States Mull Regulation of Online Commercial Lenders

By Michael J. Bologna

June 13 — Online financing platforms aimed at small businesses are drawing new scrutiny from states concerned the largely unregulated industry could cause a new predatory lending crisis.

California is soliciting data from the largest lenders as state officials eye a non-bank lending statute as a possible enforcement and regulatory tool. Illinois is considering legislation that would put most of the small business lending players under the thumb of the state’s Department of Financial and Professional Regulation (DFPR).

State scrutiny of commercial lending platforms aimed at small businesses such as restaurants, auto repair shops and tech start-ups comes as federal regulators have also begun assessing the need for greater regulation of online lenders.

Some of the largest players in the industry including OnDeck, Kabbage, CAN Capital and LendingTree are trying to forestall new regulation by developing self-regulatory schemes to curb abusive lending practices, although observers say regulation is inevitable with states likely to be the laboratories for the supervision coming to the industry.

“Regulation is going to have to happen in this sphere. Once this activity reaches a certain scale, it’s going to have to happen,” said Kevin Klowden, an economist at the Milken Institute and an authority on technology-based development. “The issue is: how much of it is going to be driven by a framework from within the businesses, versus something being imposed from outside?”

Joyce Klein, director of the Aspen Institute’s program in microenterprise development, said the first wave of regulation would come in states with track records for strong consumer protection.

“I wouldn’t be surprised if a few states move into this,” Klein told Bloomberg BNA in an interview. “Part of it depends on the political dynamics in those states. But it’s hard to say if there will be a universal movement in this direction. Some states just move faster than the feds.”

Filling the Vacuum

Traditional small business financing from regulated financial institutions declined dramatically following the financial crisis, but a new industry of online lenders and marketplaces, offering loans of up to $250,000, has emerged to fill the vacuum.

These technology-driven lending platforms offer entrepreneurs and existing small businesses important benefits, including online applications, data-driven algorithms to evaluate creditworthiness and rapid access to capital.

Karen Mills, administrator of the federal Small Business Administration during the first term of the Obama administration, has frequently pointed to the emergence of three models for small business lending since the financial crisis.

  •  Online balance sheet lenders, which typically offer short-term loans for working capital and inventory purchases. The loan products operate much like merchant cash advances, requiring daily or weekly deductions from a borrower's bank account until the loan is repaid. Examples include OnDeck and Kabbage.
  •  Peer-to-peer lenders, which link capital from institutional and retail investors to borrowers using proprietary credit models. Examples include Lending Club, Prosper, Funding Circle and Fundation.
  •  Lender-agnostic marketplaces that operate as virtual marketplaces where small businesses can comparison shop for credit from a variety of lenders, including traditional financial institutions. Examples include Biz2Credit, Lendio and Fundera.


Evidence of Abuse

Klowden and Klein said these innovations have provided benefits to thousands of small businesses. And several of the players have demonstrated strong track records for customer service, fair pricing, transparency and nondiscrimination.

At the same time, evidence of abusive conduct is emerging. Klowden and Klein said some lenders use aggressive marketing strategies to solicit borrowers and negotiate lending terms. Others obscure the terms of their loans, forcing borrowers to absorb exorbitant fees and high interest rates. Still others impose unwieldy repayment terms, trapping borrowers in hopeless cycles of debt.

While much of the abuse is anecdotal, Klein said, “We do think there are some practices that are really problematic in the marketplace.”

“Payday for Small Business.”

A recent study by the Woodstock Institute, a research and advocacy organization focusing on fair lending issues of 15 loans offered to Chicago businesses by online lenders found half featured effective interest rates of 94 percent or higher. Five loans carried interest rates ranging from 26 percent to 60 percent, but four of the loans featured rates of 324 percent or higher. Most of the lenders tacked on additional fees, including origination fees, monthly administrative fees, Automated Clearing House fees, risk assessment fees and Uniform Commercial Code fees.

An analysis of 150 loans from 54 different small business lenders by the Opportunity Fund, California's largest microfinance lender, found the average loan in the data set carried an annual percentage rate of 94 percent and one loan carried an APR of 358 percent. In addition, the Opportunity Fund's May 24 report found loans carried an average monthly payment of nearly double (178 percent) the borrower's net income, leaving the businesses in a downward spiral of debt.

“We call these loans payday for small business,” Dory Rand, president of the Woodstock Institute, told Bloomberg BNA. “They are very similar with high rates and very bad terms. They trap people in debt. It’s the same business model.”

