California passes historic truth in small-business lending law — Congress should take note
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California made history on Sept. 30 when Gov. Jerry Brown signed the nation’s first bill that will provide truth-in-lending for small-business borrowing. As an organization that promotes small and micro businesses we are excited that SB 1235 (Glazer) will give our state’s small businesses the information they need to understand the confusing world of business financing. The bill was passed with broad bipartisan votes in the California legislature: 28-6 in the Senate and 72-3 in the Assembly which shows the country that working together in a bipartisan way to solve problems of real people and support small-business owners is possible.

Traditional bank lending for small-businesses loans under $250,000 has been declining since the Great Recession. Online lending has risen in its place with little to no oversight. It’s never been faster or easier for small businesses to fill out an application and receive the money they need in their account. The problem is online lenders often throw out low numbers that sound like they are related to costs of capital, but the true cost of the funding is usually much higher.

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If a deal sounds too good to be true, it often is. It is not uncommon to find small-business financing with interest rates of higher than 50 percent - some even reaching 350 percent - without these rates being disclosed to the borrower.

  • In 2015, California's Department of Business Oversight (DBO) surveyed 14 marketplace lenders and found that the majority of their loans carried APRs ranging from 41 percent to 101 percent or higher.
  • Opportunity Fund, a mission-driven lender based in San Jose, analyzed their loans that were used to refinance online financing arrangements. Many borrowers were saddled with loans they couldn't afford with an average annual percentage rate of 94 percent with one loan having an APR of 358 percent. The average monthly loan payment was almost double the net income of the small-business owners.

Not all online small-business financing is bad. Online alternative financing can be an efficient source of capital when other sources are unavailable. But online players that have adopted responsible lending practices want transparency because they have trouble fairly competing with the online financiers who disguise their costs.

Earlier this year the Federal Reserve published Browsing to Borrow: "Mom & Pop" Small Business Perspectives on Online Lenders, which looked at small-business owners’ perceptions of online lending. The three key takeaways from the study were that

  • small-business owners were familiar with online lenders and didn’t have a good impression of them;
  • they like more information on their financing options; and
  • existing products are confusing.

What small-business owners liked was “a sample disclosure table clearly displaying interest rate, payment amount, fees, and other product terms.” In other words, nearly all of the study’s participants said clear, understandable information should be available to potential borrowers before they apply for a loan and turn their businesses’ financial data over to a lender.

Two other studies back up the Federal Reserve’s findings. Small Business Majority found that 80 percent of small-business owners they polled are in favor of ensuring interest rates and fees are clearly disclosed to borrowers. The Bipartisan Policy Center (BPC) recommended small-business disclosure rules. They said that requiring disclosure would ensure that small-business borrowers receive basic information about loan terms and conditions when obtaining funds from nonbanks lenders.

The federal Truth in Lending Act protects consumers but does not protect small businesses. That’s why California enacted SB 1235. The law proposes a common-sense solution—clearly communicate to small businesses what their financing would cost. It is the first small-business truth in lending law in the country. Other states will be following suit. What’s clear from industry is that they are not interested in a patchwork of different regulations and disclosures. We need leadership in Washington to act accordingly and pass a Truth in Business Lending Act.

Everyone should support this. Supporting small businesses is a bipartisan issue. Don’t take our word for it. According to the BPC report, “support for small businesses is a rare oasis of bipartisan consensus, among politicians and in the broader public.” Let’s use this support to protect the country’s small businesses and set them on successful path for access to capital and growth.

SB 1235 will make a positive difference for hundreds of thousands of California firms. In the upcoming session, let’s pass a national disclosure law that will make a difference for the nation’s millions.

Carolina Martinez is CEO of California Association for Micro Enterprise Opportunity. Heidi Pickman is Associate Director of California Association for Micro Enterprise Opportunity.