How to Rein in Predatory Small Business Loan Brokers
For a full draft of Fundera’s response to the Treasury Department’s Request for Information on Marketplace Lending co-authored with Fundera CEO and Founder Jared Hecht, please click here.
Jared Hecht and I firmly believe that marketplace lending is poised to transform how small business owners apply for and get credit. Last year online lenders funded about $5 billion in small-business loans, a fraction compared to the $300 billion in small-business loans outstanding at brick and mortar domestic banks. But meager market share masks immense potential: Morgan Stanley puts the addressable market at $280 billion and predicts online lenders will grow 50% annually through 2020.
However, as Jared and I argued this week in our response to the Treasury Department’s Request for Information on Marketplace Lending, achieving this transformation will depend in part on facilitating greater transparency across the sector, and reining in predatory actors.
Right now, we think the industry is falling short.
Fundera’s Fight for Transparency in Small Business Lending
Fundera has become a leading voice for transparency in small business lending. We are chronicling our fight in this timeline on our site. Fundera was the first to publicly call for the creation of industry-wide self-policing through a Small Business Borrowers’ Bill of Rights with an op-ed I penned in February 2015 in Forbes, and this past August announced alignment of a responsible business lending coalition of online lenders, community development financial institutions, advocacy organizations and think tanks on a Small Business Borrowers’ Bill of Rights, with founding partners including Funding Circle, Lending Club, ACCION, Opportunity Fund, Small Business Majority, Multifunding as well as the Aspen Institute. This is a major step in our efforts to make small business lending more transparent, but the work is far from over.
As I highlighted in op-eds in publications such as American Banker, Forbes, The Hill and Inc over the past year, nowhere is the need for transparency and accountability greater than in the broker channels which originate the overwhelming majority of marketplace lending. In our response to the Treasury RFI, Jared and I offered an assessment of predatory practices many brokers currently engage in, and outlined actions which regulators could take to rein in shady actors, with emphasis on the following:
1. Brokers Play an Enormously Important Role in Marketplace Lending
Small business borrowers are often just as untrained in the nuances of three-inch thick loan documents as everyday consumers, and depend on loan brokers to help them make sense of complicated loan options. Moreover, finding borrowers can be tricky for online lenders since they lack deposit bases, so they also often turn to brokers. In fact, offline loan brokers originate anywhere from a quarter to three-quarters of all loans in online small business lending depending on the lender.
2. Many Brokers Engage in Predatory Practices Reminiscent of the Subprime Lending Crisis
Small business loan brokers typically fall through the grips of regulators. While new Dodd-Frank rules have reined in mortgage brokers, many of the brokers who cut their teeth in the run-up to the subprime crisis have reincarnated themselves in a new industry, this time targeting small businesses. Aside from fair lending laws, they aren’t subject to federal oversight. Only a handful of states require brokers to obtain licenses. The explosive growth of largely unregulated online lenders, coupled with lax oversight of brokers themselves, has given brokers new opportunities to prey on unsuspecting borrowers.
In our response to the Treasury RFI, we identified five predatory activities which brokers often engage in to optimize short-term profit at the expense of borrowers. For example, brokers often market themselves as impartial, while steering borrowers toward loans which are more expensive for the borrower and better for the brokers’ bottom line. Brokers also routinely add up to 10–20 percentage points to the cost of a loan, but consistently obfuscate their fees, refusing to itemize their rates and making it difficult for borrowers to understand how much they’re paying for their brokers’ services.
3. We Need a Fiduciary Standard for Loan Brokers, With Duties of Disclosure, Prudence and Care
Since brokers wield enormous influence over a borrower’s financing decision, it’s imperative to establish rules of the road that compel all brokers to respect the trust of borrowers. Regulators and policymakers should be guided by core principles when deciding how to regulate loan brokers. Congress should empower regulators with legislation that requires brokers to respect fiduciary responsibilities to borrowers, including duties of disclosure, prudence and care, as I argued in an op-ed in American Banker in July. It is only fair. After all, borrowers trust brokers to help them find loans that best fit their needs, not loans that best compensate their broker.
4. Treasury Could Pursue Targeted Executive Action at the Federal Level to Rein in Predatory Loan Brokers
While not a regulator, Treasury could rein in predatory activity beyond advocating for a fiduciary standard, and needn’t wait on Congress to take action. In keeping with President Obama’s “We Can’t Wait” efforts and “pen and phone” strategy in other sectors, Treasury could pursue a series of near-term executive actions: first, publicly supporting self-policing efforts, particularly the Small Business Borrowers’ Bill of Rights which Fundera helped lead; second, promulgating first principles which could guide regulators in overseeing borrower protection; third, hosting a summit focused on responsible business lending to continue to raise awareness on predatory activity and put pressure on irresponsible actors to change behavior. In addition, Treasury could encourage the Consumer Financial Protection Bureau (CFPB) to implement Section 1071 to “name and shame” the most egregious offenders as I pointed out in an op-ed in The Hill recently, while advocating for consolidation of oversight of borrower protection in CFPB.
The subprime crisis illuminated the dangers of letting loan brokers go unchecked. Regulators and policymakers should heed those lessons when evaluating how to respond to irresponsible loan brokers in marketplace lending. Better oversight could keep small business owners safe from some of the most egregious traps, and make sure that as the alternative lending industry matures, predatory brokers do not lead us down the wrong path.
Brayden McCarthy is Head of Policy & Advocacy at Fundera, and was previously Senior Policy Advisor at the White House National Economic Council and the U.S. Small Business Administration. Jared Hecht is the CEO and Co-Founder of Fundera, and was previously CEO and Co-Founder of GroupMe. For their full response to the Treasury Department’s RFI on Marketplace Lending, please click here. To learn more about Fundera’s efforts to make small business lending transparent, fair, and accountable, please visit Fundera’s Timeline to Transparency in Small Business Lending.
