We protect individuals from predatory lending practices — why not small businesses too?
Despite the extraordinarily difficult two years our nation’s small businesses have been through, we are seeing signs of resilience and optimism — with most firms reopening after temporary shutdowns and an unprecedented rate of new business formation. The latter, though, may be partly due to workers seeking alternatives to the lack of good options in the markets for wage labor.
At some point, these new and recovering firms will need new injections of financing. The question is whether they will be able to access that capital, and whether the types of capital they are able to tap will support their growth and recovery or hinder it.
Commercial bank lending is falling, which is not unusual after a recession or an economic shock. Commercial lenders looking at the financial statements of small businesses for 2020 and 2021 would be hard pressed to determine whether a firm is ready and able to grow and thrive. But it’s not just a question of the pandemic. Banks have always been reluctant to lend to firms that are less than two years old. And small business lending in amounts of less than $250,000 had been falling for decades, largely because these loans generate little to no profit for banks.
The lenders that step into this credit void are nonbank lenders. These take multiple forms — fintech firms; mission-led community development financial institutions; large payment or e-commerce firms; and commercial lenders offering products such as factoring or merchant cash advances. To assess whether these lenders are aiding small businesses as they seek to recover and grow, the most important factor is not the type of institution they are, but the products they offer and the practices they use.
Predatory small business lending has a long history in the United States, often in the guise of “helping” those on the margins (it’s a motif in films like “It’s a Wonderful Life” and “The Godfather”). Predatory lenders, particularly in the digital age, aren’t as easy to recognize as they are in films. Prior to the pandemic there was rapid growth in “new” lenders offering products with annual percentage rates in the high double or triple digits, with monthly payments often double what the business could afford to pay, and sometimes using high-pressure collections tactics when borrowers fell behind on their products. The Responsible Business Lending Coalition — of which the Aspen Institute is a founding member — has been tracking these practices and working to identify and advocate for policies that help ensure that small businesses access financing that is fair and responsible.
These lenders seem to have disproportionately targeted business owners of color — which is not surprising given those are the small businesses who have always had the hardest time accessing capital. Why are small businesses in general and entrepreneurs of color a target for predatory lenders? Because currently small businesses are not afforded protections from predatory lending that consumers are now used to, such as transparency and reporting requirements that inform fair lending.
There are some simple steps that could expand access to capital while protecting small businesses. This Thursday, the Subcommittee on Consumer Protection and Financial Institutions of the U.S. House’s Committee on Financial Services is hosting a hearing on Small Businesses, Big Impact: Ensuring Small and Minority-Owned Businesses Share in the Economic Recovery. The hearing will likely cover two policy efforts that could play an essential role in ensuring that small businesses — including those owned by business owners of color — are able to access fair and responsible credit.
One policy involves implementation of an existing law: Section 1071 of Dodd-Frank. Currently, there is no comprehensive information anywhere about how much small business lending is happening, who is being served, or at what terms. Section 1071 calls on the CFPB to collect data on small business credit, and the agency is close to formalizing its rules and process for doing so. The RBLC is strongly supportive of the CFPB’s approach to date — which we believe is pro-innovation. But we strongly recommend that the agency include the collection of data on annual percentage rates APR among the pricing metrics it requires, and that the reporting requirements include all types of business financing, including factoring.
The second step involves passage of the Small Business Lending Disclosure Act of 2021, introduced in November by House Small Business Committee Chairwoman Nydia Velázquez (D-N.Y.) and Sen. Bob Menendez (D-N.J.), senior member of the Senate Banking Committee. It’s surprising to many that commercial (or small business loans) are not subject to the same truth-in-lending requirements as consumer loans, mortgages and credit cards. The bill would require standard disclosures of rates, fees and annual percentage rates (APRs) for small commercial financing products, and provide the Consumer Financial Protection Bureau with expanded ability to oversee small business lending.
Some opponents of the bill claim that because they offer shorter-term products (e.g., less than a year), that disclosing APR doesn’t make sense or isn’t feasible. But we already require disclosure of APRs on credit cards, which are often used for short-term financing (and credit card lending has grown significantly since the CFPB introduced new disclosure requirements a decade ago). The bill would not prohibit lenders from sharing other pricing metrics that small businesses might find useful. But it would ensure that all financing offers include the one metric that allows small businesses to make apples-to-apples comparisons on price. In the end, having this information will allow business owners to make the most informed choices among the credit offers they receive.
Our economy and communities will recover more strongly from the pandemic if new and small firms are able to access the financing they need to adapt, rebuild, and grow. But not all financing is the same — some can spur growth and help business owners to manage volatility, while some can hollow out cash flow and strip wealth. Small businesses are critical to local, state and national economies. They deserve the same basic standards of transparency and fairness, and protection from bad actors, that American consumers now have. Let’s put in place the policies small businesses need to get access to capital that will help them recover, not bury them deeper.
Joyce Klein is the director of the Business Ownership Initiative at the Aspen Institute and Chair of the Executive Committee of the Responsible Business Lending Coalition.
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