NCRC Initial Analysis of the CFPB SBREFA Panel Outline: A Step in the Right Direction but Improvements Sought

Summary 

The Consumer Financial Protection Bureau (CFPB) released an outline of proposals for implementing Section 1071 small business lending data required by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. These proposals are for a small business advisory review panel (SBREFA), which is required before a rulemaking process commences. The CFPB’s initial proposals for the small business lending data take some steps in the right direction such as including a broad range of institutions from banks to non-bank financial technology companies that would be required to report data. However, some proposals would keep lending activity in the dark such as the proposal to not report Merchant Cash Advances, a form of credit that is higher cost and has been subject to abuses. 

The CFPB has asked for public comments on its outline which are due on December 14. NCRC offers this initial analysis and invites feedback from stakeholders as it develops its comment letter. 

Introduction

In September, the Consumer Financial Protection Bureau (CFPB) released its outline of policy considerations and questions regarding the Section 1071 small business loan data mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. Section 1071 of Dodd-Frank requires lending institutions to report demographic information about applications for small business loans including race and gender of the business owners. 

Presently, Community Reinvestment Act (CRA) small business loan data provides information for only a few data points on bank lending such as census tract location of the loan but not on the demographics of the small business owner. Section 1071 would represent a significant improvement in the publicly available small business data and would help hold small business credit lenders accountable for lending disparities and ensure that all small businesses have fair access to capital necessary to participate in an economic recovery. 

Small business owners of color have faced challenges accessing credit to start and expand their businesses. Most recently, structural problems at the outset of the Paycheck Protection Program (PPP) meant that many small businesses owned by people of color were unable to access this vital forgivable loan program designed to help small business owners and their employees weather the current crisis. Recent NCRC research found that business owners of color where more likely than White business owners to face discouragement and discrimination when applying for forgivable PPP loans. 

Collecting and disclosing information about small business loan applications, approvals and terms will improve the enforcement of fair lending laws and strengthen oversight of banks and non-banks that lend to small businesses. In addition, publicly available data provides community organizations, regulators and lenders a market wide view necessary to expand access to capital to small business owners of color, woman-owned businesses and businesses in lower-income communities.

A small business advisory review panel (SBREFA) is required before a rulemaking process commences. This panel consists of small business entities (lenders in this case) that offer their recommendations and consider benefits and costs of the pending rule. The CFPB’s outline for the SBREFA panel contains some provisions that will improve lender accountability but also some that, if included in a future rule, will keep lending practices shrouded. 

This is an initial analysis and NCRC will provide more detailed comments in the coming months. Any member of the public can comment to the CFPB. Comments should be emailed to 2020-SBREFA-1071@cfpb.gov no later than December 14, 2020.

Aspects of the proposal, if adopted, will bring much needed, uniform transparency to the small business credit market by:

• 1. Collecting data on applications from and loans to small businesses, woman-owned businesses and businesses owned by people of color
  2. Requiring disclosure from most types of lenders active in the small business market, including banks, credit unions, online lenders and others, ensuring that lenders cannot exploit loopholes
  3. Collecting data on loan pricing, number of employees and years in business to ensure fair access for the smallest businesses and start-ups

A number of approaches considered by the Bureau, however, must not be included in the next step in the regulatory process. Many of these options would make the small business credit market less transparent, and would make it difficult to prevent well-documented discrimination.  

• 1. Bureau must require consistent reporting from all types of lenders, including banks, credit unions, online lenders and others.
  2. The Bureau should not exempt lenders from the new disclosure requirements based solely on the assets held by the institution.  An asset threshold would exclude some small banks and credit unions, which are important small business lenders, and exclude non-depositories, such as online lenders.
  3. The Bureau should not exempt non-traditional lenders, such as merchant cash advance providers and others.

The following is more detail on major parts of the SBREFA outline. 

Lenders Required to Report

The statutory language of Section 1071 was designed to ensure market wide coverage and reporting from the wide variety of institutions that provide credit to small businesses, including banks, credit unions, online lenders and other lenders. Section 1071 defines a lender as “any partnership, company, corporation, association (incorporated or unincorporated), trust, estate, cooperative organization, or other entity that engages in any financial activity.” This would include depository institutions like banks and credit unions and non-depository institutions such as financial technology companies.

