• George Cook

Let's Geek out for a Minute: Community Lending and Economic Theory


Small businesses matter. Trust us, it’s math.

As I’ve discussed in previous posts (VIEW PREVIOUS POST HERE), community-based lending for local businesses is vanishing due to massive bank consolidation in the United States. Sadly, we lose one community bank nearly every day.

Here, we want to demonstrate why this is such a serious problem by employing some basic economic theory. George is a former economist at the U.S. Bureau of Labor Statistics and Ken holds a Master’s in Economic History from the London School of Economics, so you’ll have to excuse us while we geek out a bit. But first, some Econ 101 vocabulary:

Externality - An externality is a side effect of one person or group’s action that impacts others. Externalities can be either negative or positive and by definition are not captured in the actors’ decision-making:

  • A negative externality happens when someone else’s action has a negative impact on you. It could be secondhand smoke or pollution. Basically, there is a hidden cost that is being paid by you, not the smoker or the factory. As a society we often try to reduce negative externalities through taxes, regulation, or education.

  • A positive externality is when you get a free benefit from someone else’s action. For example, if your neighbor has a beautiful flower garden, you get to enjoy the view - and maybe even reap some home value appreciation - without tending the garden yourself. Sometimes we try to incentivize positive externalities by subsidizing healthcare or job training.

Market Failure - Economics is rooted in supply and demand. A market failure is some distortion that prevents supply and demand from reaching their optimal meeting point, known as equilibrium. As we’ll explore, the hidden costs and rewards of externalities can cause market failures.

As it turns out, local businesses on Main Street America are oozing with positive externalities, for example:

  • Clean sidewalks and streets with well maintained storefronts

  • Higher employment levels and a stronger tax base

  • Support for local programming like Little League Baseball or Shakespeare in the Park

  • A general spirit of optimism and progress

This is great for us community members who get to enjoy the benefits that local businesses provide. In fact, the Buy Local movement helps show we are often willing to pay a little more for something that is sourced or sold locally. That is called internalizing an externality - we pay a small premium for all of those positive externalities.

Historically, community banks also enjoyed benefits from the positive externalities of local businesses - a prospering commercial district supports the health of all local businesses which strengthens the performance of a community bank’s local loan portfolio. Therefore, whether consciously or not, community banks would factor positive externalities into their underwriting decision.

However as banks consolidate, lending decisions are being made further and further from the communities they impact and without a local perspective, positive externalities are no longer being taken into account. To sum it up graphicly:

By failing to take into account a business’s positive impact on the community, traditional lenders are providing too little credit to local business. In Econ-speak the supply of credit is suboptimal because positive externalities are not being internalized. This is artificially pushing interest rates higher and making it more difficult for businesses to get loans.

Bringing the community’s perspective back to business lending will allow us to internalize positive externalities again, thus making it easier for a business to get a loan while reducing borrowing costs. We firmly believe that this will strengthen communities all across America.

It’s unlikely that we will see a massive resurgence in the traditional brick and mortar community bank model. That’s why we advocate for technology empowered solutions that bring community lending back in a scalable way. This vision inspired us to build Honeycomb - a debt crowdfunding platform that allows local businesses to borrow from their own loyal customers.

Honeycomb’s business model allows the recipients of the positive externalities - the customers of local businesses - to internalize those externalities by lending the money themselves to businesses in their own communities. Businesses get broader and more affordable access to expansion loans while individual investors have a new-found opportunity to invest locally and support the businesses and communities they love.

How have businesses made your community better? What ideas do you have to bring a local voice back to lending solutions? We’d love to hear from you!

George Cook is the Co-Founder and CEO of Honeycomb. As a sixth-generation small-town community banker, George is passionate about the positive impact that local lending can have on communities. When he’s not trying to fix the U.S. financial services system, George can be found exploring the wonderful neighborhoods and local businesses of Pittsburgh with his wife, Elizabeth.

Ken Martin, CFA is the Co-Founder of Honeycomb. As a serial entrepreneur, Ken has experienced the highs and lows of being a business owner and left his investment banking career to devote himself to building great companies. When not geeking out over fintech regulations you can catch Ken and his lovely girlfriend, Lindsey, sailing the SF Bay.


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