What Is Industry Risk in Lending?

11 min read

Executive Summary

Your industry's "risk" is often comes up during lending application processes. One of many factors that lenders look at is your industry, and how inherently risky they believe that industry to be. Here's everything you need to know, including why you shouldn't fudge your NAICS code.

Disclaimer: Our first priority is giving you the best financial advice for your business. Tillful may receive compensation from our partners, but that doesn’t affect our editors’ opinions or recommendations in the content on our website. Editorial note

When you apply for a business loan, the lender is going to consider a variety of factors including your credit score, annual revenue, time in business, and industry risk. While you’re likely familiar with the first three, industry risk is a lesser-known term. So, what is it, exactly? Further, what factors make an industry more or less risky? Here’s what you need to know.

Table of contents:

What is industry risk in lending?

Industry risk in lending refers to the practice of a lender assessing the industry a business owner operates in to evaluate if it’ll impact their ability to repay a loan. For example, if you’re a financial consultant and apply for a business loan, your lender may research the financial advisory industry. It’ll look for anything that could disrupt your revenue or stability such as high chargebacks, extensive legal red tape, or technology disruptions. The less risk that your industry presents, the more likely you’ll be able to repay your loan — hence, the better the odds that you’ll get approved.

When do lenders evaluate industry risk?

It’s common practice for lenders to evaluate industry risk when vetting business loan applicants because a business’s ability to make the agreed-upon repayments hinges on the business’s revenue and performance. Consumer lenders may also consider industry risk if a borrower is self-employed for the purposes of extending personal loans, mortgages, and other lending products. With self-employment, again, the ability to repay a loan will hinge on the success of the business.

How do lenders evaluate industry risk?

During the initial credit application, lenders will often ask you to select your industry from a dropdown menu of business categories. They’ll typically use the Standard Industry Classification (SIC) and/or North American Industry Classification System (NAICS) to categorize business industries and their associated risks.

SIC codes

SIC codes are four-digit numbers that identify the primary activity of a business. For example, SIC code 6163 refers to loan brokers in the finance industry. The SIC system was created in the 1930s by the Securities and Exchange Commission, a branch of the U.S. government, for its own purposes. However, it began to be adopted by banks and lenders for the purpose of assessing business risk.

NAICS codes

By the 1990s, the SIC system was falling short. In response, the NAICS was developed by statistical agencies in Mexico, the US, and Canada. The goal was to establish a more logical and comprehensive system that could function as the North American standard. The NAICS goes beyond the four digits of the SIC system, with six digits.

Today, both systems are still in use in different capacities. For example, the credit reporting agency, Dun & Bradstreet, created an extension of the SIC system and uses it to define its customer’s business types. NAICS codes, on the other hand, are the standard used by federal agencies like the IRS.

Your lender will likely have you identify your business’s code from one of these systems. Then, it will look at the data on your selected business type to assess industry risk. The NAICS also releases an annual report on the business types that present the highest amount of risk (more on that below).

9 factors that can make your business high-risk

So, by now you may be wondering why industries are seen as risky. Note that these are based on ongoing assessments that take current events into consideration. The NAICS releases an updated list each year showing which businesses are the highest risk, suggesting that the ranking changes. Here are 9 possible factors.

High legal regulation

When industries are subject to extensive rules and regulations, it can make it more difficult for them to grow and be profitable. Highly regulated sectors include banking, insurance, transportation, healthcare, energy, agriculture, construction, defense, and postal services, according to Deloitte.

Sensitive to economic cycles

Certain industries are considered “cyclical,” which means they’re highly sensitive to economic cycles. They soar higher during good times and dive lower during downturns. These large fluctuations can be risky from the lender’s perspective. Examples of cyclical industries include construction and professional/business services, according to the data from the Bureau of Labor Statistics. Financial products and services (e.g. forex, cryptocurrency, etc.) are also inherently volatile as they’re directly connected to the financial market.

Cash intensive

Cash-intensive businesses like grocery stores, restaurants, and laundromats receive a significant amount of their receipts in cash. Unfortunately, these types of businesses are sometimes used by criminals for money laundering and terrorist financing operations. As a result, they will likely be subject to more scrutiny by lenders.