Appropriately, the CFPB states that the lenders likely to be included are “online lenders/platform lenders, community development financial institutions (both depository institutions (DIs) and non-DIs), lenders involved in equipment and vehicle financing (captive financing companies and independent financing companies), commercial finance companies, governmental lending entities and non-profit, non-DI lenders.”^[1]

The statute provides the CFPB with authority to exempt financial institutions from the reporting requirements. The CFPB is considering either an asset-size threshold (asset level below which an institution does not report data) or an activity-threshold (number of loans below which an institution does not report). In the case of non-depositories, the CFPB cannot readily apply an asset threshold since non-depository institutions do not have stable asset sizes unlike banks. Even in the case of banks, an activity threshold makes more sense since it is a clearer indication of whether a lender is substantially engaged in the business of making small business loans or whether a nominal number of loans indicates that small business lending is incidental to its lending activity. 

A workable activity threshold is 25 loans annually. The CFPB had used this threshold to determine whether a lender must report Home Mortgage Disclosure Act (HMDA) data, but unwisely raised it to 100 home loans in 2020, which will likely serve to exempt many smaller lenders operating in smaller cities or rural counties and reduce the transparency of the market in these important areas. For Section 1071 data, the CFPB is considering an activity threshold of 25 loans, which is similar to an asset threshold level of $100 million in terms of how many smaller depository institutions would be exempted. The CFPB is also contemplating activity thresholds of 50 or 100 loans and an additional asset threshold of $200 million.^[2]

The CFPB will decide on exemptions based on a cost-benefit analysis considering the benefits of data collection compared to costs for lenders and possible increases in costs for borrowers as lenders pass them on. The CFPB will be using the SBREFA process to collect more information on costs and will be surveying lenders.

Initial indications, however, is that costs are minimal just as they are with HMDA data. The CFPB estimates variable costs ranging from $17 to $40 per application for smaller lenders. As a result of these minimal costs, “Even if the variable cost were passed on in full to small business borrowers in the form of higher interest rates or fees associated with a loan or line of credit, the Bureau expects that this would comprise a small portion of the total cost of the average loan to the small business borrower.”^[3]

The initial cost-benefit analysis suggests the lowest thresholds are feasible and desirable in achieving the fair lending and community needs objectives of the statute. NCRC believes that additional analysis will confirm the need and desirability for low thresholds and expansive inclusion of lenders required to report the data. 

Definition of a Woman- and Minority-Owned Small Business

The CFPB is considering defining a woman-owned or a minority-owned business as one in which women or minority individuals have 50% or more control or ownership. The definition of minorities includes African Americans, Asians, American Indians or Alaska Natives, Native Hawaiians or Other Pacific Islanders, and/or Hispanic or Latinos. The CFPB definition of minorities will reference those in the Home Mortgage Disclosure Act (HMDA) data. This is sensible since it will promote consistency across these two vital databases. ^[4]

Moreover, small business owners should have the choice of selecting disaggregated race and ethnicity categories on their application forms just as borrowers of home loans do. The disaggregated race and ethnicity categories have proven popular with home loan borrowers (for example, more than 50% of Asian applicants indicated an additional disaggregated category in the 2018 data)^[5] and reveal important differences in access to affordable credit for subgroups within race and ethnic categories (for example Filipinos paid almost $2,000 more in closing costs for home purchase loans than Asian Indians in 2018). ^[6]

Over the coming weeks, NCRC will also be considering how racial and ethnicity categories in HMDA data correspond to those in the Annual Business Survey and the forthcoming Non-Employer Statistics-Demographics (NES-D) data. As much as possible, it is desirable to align the categories so data analysis can compare the composition of racial and ethnic small business loan applications with that of small businesses. 

The CFPB will not require lenders to observe visually the demographics of applicants that refuse to provide their racial/ethnic or gender status.^[7] This is in contrast to HMDA, which requires lenders to take this step. It is understandable that this procedure could be more difficult to implement in a small business lending process since businesses could be owned or controlled by more than one individual, some of whom may not be present when the application is submitted. 

Census Tract Location of a Small Business

The CFPB prefers that a lender reports an address where the loan proceeds will be principally applied.^[8] This would be geocoded into a census tract. If this address is unknown, the CFPB asks for the address of the business headquarters or the address associated with the application. The CFPB is correct in prioritizing the address where the proceeds would be used because as it states, this is in accord with the statutory purposes of Section 1071 to see if community credit needs are being met. 

Definition of a Small Business 

The CFPB is considering various criteria for defining a small business, including annual revenue and number of employees. When the agency asked for comments a couple of years ago, a popular definition was a business with less than $1 million in revenues. The CFPB is considering this definition. However, the agency also says that the Small Business Administration (SBA) defines a small business as one with 500 or fewer employees and up to $8 million in annual revenues. 

If the CFPB adopts the $1 million in revenue threshold, it reports that about 23% of small firms with employees would not have their applications reported in the Section 1071 data. In contrast, the SBA definition may result in an omission of just 63,000 small businesses. It could be prudent to err on the side of inclusion and to adopt the more expansive definition of small business in order to maximize the accuracy of the loan database in capturing experiences of small businesses in the lending marketplace. Also, data fields of revenue size and number of employees can make it possible for data users to separately analyze the experiences of the smallest businesses from their larger counterparts. 