State Impatience

In this climate, some states have become impatient with any potential federal solutions and are examining options for more local responses.

“Nothing is going to be accomplished on the federal level anytime soon because of the lobbying influence of the banks,” said Illinois State Sen. Jacqueline Y. Collins (D). “I’m not sure how successful we will be at the state level, but we need to at least begin the conversation.”

Collins drafted Senate Bill 2865, creating the Small Business Lending Act. The proposed law, which won approval from the Senate Financial Institutions Committee on April 13, represents an aggressive, pro-borrower response to perceived abuses in the market. The legislation would impose licensing requirements on small business lenders, bar deceptive advertising, require basic underwriting standards and limit prepayment penalties and late fees.

Collins told Bloomberg BNA S.B. 2865 ran into resistance from online lenders and the banking industry. She agreed to put the measure on hold to convene negotiations with the stakeholders this summer. Collins expressed hope that the process would result in an “agreed bill” palatable to all stakeholders. Whether that process succeeds or fails, Collins said she would seek support from the full Senate during the November veto session and “hope for the best.”

California and New York

Tom Dresslar, a spokesman for California's Department of Business Oversight, said his agency is engaged in a fact-finding mission to assess whether the state's current regulatory structure can adequately protect small business consumers using online lending platforms. He said DBO believes it has some authority to regulate under the California Finance Lenders Law, which contains language pertinent to nonbank lending.

As part of that fact-finding process, DBO solicited information from 13 of the nation's largest online lenders to gain some perspective on the scale of the industry. The process resulted in a report, issued April 8, showing total consumer and small business transactions from the online lenders expanded from $1.99 billion in 2010 to $15.91 billion in 2014, a jump of 700 percent. Small business' share rose from $403 million to $2.94 billion, a 630 percent increase.

Potential Enforcement?

Dresslar said a round of follow-up queries came in April on a more targeted set of issues. In particular, DBO wants to know about partnerships between the online lenders and traditional financial institutions. DBO also asked questions about compliance with California's fair lending laws and sought documentation about the lenders' approval and denial processes.

Dresslar said DBO has no specific goal for the project, but “all options are on the table from enforcement actions to making recommendations to the legislature on how to fill gaps that need to be filled in the law.”

He added, “We are open to sitting down with the representatives of the industry and having a dialog on working together on a regulatory regime that works for consumers and lenders.”

Legislation introduced last month in New York's state Assembly requires the state's Department of Financial Services to study online small business lending and issue a report to the governor and the legislature by Jan. 1, 2018.

CFPB Action

At the federal level, the Consumer Financial Protection Bureau signaled its interest in the issue recently with the appointment on April 14 of Grady Hedgespeth to the new position of assistant director for the Office of Small Business Lending Markets. The agency said Hedgespeth would lead a team developing rules to implement the small business lending data requirements of Section 1071 of the Dodd-Frank Act. While the work is expected to focus on financial institutions' collection of data on equal access to small business credit, many expect the office to also examine the emerging role played by online lenders.

Getting Ahead of the Regulators

The online commercial lending industry is trying to get ahead of state and federal regulators by developing a menu of best practices.

Several of the largest lenders unveiled the Innovative Lending Platform Association on May 5. The organization, launched with the assistance of the Association for Enterprise Opportunity, said it would focus on projects that advance education, advocacy and best practices. The participants include OnDeck, Kabbage, CAN Capital and LendingTree.

The association's first project will be a disclosure tool called SMART (Straightforward Metrics Around Rate and Total Cost) Box. SMART Box will attempt to standardize and display features of small business loans in a format that enhances understanding and permits consumers to comparison shop.

“As our industry rapidly evolves, we believe it is critical to provide the tools and transparency businesses need to make informed borrowing decisions,” Kathryn Petralia, chief operating officer of Kabbage, said in a statement May 5.

The Aspen Institute's Klein said consumer advocates, think tanks, community development lenders and some industry players launched a much broader effort late last year as the Small Business Borrower's Bill of Rights.

The effort hopes to drive responsible small business lending by compelling lenders to adhere to six core principles. Participating lenders must agree to transparent pricing and terms; non-abusive products; responsible underwriting; fair treatment from brokers; inclusive credit access; and fair collections practices.

“In the absence of a clear federal regulatory regime for this kind of commercial lending, and the way Congress looks right now, we thought the best way to promote responsible lending was through this industry-based approach,” Klein said.

To contact the reporter on this story: Michael J. Bologna in Chicago at

To contact the editor responsible for this story: Seth Stern at