High chargeback rates

Chargebacks occur when customers dispute credit card payments with their card or bank account providers. If successful, a customer will have their funds returned from the business.

More chargebacks mean less revenue staying in the business’s pockets and more risk for lenders. Certain industries — including education/training, financial services, and software — tend to have higher-than-average chargeback ratios so may be seen as higher risk.

Pro tip: These are different from refunds. Most often, chargebacks are due to fraud but they can also result from cardholder disputes. To reduce their risk, credit card processors and merchant account providers typically set limits on the percentage of chargebacks businesses are allowed to have before they encounter fees and other restrictions.

Questionable products

When products are controversial or have a questionable impact on the public, they present a higher risk. Common examples include tobacco, vape products, fantasy sports, gambling, adult entertainment, cannabis, firearms, and casinos.

Lenders may consider these business types ineligible for funding. For example, the U.S. Small Business Administration won’t extend SBA loans to businesses engaged in gambling or rare coin dealing.

Vulnerable customers

Industries that serve customers that are at a higher risk of being exploited or harmed are considered riskier themselves. For example, businesses that provide financial services like payday loans, debt collection, and credit repair to customers struggling with a troubled credit history would fall under this category.

Technological disruptions

When industries undergo technological disruptions that fundamentally change how business is conducted, it creates instability and can drive companies out of business.

For example, digital media and technology have completely changed how American access news and entertainment. According to U.S. Census Bureau's Service Annual Survey (SAS), the revenue of newspaper publishers dropped by 52% between 2002 and 2020. Further, videotape and disc rentals decreased by 88.5% over the same period.

You can see similar trends in retail brick-and-mortar stores competing against e-commerce sites, taxi drivers being replaced by rideshare drivers, arcades being replaced by online gaming, and hotels competing against Airbnb and VRBO. If your industry is undergoing a tech disruption, it will likely raise red flags in the eyes of lenders.

High research and development (R&D) costs

When businesses within industries require a heavy investment in research and development, it can increase the risk level due to long product cycles, higher costs, and uncertain outcomes. This is common in the pharmaceutical, biotech, aerospace, automotive, and technology industries.

Supply chain shortages

Lastly, supply chain shortages can also increase the risk for lenders. When industries are facing shortages, businesses within them lose their ability to conduct business and meet demand. In recent times, pandemic-related supply chain disruptions have recently hit manufacturing, construction, retail trade, wholesale trade, and accommodation/food services the hardest, according to the U.S. Census Bureau.

Which types of business are considered high-risk?

Now that you know many of the factors that can cause a business to be considered high-risk, here’s a look at the list of high-risk business types for 2022, according to the NAICS Association.

  • New car dealers
  • Used car dealers
  • Recreational vehicle dealers
  • Boat dealers
  • Motorcycle, ATV, and all other motor vehicle dealers
  • Automotive parts and accessories retailers
  • Travel agencies
  • Casinos (except casino hotels)
  • General automotive repair
  • Specialized automotive repair
  • Automotive body, paint, and interior repair and maintenance

The NAICS also names many business types which are high-risk due to being cash intensive, including:

  • Tobacco product and electronic cigarette merchant wholesalers
  • Home centers
  • Paint and wallpaper retailers
  • Outdoor power equipment retailers
  • Nursery, garden center, and farm supply retailers
  • Convenience retailers
  • Vending machine operators
  • Beer, wine, and liquor retailers
  • Furniture retailers
  • Floor covering retailers
  • All other home furnishings retailers
  • Electronics and appliance retailers
  • Department stores
  • Pharmacies and drug retailers
  • Gasoline stations with convenience stores
  • Clothing and clothing accessories retailers
  • Shoe retailers
  • Sporting goods retailers
  • Hobby, toy, and game retailers
  • Sewing, needlework, and piece goods retailers
  • Musical instrument and supplies retailers
  • Book retailers and news dealers
  • Florists
  • Office supplies and stationery retailers
  • Gift, novelty, and souvenir retailers
  • Used merchandise retailers
  • All other miscellaneous retailers
  • Full-service restaurants
  • Limited-service restaurants
  • Cafeterias, grill buffets, and buffets
  • Parking lots and garages
  • Other grantmaking and giving services