NCRC initially agrees with the CFPB’s interpretation of the authorizing language in Dodd-Frank to include data reporting requirements for applications submitted by small businesses with a maximum of 500 employees. As the CFPB notes, the types of lending and underwriting are different for large businesses as opposed to smaller businesses with 500 or fewer businesses. A definition using more than 500 employees as a cut-off captures about 99% of women- and minority-owned small businesses.^[9]

Types of Credit Included

In order for a database to reflect accurately the experiences of small businesses applying for and receiving credit, it must include the major types of credit for which small businesses apply. The CFPB appropriately proposes to include not only term loans, but also credit card lending. Credit cards are widely used by small businesses, often with smaller principal balances and higher interest rates than term loans. It is thus important to assess whether the smallest businesses or women- and minority-owned businesses have equitable access to term loans or are served disproportionately by credit card loans or other small business credit products. If an imbalance exists, stakeholders can then determine the factors behind the imbalance and take steps to narrow the disparities in access. The CFPB also contemplates including lines of credit.

The CFPB is proposing to exclude a variety of types of credit including consumer-designated credit, leases, factoring, trade credit, and merchant cash advances. NCRC will investigate the reasons for the proposed exclusions more thoroughly over the comment period, but two exclusions, factoring and merchant cash advances (MCAs), stand out. In a factoring arrangement, a small business will sell its receivables to a company called a “factor.” The factor will then advance a portion of the receivables to the small business and collect the receivables from the small business customers. A downside to factoring is that it is an expensive form of credit; the factor will effectively charge an interest rate of around 20% by discounting the total amount of receivables and advancing about 75% to 80% of the receivables to the small business. The other significant drawback is that the small business cedes collections of receivables to the factor. This could be problematic if the factor engages in abusive collection techniques, alienating the customer from the small business. ^[10]

Under an MCA agreement, in exchange for an advance on future earnings, a lender receives a percentage of a small business’ receipts on a daily basis. This August, the Federal Trade Commission filed a lawsuit against Yellowstone Capital for withdrawing substantial sums of funds from small businesses’ accounts without the owners’ consent and often after the owners had repaid the MCA. ^[11]

Both factoring and MCAs are widely used by small businesses as a form of credit and should be included in the definition of credit under Section 1071. A CFPB white paper estimates that the number of factoring and merchant cash advances is about 8 million (7 million for factoring and one million for MCAs), which exceeds the 6 million loan term accounts. While the dollar amount of factoring and merchant cash advance is smaller than term loans, measuring factoring and merchant cash advance by number of accounts illustrates that these types of credit are widespread.^[12]

Even though the CFPB found that MCAs and factoring were prevalent, the agency opted against including them on the grounds that their complexity would make reporting difficult for lenders.^[13] However, financial providers that make substantial volumes of MCAs and factors are well acquainted with them and should be able to handle a data reporting requirement. Moreover, this type of credit has been associated with abuses, making disclosure necessary in order to monitor whether disadvantaged small businesses disproportionately receive this type of credit.

Additional reporting items regarding the type of credit that the CFPB contemplates would provide important information. For example, the CFPB proposes to require reporting whether the loan has a government guarantee such as from the Small Business Administration (SBA) and whether the loan is secured by a form of collateral or unsecured.^[14] Additional detail in some of the data fields like knowing whether a small business owner used her or his house for collateral would be important to gauging the risk involved in receiving loans for various subgroups of small businesses. Loan terms and conditions provide important information regarding access to various types of loans for subgroups of small businesses and whether potential fair lending issues should be probed further. 

Loan Purpose

The CFPB is appropriately considering requiring the reporting of a variety of loan purposes. This is important because it gauges whether small businesses can obtain credit for various needs relating to loans for start-up, working capital, expansion, buying equipment or acquiring commercial real estate. ^[15]

The CFPB lists in its outline a loan purpose of “refinancing existing debt.”^[16] However in a summary document accompanying the outline, the CFPB contemplates excluding from the definition of an application whether the request is for a renewal of the loan.^[17] This is contradictory unless the CFPB is defining refinancing existing debt as debt that does not include a previous loan from the particular lender the borrower is currently using. In any case, all refinances and renewals should be included in the database since they are credit needs that should be monitored. 

The CFPB is considering requiring lenders to report data on an application when a borrower requests additional loan dollars.^[18] This is positive, but the database should be made more complete by including requests for refinances or renewals (extension of existing principal past the original due date) of the original loan as well as when a borrower requests additional dollars.

