Last month a collective of lenders, brokers, think tanks, and advocates announced the Small Business Borrower’s Bill of Rights, an effort to self-regulate the market for alternative small business lending. Despite the positive reception of the Bill, its creation has prompted many questions about why such self-regulation is necessary for players in the financial sector.
Since the Financial Crisis, the popularity of so-called “alternative lenders” has grown dramatically as banks became more conservative in their lending. In 2014, Lending Club issued more than $3 billion in consumer and commercial loans and went through a successful IPO in December of that year, for which the company was valued at $9 billion.1 Now, alternative lending has become so mainstream that it has attracted the attention of major public figures, including Republican presidential hopeful Jeb Bush, who has a portion of his investments on the Lending Club platform.2
However, commercial loans given by such lenders are still subject to very little regulation for several reasons.
First, most laws make distinctions between commercial loans (loans to business entities) and consumer loans (loans to individuals for personal use) and afford higher protection to consumer borrowers. For example, state-level usury law is generally only applicable to consumer loans, creating a cap on interest rates only on consumer loans.3 Almost always commercial loan products are excepted from such laws, and so alternative lenders may charge rates in excess of these caps. Interest rate caps also usually define by statute the rate being capped as including any applicable finance charges; therefore, there is no obligation to cap finance charges added to the price of a loan product for a small business borrower.
In addition, the Dodd-Frank Act predated the rise of alternative lending and as such does little to regulate the industry. Anti-Predatory Lending provisions are directed at mortgage providers, while other provisions regulate insurance companies and hedge funds. The Dodd-Frank Act gives the Financial Stability Oversight Council (“FSOC”) the authority to designate nonbank financial institutions for additional supervision if it deems the institution a threat to financial stability, but as of yet no alternative lending companies have been designated as such. In fact, it is not clear that alternative lenders fit within the definition of a “financial institution” under Dodd-Frank unless the lender is a broker-dealer.4
It is important to remember that while specific consumer protection law does not apply, fair lending, anti-discrimination, and Unfair and Deceptive Acts and Practices (“UDAP”) laws do apply and create limitations for these lenders.5
The result of this absence of regulation is what has been described as a “wild west” for alternative lenders, creating the need for the Small Business Borrower’s Bill of Rights. The Bill was designed to foster transparency and accountability within the commercial loan industry.6 In the six weeks since the release of the Bill, many new companies have signed on to the Bill, following a process that requires a CEO-signed attestation.7
The rights outlined are as follows:
- The Right to Transparent Pricing and Terms,including a right to see an annualized interest rate and all fees
- The Right to Non-Abusive Products, so that borrowers don’t get trapped in a vicious cycle of expensive re-borrowing.
- The Right to Responsible Underwriting, so that borrowers are not placed in loans they are unable to repay
- The Right to Fair Treatment from Brokers,so that borrowers are not steered into the most expensive loans
- The Right to Inclusive Credit Access,without discrimination
- The Right to Fair Collection Practices, to prevent harassment and unfair treatment.8
While the rights are intended to be clear on their face, the creators further explain some of the unethical practices and products that the Bill is intended to protect against. One practice elaborated upon is “double dipping.” Double dipping occurs when, before a borrower finishes paying off a first loan, the lender extends him a second loan and charges new finance charges. The borrower then uses at least part of the second loan to pay off the first, and the effect is that the borrower is paying double finance charges on the money. A second unethical practice, specific to merchant cash advances, is called “stacking.”9 In the merchant cash advance model, the borrower is charged, rather than typical interest, a percentage of his business sales. Stacking occurs when lenders extend multiple merchant cash advances to a single borrower, and the borrower owes percentage of his sales beyond his profit margin. This unethical, or at least irresponsible, underwriting prevents the borrower from fully paying off debts and will likely require that he take out additional loans to cover the merchant cash advances.10
This industry may see more regulation in the future, having come to the attention of lawmakers relatively recently. In March 2015 the Consumer Financial Protection Bureau released an “Outline of Proposals and Considerations” that considers, among other things, expanding the scope of consumer protection to small business loans.11 The next month, Sam Hodges, co-founder of Funding Circle, another industry leader, spoke at a House Small Business Committee hearing on peer-to-peer lending. In July 2015, the Treasury Department announced that it would be requesting information on marketplace lending, and in August the request was extended until the end of September 2015.12
Lending Club Statistics, Loan Statistics, Lending Club, https://www.lendingclub.com/info/demand-and-credit-profile.action (last visited Sep. 21, 2015); Karima Greene, Early investor calls Lending Club IPO a no brainer, CNBC (Dec. 12, 2014, 3:25 PM) ’http://www.cnbc.com/2014/12/12/early-investor-calls-lendingclub-ipo-no-brainer.html ↩
Presidential Hopeful has Lending Club Stake, PYMNTS.com, (Aug. 13, 2015, 8:13 AM), http://www.pymnts.com/news/b2b-payments/2015/presidential-hopeful-has-lending-club-stake/ ↩
State Usury Laws, Lending Karma (May 11, 2012), http://www.lendingkarma.com/content/state-usury-laws-legal-interest-rates/ ↩
12 U.S.C. §5462 (2010) ↩
Colin Wilhelm, Regulatory Road Likely to Get Bumpier for Alternative Lenders, American Banker (May 15, 2015) http://www.americanbanker.com/news/marketplace-lending/regulatory-road-likely-to-get-bumpier-for-alternative-lenders-1074363-1.html?zkPrintable=1&nopagination=1 ↩
Small Business Advocates, Lenders & Online Credit Marketplaces Unveil Small Business Borrowers’ Bill of Rights, PR Newswire (Aug. 6, 2015) http://www.prnewswire.com/news-releases/small-business-advocates-lenders–online-credit-marketplaces-unveil-small-business-borrowers-bill-of-rights-300124536.html ↩
Join Us, Responsible Business Lending Coalition, http://www.responsiblebusinesslending.org/join-us.html (last visited Sep. 21, 2015) ↩
Responsible Business Lending Coalition, http://www.responsiblebusinesslending.org (last visited Sep. 21, 2015) ↩
Outline Of Proposals Under Consideration And Alternatives Considered, Small Business Advisory Review Panel For Potential Rulemakings For Payday, Vehicle Title, And Similar Loans (Mar. 26, 2015), http://files.consumerfinance.gov/f/201503_cfpb_outline-of-the-proposals-from-small-business-review-panel.pdf ↩
Notice and Request for Information, Public Input on Expanding Access to Credit Through Online Marketplace Lending, 80 FR 42866 (July 20, 2015); Notice, Extension of Comment Period, Public Input on Expanding Access to Credit Through Online Marketplace Lending, 80 FR 42866 (Aug. 18, 2015) ↩