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Cleaver Investigation Denounces Lack Of SMB AltFin Transparency

U.S. Representative Emanuel Cleaver II (D-MO) has published the preliminary findings of his investigation into the alternative small business lending market in an effort to probe whether algorithms used by FinTechs are able to adequately protect against discrimination.

At the heart of the investigation is alternative lending companies’ use of “alternative” underwriting data, including social media profiles, criminal records and zip codes.

“Not only is this information unrelated to the purposes of loan seeking, it can be used to discriminate against certain people, predominately lower-income borrowers and people of color,” the report, released earlier this month, stated.

Analysis of a range of FinTechs, including OnDeck, Biz2Credit, LendingClub and Kabbage, found an array of good and bad practices. For example, “almost every” lender that provided adequate information to policymakers for the report admitted to the use of forced arbitration clauses in their borrower contracts.

“These clauses require individuals to resolve all disputes out of court in a situation that is more favorable to the lenders, both from a monetary and public relations perspective,” the report said.

Cleaver’s investigation also pointed to the widespread use of consumer credit scores to determine creditworthiness of small business loans — common among traditional lenders, but a practice the report called “exploitative” and “largely unnecessary.”

“One of the most concerning findings was how willfully vague some companies were being about the structure and nature of their algorithms,” the report continued. “While a few companies provided detailed information, others did not disclose whether they used race and gender information, or proxies for it, in their loan calculation.”

A lack of transparency in these alternative lenders’ algorithms and underwriting process is “concerning,” the report stated, particularly when considering the current lack of regulatory oversight of the alternative finance market.

Incomplete and insufficient information about FinTechs’ algorithmic strategies is “by far the most ubiquitous issue.”

“If companies cannot volunteer even the most limited information, how can they be trusted to provide fair credit to small business owners?” the report asked.

The investigation did reveal several instances of good practices in how alternative finance companies are using their technologies to protect against discriminatory behavior, however. One such example is the development of proprietary credit scores, which are used in lieu of a personal credit score and instead focuses on the performance of the business itself, analyzing cash flow and credit history data. Another tactic is the use of a third party to prevent “unintentional discriminatory behavior.”

Most of the businesses analyzed have taken at least some measures to prevent against discrimination, investigators said, however more action is needed to improve transparency and take accountability in an effort to prevent against discriminatory and unfair small business lending practices.

The preliminary report was published about one year after reports first emerged that Cleaver had begun to probe alternative small business lending practices in the U.S. At the time, reports in JD Supra said, the representative had sent letters to at least five small business lending companies with questions related to borrower protections, efforts in transparency, and more.

The investigation comes as lawmakers begin to explore heightened regulations for the alternative finance market overall.

“Current law does not provide certain protections for small business loans, compared to other consumer laws,” Cleaver said. According to reports, the Truth in Lending Act and other legislation geared towards borrower protections do not cover small business borrowers in their language.

Cleaver is the top Democrat on the House Financial Services’ Housing and Insurance Subcommittee. Earlier this year, he spoke with American Banker to raise awareness of alternative finance regulation and small business borrower protections.

“If we fail to act on FinTech, we are setting ourselves up for problems down the road,” he told the publication. “Not because the FinTech folks are evil … but because we are behind the curve. We have a good chance now to build a road down which the wagon travels, and I think we ought not to blow it.”

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