Additionally, it names a few businesses that are high-risk due to being money-service businesses or non-bank financial institutions. Those include:

  • Consumer lending
  • Payment service providers, reserve, and clearinghouse activities
  • Other activities related to credit intermediation
  • Commodity contracts intermediation
  • Jewelry, watch, precious stone, and precious metal merchant wholesalers
  • Jewelry retailers
  • International, secondary market, and all other nondepository credit Intermediation (e.g. pawn shops)

Industries that we’ve seen lenders in our network consider high-risk

  • Trucking: though not fully restricted, usually, lenders require higher revenue and/or time in business for this industry
  • Contractor services: same as trucking
  • Credit repair
  • Other financial services
  • Cannabis

Myth or fact: You can get around NAICS codes by changing your business name

If your primary business activity is considered high-risk and thus has a high-risk NAICS, lenders may deny your loan applications. To get around that, some may try to misrepresent their primary business activity through steps including changing their business name. For example, a business that is primarily involved in the sales of automobiles may present itself as a seller of auto parts. While this could work, misrepresenting your primary business activity to a lender in order to get a loan could be considered fraud, and so isn’t recommended. Your NAICS code should best describe your primary business activity.

Ben Michael, Attorney, M & A Criminal Defense Attorneys says that once you register your business and get an NAICS code, that information is distributed to several different government agencies, each of which maintains their own records from that point on. This, he explains, is the weakness in the system that businesses sometimes think they can exploit.

He does acknowledge that using an NAICS code that isn’t actually associated with your business can be hard to catch. However, the consequences of getting caught may not be worth it. Ben says, “At minimum, your company may lose out on this particular contract. It's not out of the question that you'll be flagged and denied future deals as well, and if the fraud is extensive enough, there [could be] some risk of criminal or civil liability.”

Carolyn Young, Lead Business Expert for Step by Step Business, adds that changing your business name is unlikely to fool lenders anyway. She notes that when applying for funding, you often need to provide a business plan which reveals the true nature of your business, and that by trying to manipulate your code, you’re essentially committing fraud. Carolyn recommends that you’re better off creating a compelling business plan or proposal that will ease their concerns about the risks in your industry.

How to check your potential risk

To assess the risk in your industry, you can check the most recent NAICS list of high-risk business types. Then, look into the factors that make an industry or type of business part of a high-risk category. For example, ask:

  • Does the industry raise any red flags?
  • Do you face a great deal of regulatory red tape?
  • Do you have long research and development periods with uncertain outcomes?
  • Do you have a high amount of chargebacks?
  • Is the impact of your product or service questionable to the public?
  • Is technology currently changing the way your business operates?
  • Are you facing supply chain shortages?
  • Is your business cash-intensive?

By assessing how your business fares in terms of risk in current times, you can better understand how lenders may view it when considering your application.

How to improve your odds of getting approved for business credit

Not exactly a low-risk business? Don’t give up hope! If you’re worried about getting denied a business loan due to operating in a risky industry, you can work to counteract the risk by increasing your creditworthiness.

A lender may see that your industry falls into a higher-risk category, but good credit, longer time in business, and solid cash flow can all help to balance out the risk you present. It’s also always a good idea to shop around. Borrower requirements vary from one lender to the next so one may approve a loan that another denies. There are also some lenders that specialize in lending to higher-risk industries. You can do a search to see if any service yours.

Learn more about business credit...

About the author

Jessica Walrack

Written by Jessica Walrack

Jessica Walrack is a personal and business finance writer who has written hundreds of articles over the past eight years about loans, insurance, banking, mortgages, credit cards, budgeting, and all things credit. Her work has appeared on Bankrate, The Simple Dollar, The Balance, MSN Money, and Supermoney, among other publications. Her love of a good number breakdown and passion for making complex concepts easy to understand makes writing about finance a natural fit.

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