Applications and Action on Applications

The CFPB proposes to define an application as “an oral or written request for an extension of credit that is made in accordance with procedures used by a creditor for the type of credit requested.”^[19] According to the CFPB, the definition accords with that in Regulation B, which implements the Equal Credit Opportunity Act. This is sensible and is much preferable to an alternative definition, which the CFPB also floated out to the public in its SBREFA outline. 

The alternative definition involves receiving all the information that the creditor needs in order to render a decision.^[20] The CFPB must not implement this definition because applicants sometimes do not submit all the needed information. In some cases, an incomplete application results when the lender discriminates and indirectly or explicitly discourages an applicant from completing an application. The CFPB would miss recording incomplete applications in its database if it defines an application as occurring only when an applicant submits all the necessary information necessary for rendering a decision. 

The actions on applications that the CFPB contemplates reporting include loan originated, application withdrawn, loan approved but not accepted (by the applicant), application denied, and incomplete application. Mirroring HMDA action categories, these action categories are necessary for fair lending analysis to see if subgroups of small businesses are denied disproportionately or otherwise treated differently than other groups. ^[21] 

Timing of Collecting 1071 Data

The CFPB proposes that lenders do not need to collect Section 1071 data during any specified time period during the application process. The CFPB states it does not want to impose costs on lenders by interfering with the timing of their data collection activities during applications. However, the agency acknowledges that a lack of standardizing when to collect Section 1071 may lead to inconsistencies among lenders or delays in obtaining Section 1071 data if the data is collected “late in the process when applicants may be less motivated to supply their demographic information.” ^[22]

Instead, the CFPB should require the collection of Section 1071 data when a customer has requested an application, that is, when the customer requests credit. The CFPB mentioned it was considering this option and should adopt this option. ^[23]

Discretionary Data Points

The CFPB has authority under Section 1071 to require that lenders report additional data points beyond those specified in the statute. The CFPB contemplates requiring time in business, number of employees, North American Industry Classification System (NAICS) code and loan pricing.^[24] These discretionary data points would be critical in achieving the fair lending purposes of the statute. Research has shown that start-ups and businesses with the fewest employees have the most difficult time obtaining loans. During data gathering, another important question is asking non-employer businesses (those businesses with no employees) whether the business is their primary form of income or is a form of supplemental income. This question may help explain some of the differences in access to credit.

The NAICs code, which indicates the sector of the small business, will help assess the experiences of different small businesses in obtaining credit. It is probably sufficient to ask lenders to report six digit NAICs codes instead of the full 13 digits but NCRC will be further considering this issue during the coming weeks. 

Loan pricing in the form of an Annual Percentage Rate (APR) or interest rate and fees will shed further light on whether the loans are affordable and whether subgroups of small business are disproportionately receiving the highest cost loans. Ideally, the disclosure should be an “all in” APR that includes not only the interest rate, but also all fees and other loan expenses. 

The CFPB did not discuss any data associated with creditworthiness of the small business borrower but should consider data on credit profiles in order to increase the explanatory power of the Section 1071 data. NCRC has advocated for creditworthiness data to be reported by buckets or percentiles. In addition, a data field should be added indicating if the credit profile was based on the personal credit profile of the owner or on the credit profile of the small business. 

These additional discretionary data points will help researchers and advocates control for types of businesses in their analysis and will help them identify women- and minority-owned small businesses that are receiving higher priced loans despite having similar characteristics as their counterparts. They can then raise evidence of these disparities to policymakers and enforcement agencies. 

Privacy Provisions and Data Disclosure 

The CFPB is grappling with how to shield applicants’ demographic information from underwriters and how to preserve applicant privacy when publicly disclosing the data. Section 1071 requires that underwriters not have information on the demographic information of applicants. However, if it is not feasible to shield this information from underwriters (presumably at smaller lenders), then the statute requires that small business applicants receive a notice informing them that the lender cannot discriminate.^[25] NCRC will be further considering this issue. However, all applicants should receive this notice, not only applicants whose information cannot be shielded in a “firewall” from underwriters. 

Another privacy issue is whether the publicly available data can be used to identify applicants. The CFPB will employ a balancing test to assess whether costs (risks of identification) outweigh the benefits (assessment of fair lending and community need) of data disclosure.^[26] The experience with HMDA data has not revealed a single incident of applicant identification in more than 40 years of HMDA’s existence. If appropriate safeguards (such as reporting some data points in buckets or intervals instead of precise values), NCRC believes Section 1071 data can be robust without raising privacy concerns.

Josh Silver is NCRC’s senior policy advisor.

Tom Feltner is NCRC’s director of policy.

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