On August 6, the Aspen Institute and the Responsible Business Lending Coalition gathered government officials, regulators, thinktanks, lenders and brokers to announce the Small Business Borrower’s Bill of Rights. The “BBOR” represents the first consensus regarding responsible small business lending practices.
As America works to regain solid footing in the aftermath of the great recession, it’s important to remember the role that small businesses have played in our progress: According to the U.S. Small Business Administration (SBA), of the eleven million jobs created during the recovery, more than seven million were generated by startups and small enterprises. In 2014 alone, small businesses added nearly two-thirds of the three million new jobs generated in the private sector. Business wealth is also the second-largest source of family wealth in our country. That means the success of small and new businesses is absolutely critical to our nation’s ability to regain household wealth that was lost during the recession.
While there has been much media coverage of the post-recession decline in bank lending to small businesses, there has been far less coverage of another development that can also undermine the growth and success of this important source of jobs and wealth. That trend is the emergence of predatory lending practices among some of the non-bank lenders that have stepped in to fill the vacuum in the small business lending market. These practices are sadly reminiscent of those used by purveyors of subprime mortgages and payday loans.
The Aspen Institute’s FIELD program and Opportunity Fund have been long-time partners working to expand the opportunity for small and microbusiness ownership especially among minority and low-income Americans who face the greatest challenges in securing business credit. FIELD’s role has been at the national level, as a primary source of research and thought-leadership about the U.S. microenterprise field. Opportunity Fund is one of the largest and most rapidly-growing nonprofit small business lenders in the nation. As our focus has always been on stimulating the flow of capital to small firms, we were surprised to see the recent emergence of a new challenge for small businesses –predatory lending. Although advances in technology and the decline in bank lending to small businesses have opened up opportunities for innovation and for new players to enter the market, these trends have also given rise to disturbing practices we’ve seen elsewhere in the lending industry. These include lack of transparency about rates and the full costs and terms of borrowing; “stacking,” in which lenders layer multiple loans on top of each other; and “debt traps,” created when lenders advance more funds than a borrower can reasonably be expected to repay without having to refinance the debt.
These practices come at a high cost to small business owners. Because many financing companies get repaid by taking a daily ‘cut’ directly from a business’ bank account or credit card receipts, they are first in line to be repaid – even if the business needs the cash to stay afloat. The following is a real-life example of how one business shut its doors after being getting caught in a debt-stacking trap:
By the time an immigrant-owned Southern California bakery contacted Opportunity Funding hoping to refinance its existing debt, the owners were making daily payments of more than $600 to four different high-cost, short-term lenders. The payments ate up more than 25 percent of their daily revenue. For a food business such as a bakery, with profit margins typically around ten percent, that level of indebtedness is simply not sustainable in the long term. Unfortunately, Opportunity Fund was unable to refinance the high-cost debt — even with a much longer loan term. The bakery eventually shut down, putting its 13 employees out of work. In cases such as these — and we’re aware of scores of similar examples — each shuttered business represents not just the damaged dreams and credit of the individual owners, but lost jobs, vacant storefronts, and the loss of local goods and services as well.
Surprisingly, the majority of these new and alternative business financing providers are operating almost without any regulation. Because the companies are not banks, they are not regulated by federal banking rules. In some cases, these lenders choose to set up shop in states with lax limits, while others structure their products as “advances” rather than loans to avoid being considered lenders at all.
The damaging practices employed by some players in the market also have the potential to do real harm to the responsible players in the alternative small business financing industry in at least two ways. First, these firms are paying high yields to investors while experiencing substantial growth, which could lead investors in the lending sector overall to expect unrealistic yields. These expectations undermine the more responsible actors who cannot provide a 20 percent annual return. Second, because these high yields are not sustainable (and the business practices that lead to them are unpalatable), the long-term effect of their work may be to drive investors away from the sector entirely. This would limit access to capital for the millions of main street businesses that must now look beyond their local bank branch to secure financing.
Concerned by these problematic lending practices, a multi-faceted coalition of organizations has come together to create a Small Business Borrower’s Bill of Rights that defines responsible small business lending. The bill of rights outline six fundamental financing rights that all small businesses deserve, and specify lender and broker practices that uphold those rights. The six rights are:
- The Right to Transparent Pricing and Terms
Every borrower deserves the right to be presented the terms of a loan or financing product in plain English. In other words, lenders bear the burden of describing all key terms including the loan amount, payment amount and frequency, collateral requirements and cost of repayment in an easy-to-understand manner. Moreover, all fees, an annualized interest rate and or preferably an APR should be disclosed upfront.
- The Right to Non-Abusive Products
Lenders should abstain from predatory practices such as debt traps, “double dipping” (charging loan fees twice on unpaid debt during a refinance) and unearned interest. Borrowers should be provided with a pressure-free environment to consider their credit options.
- The Right to Responsible Underwriting
Not only should lenders have high confidence that their borrowers can repay their entire debt burden without defaulting or re-borrowing, it is the lender’s responsibility to only offer financing that meets the borrower’s need, rather than maximizing the lender or broker’s return. Lenders should also report to credit bureaus so other lenders can make informed decisions about the borrower’s ability to repay while helping the borrowers build credit.
- The Right to Fair Treatment from Brokers
To enable borrowers to make informed decisions about their credit options, brokers should disclose all loan options for which the borrower qualifies through the broker’s services and educate borrowers on each loan option before they sign a loan document. In the spirit of disclosure, brokers should also prominently post aggregate results of borrowers who have obtained funding from them, disclose all compensation paid to the broker and charge no fee if the broker is unable to find a loan or if the borrower does not accept a loan secured through the broker.
- The Right to Fair Collections Practices
Every borrower should be fairly treated in the collection of consumer debts. Signatories pledge to diligently review and oversee the collection practices of third-party collectors and debt buyers.
- The Right to Inclusive Credit Access
All should be afforded fair and equal opportunity to credit.
Our intent is for the Small Business Borrower’s Bill of Rights to be used in two ways. First, it should serve as a tool for educating small business owners about what they should expect — and demand — from a relationship with a lender or broker. Second, it can be a tool for encouraging accountability and changing the behavior of some lenders and brokers. All small business lenders and brokers who are willing to attest in writing that they comply with all of the practices laid out in the bill of rights are invited to become signatories. In addition, we encourage other organizations — small business and consumer advocates, policy organizations and think tanks, policymakers, government agencies, and investors — to endorse the bill of rights and take action to promote and support compliance with its practices. Through this industry-led approach, we hope to create market pressure for the small business lending market to adopt more responsible practices.
Together, we are working towards a world without predatory lending — a win-win scenario in which small business owners are protected and lenders pursue sustainable lending practices. Small business owners should have the ability to access sufficient credit, and given that responsible lenders and brokers only thrive when their clients succeed, the small business lending industry should recognize that its chances of success are diminished when employing predatory practices. We believe that the Small Business Borrowers’ Bill of Rights is a critical step to address problems in the small-business lending industry, and are proud to have taken an active role in encouraging the industry to move toward more responsible lending behavior.