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By Victoria Finkle
June 20 — The Consumer Financial Protection Bureau (CFPB) has business lending in its sights thanks to an oft-forgotten mandate of the 2010 Dodd-Frank Act.
The agency is beginning preliminary work to implement Section 1071 of the law, which requires it to collect new data on the state of small-business lending, along with information about access to credit for women-owned and minority-owned businesses.
For traditional banks and online lenders, questions remain about what regulators intend to do with the information they ultimately gather. Financial institutions are already bracing for the possibility of fair lending enforcement cases, and some worry that the agency could explore additional ways to oversee business lending activities.
“The industry has concerns the CFPB may expand its authority beyond consumers and the data collection requirements of Section 1071,” said Scott Talbott, senior vice president of government affairs at the Electronic Transactions Association, which represents traditional banks, as well as online small-business lenders.
The language that wound up in the Dodd-Frank Act came from an earlier bill to overhaul the Community Reinvestment Act. It was initially included in an early Treasury Department draft of what became the financial reform law.
The provision amends the Equal Credit Opportunity Act, requiring financial institutions to collect and report information about credit applications from small businesses, women-owned businesses and minority-owned businesses to the consumer agency. Crucially, the mandate will apply to banks and nonbanks, such as online lenders, that lend to applicable businesses.
Experts note that there’s currently a lack of information about access to credit, particularly in the case of women and minority entrepreneurs — though the data available suggest that such borrowers have difficulty getting loans.
“The main issue is that we don’t have the data,” said Karen Mills, a senior fellow at Harvard University and former head of the Small Business Administration (SBA) under President Barack Obama.
She added that women-owned and minority-owned businesses are more likely to access the SBA loan programs, which suggests difficulty obtaining credit directly from a bank.
“We know there’s this whole portfolio of good small businesses where women and minorities are overrepresented that have had trouble getting access to credit from traditional sources,” Mills said. “That’s the best data that we have, so it would be very helpful to find more ways to get that data.”
So far, the CFPB has been slow to enact the new data collection requirement, as regulators wade through numerous other mandates required under Dodd-Frank. Democratic lawmakers in both chambers sent letters to the agency last summer, urging it to begin work on the provision.
But there are now signs that the CFPB is turning its attention to the issue. The agency announced in April that it hired Grady Hedgespeth, a former SBA official with a background in banking, to serve as assistant director of the office of small business lending markets.
“Grady understands small business, and he has a history and commitment to this issue. It’s a very good sign for the CFPB,” said John Taylor, president and CEO of the National Community Reinvestment Coalition.
In its spring 2016 rulemaking agenda, the CFPB said it is “in the very early stages of starting work to implement Section 1071” and that it will focus on “outreach and research” in the market before developing regulations. It’s unclear at this point whether the CFPB will issue a formal request for information from stakeholders, or when a proposed rule might be released.
“This first phase will focus on gathering facts and exploring a number of questions concerning the data to be collected about small, women-owned and minority-owned businesses,” said Samuel Gilford, a spokesman for the agency. “These fundamental questions include what loan data to collect, as well as the appropriate procedures to safeguard information and protect privacy.”
Gilford added, “The bureau’s role in the small business lending space is limited to enforcement of the Equal Credit Opportunity Act and implementation of the expanded small, women-owned and minority-owned business lending data collection requirements of Dodd-Frank Act Section 1071.”
Looking ahead, the biggest concern for traditional banks and online lenders is what the agency plans to do with the data it collects.
“There are going to be some lenders who do a pretty good job, and then there's going to be some who are doing a miserably poor job,” Taylor said.
The most likely outcome is that the CFPB could try to use its ECOA authority to pursue fair lending cases against institutions that aren’t lending enough to underserved groups. The agency also said in February that it may add small-business lending as a category in its complaints database in the next two years, “subject to an assessment of feasibility.”
Some observers predict that efforts could mirror the bureau’s work in the auto finance market. While the Dodd-Frank law exempts oversight of auto dealers, the CFPB has been able to influence lending in the auto market by looking for signs of disparate treatment among borrowers based on gender, race and ethnicity. In that case, they used a statistical proxy method to impute demographic factors about borrowers to root out signs of indirect or unintentional discrimination.
