Industry experts have been anticipating the regulatory crackdown of the alternative lending market for some time. After all, there are far more rules in place to regulate traditional banks’ small business lending practices. Similar rules for alternative lenders are surely to follow, right?
This month, U.S. government officials have been busy turning their attention towards small business lenders of both the traditional and alternative breed. But the latest moves by policymakers are ones that appear to signal support for alternative lenders and their ability to provide SMEs with working capital when a traditional bank cannot.
While regulators have been praised for their support of small business, some opponents argue that lawmakers are entirely missing a chance to bring much-needed regulation to the largely unregulated alternative finance sector.
U.S. Treasury Starts Asking Questions
One of the government entities to begin scrutinizing the alternative lending market space is the U.S. Treasury. Reports published last week revealed that the department initiated a request for information, opening up a 14-question survey to the public all concerning the rise in marketplace lending.
The Treasury’s notice of the review announces the department’s interest in “the potential for online marketplace lending to expand access to credit to historically underserved market segments,” including small businesses, as well as in “how the financial regulatory framework should evolve to support the safe growth of this industry.”
Questions include topics like the use of data and technology by marketplace lenders and how data affects the ability to detect lending fraud or credit risk, as well as how accurate the models used by marketplace lenders are to assess credit risk.
According to reports in Forbes, the Treasury Department does not appear to be taking an “attack-dog” approach to the industry. “Marketplace lenders have largely been viewed as consumer champions,” Forbes wrote. “And from the tone of the Treasury Department questions, it looks like the regulators want this industry to grow and to succeed.”
Congress Sides With SMEs
The Treasury is not the only government entity that has turned its attention to the SME lending industry. Earlier this month, 19 Democratic lawmakers launched an initiative to have the Consumer Financial Protection Bureau (CFPB) increase its efforts to draft rules to collect and disclose small business lending data.
The senators, which include Elizabeth Warren (MA) and Al Franken (MN), are asking the CFPB to implement a section of the Dodd-Frank Act that requires the bureau to collect data on small business lending and make it public — language known as "Regulation B." According to the lawmakers, this information would ensure fair lending practices and increase SMEs’ access to financing.
“While entrepreneurship can open the door to achieve the American Dream, it can be difficult for entrepreneurs to get their businesses started,” the letter, addressed to CFPB Director Richard Cordray, said. “Access to capital is often limited in underserved and underrepresented communities … While access to capital has improved in these areas, it is difficult to gauge whether lending practices have broadened to incorporate businesses that operate and employ in these underrepresented communities.”
The senators added that under the CFPB’s current data collection practices, information on small business lending is fragmented and incomplete. “Together, we want to emphasize the critical need for greater transparency around small business lending data,” the letter reads. “Regulation B will facilitate the enforcement of fair lending laws and help identify the credit needs of women-owned, minority-owned and all small businesses.”
The push for Regulation B follows the implementation of similarly nicknamed Regulation A+ of the JOBS Act, which was adopted by the Securities and Exchange Commission. The rules make it easier for small businesses to raise funds through a mini-IPO.
Collectively, U.S. policymakers in the Treasury, Senate, CFPB and SEC have all made recent efforts to strengthen small businesses’ access to finance, all while the general sentiment concerning alternative lending remains a positive one — and one whose goals align with that of lawmakers.
But some are voicing their disapproval of the government’s actions as being too lenient on the alternative lending market and failing to address the risks associated with such an under-regulated industry.
Following reports of the senators’ request to the CFPB, Brayden McCarthy, head of policy and advocacy for online lending comparison site Fundera, published a blog post on U.S. political site The Hill calling on the CFPB — and lawmakers in general — to begin focusing on predatory online lenders.
“Missing from the debate so far … is the critical role that 1071 [Regulation B] could play in publicly differentiating good players from bad in the fast emerging sector of online small-business lending,” McCarthy said. He added that while the massive growth of online alternative lending has helped small businesses to secure working capital, “much of this activity is emerging with little oversight by states and virtually none by federal regulators.”
Triple-digit interest rates, a lack of transparency in borrowing fees and costs and biased loan brokers, he argued, are all making the online SME lending arena dangerous for lenders and small businesses alike. Mandating data disclosure, as the CFPB is tasked with doing, would help to identify the worst offenders and provide regulators with the information they need to crack down on these offenses, he added.
McCarthy has been a vocal advocate of tighter regulation of the alternative lending space. In an earlier interview with American Banker, the executive described the industry as “the Wild West” for SMEs due to a lack of oversight.
And he’s not the only one. Bloomberg obtained a broker agreement with one alternative SME lender that revealed a lender is looking for a 14-month profit on a six-month term small business loan, funds that are added to the double-digit fees charged by brokers in the first place. Some experts said the document revealed the often high, and often unknown, cost to small businesses when working with alternative lenders.
In an interview with PYMNTS last week, the founder and CEO of alternative lending behemoth Capify, David Goldin, noted that as a balance sheet lender, his lending business takes on the risk of small business lending. Online marketplaces, however, simply connect a borrower to a lender without taking on risk — a practice he described as “scary” and potentially misleading to investors.
While federal policymakers have been increasing their presence in the small business lending industry — with traditional and alternative lenders alike — the calls for a harsher stance on alternative lending practices are similarly on the rise. The challenge for the government, experts say, will be to crack down on predatory SME finance practices without introducing a barrier to small businesses that need the financing many of these alt-lenders have been able to provide.