBA) and repayable, participating lenders are not exposed to credit risk and concerns about defaults are irrelevant. In addition, the eligibility conditions of the request only require good faith certification from the borrower.

“Our research shows that banks have leveraged the PPP loan allocation to strengthen their business relationships with large, connected companies amid the COVID-19 crisis,” Martin said. “That, together with the origination fees charged by banks and their lack of exposure to credit risk, amounted to a net transfer from taxpayers to banks. “

This misuse of public funds is not unique to PPP.

“In general, when public funding – such as grants or credits – is allocated by private entities, the incentives of different actors must be taken into account in the design of the program to counter perverse incentives and ensure that the program is continuing towards its intended use, ”Martin mentioned.

The public outcry that followed the early stages of the PPP led to increased government control and oversight. Unsurprisingly, their research found that relationship lending played a weaker role in the second round of PPP. However, the effect of personal relationships, which are more difficult to detect and control, intensified in the second round.

When the third round of PPP funding was launched last month, the program included new guarantees to ensure funds were used appropriately. Based on their research, Martin said these efforts should go a long way in alleviating favoritism.

“While controversial, I think government oversight such as screening borrowers on their eligibility and ex post (after the fact) monitoring of loans can help on this front. By employing technology-based fintech companies to participate in distribution and oversight, the SBA should have a greater ability to tighten up the lending process, ensuring that taxpayer dollars go to their intended use, ”he said. she declared.


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