Similarly, the agency may be able to make changes to the small-business lending market — even without direct supervisory oversight.
“I work under the belief that the CFPB is an incredibly nimble and inventive agency, and when CFPB has faced a closed door, they find an open window,” said Isaac Boltansky, a policy analyst at Compass Point Research & Trading. “They have found a circuitous, albeit inventive, way to influence dealer operations without any direct oversight of auto dealers.”
Under the small-business lending provision, the agency would likely already have data on hand to pursue a fair lending case, removing the need for the statistical work that’s garnered the toughest criticism from the financial industry and members of Congress.
“Republicans will still raise Cain and argue that disparate impact is nonsense and that the lending entity didn't mean to discriminate, but the CFPB has a very strong leg to stand on, because after the rules are promulgated, it will be getting the data,” said Brandon Barford, a partner at Beacon Policy Advisors.
This type of analysis could pose the biggest threat for online lenders, such as OnDeck and Kabbage, that provide credit to small businesses, because their methods are newer and so far untested relative to those employed by traditional banks.
Whereas banks typically rely on a standard slate of backward-looking metrics such as debt, income, credit history and collateral, online lenders can employ a much wider swath of variables — such as education level and even college major.
“Banks that use FICO and more traditional metrics can lean on those. They can say, we’ve been doing lending the same way for 20 years,” Barford said. “The online lenders don’t use the same metrics. People are able to get approved more often, but they can still be subject to higher rates and the financial products are sometimes more confusing.”
The CFPB’s renewed focus on the issue comes as the Treasury Department highlights its own focus on the small-business lending market. The agency issued a highly anticipated report about online lenders in May that raised fresh concerns about the role those businesses are playing in small-business lending.
Officials discussed the need for greater transparency and noted that small-business loans under $100,000 “share common characteristics with consumer loans, yet do not enjoy the same consumer protections.”
The report added that Treasury is “willing to work with members of Congress” on legislation to potentially address these oversight gaps. The report was produced in consultation with the CFPB and other financial agencies and built on input from financial firms, academics, consumer advocates and others.
Meanwhile, CFPB Director Richard Cordray said during a March hearing that he’d welcome additional authority to oversee small business lending.
“If I had my way — I don’t have my way on many things — we would do what I did when I was Ohio attorney general, and seek to protect not only individual consumers as our statute authorizes us to do, but also small businesses, who often operate in the marketplace with no greater clout than an individual household does,” he told the House Financial Services Committee. “If the Congress sees fit to give us that authority, we will aggressively pursue that and it would help small businesses across the country.”
For now, the agency still has a long way to go when it comes to collecting the new small-business data, and the rule-writing effort itself is likely to raise some important questions. For example, it’s not clear what types of loan products will be included or what size loans will be within the scope of the rule. Industry officials also warn that adding new data collection mandates to the loan process will be costly.
“This will be a big lobbying battle, trying to influence what the rules are like,” Barford said.
ETA’s Talbott said he also worries how the agency will treat lending to sole proprietors, and whether they will be considered small businesses or consumers under the forthcoming regulation.
“We’re concerned about the blurring of the lines or the lumping together of consumers who borrow for a vacation, and businesses who borrow to hire employers or buy inventory,” he said.
During his March testimony before Congress, Cordray acknowledged there are areas “where the line between commercial lending and consumer lending is blurry,” such as when an entrepreneur uses credit card debt to fund a business.
The most important thing is for the agency to start collecting data now, even if it can’t capture every aspect of the market initially, Mills said.
“If you knew exactly how many loans were being made, who was making them and what the creditworthiness was of the various pools of loans, you would know quite a bit about whether the industry was full of bad actors or impossibly high rates,” she said. “As we begin to see default rates, we could also know much more in real time about the health of new segments and sectors.”
Still, some in the industry emphasize that the CFPB’s authority in the small-business lending space is narrow — at least for now — which will ultimately limit the actions it can take under Section 1071.
“It’s the Consumer Financial Protection Bureau, not the Small Business Protection Bureau,” said Scott Pearson, a partner at Ballard Spahr.
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