Over a decade ago, Congress passed an amendment to the Equal Credit Opportunity Act that instructed the Consumer Financial Protection Bureau to introduce a new system for collecting data on small business loans, similar to the system that exists in the mortgage industry. Last week, a month before a court deadline, the Bureau released its long-awaited settlement proposal. The proposal was broadly in line with previous Bureau statements on its approach, but still contained some surprises that reflect the change in leadership at the GFPB. Lenders must carefully consider the impact the proposed scheme will have on their business.
The proposed rule would require a wide range of lenders to collect data about loans they give to small businesses, including information about the loans themselves, the characteristics of the borrower, and demographic information about the principal owners of the borrower. This information would be reported to the Bureau annually and eventually published by the Bureau on its website with some possible changes.
The stated intent of the statute is to “facilitate the enforcement of fair lending laws and enable communities, government agencies and creditors to understand the needs and opportunities of business and community development needs and opportunities of women, minorities and small businesses”. Acting Director of the CFPB, Dave Uejio, reiterated these issues in prepared remarks, suggesting that the proposal was a step towards “a fairer, more transparent credit market for small businesses”. However, the Bureau itself admits that it is doing a trade-off, weighing the intended benefits of the rule against the costs imposed on lenders (and hence borrowers), the risk to privacy, and the risk of unintended consequences that come with major regulatory encroachment . The public, including lenders who may be subject to the regulation, has 90 days to comment on whether the bureau has struck the right balance.
The proposed rule would cover most of the small business credit market
According to its provisions, the statute would generally apply to any “financial institution” lending to women, minorities or small businesses. However, the statute also allowed the Bureau to exempt any “class of financial institution” from its requirements. Last fall, under a process required by the Small Business Regulatory Fairness and Enforcement Act (SBREFA), the Bureau proposed that lenders be targeted based on their size (i.e., those below the $ 100 million or $ 200 million thresholds) Assets), their lending activity (i.e. those who issue 25, 50, or 100 or less loans annually) or based on one of the two thresholds. The proposed rule lands at the broadest end of this possible spectrum by abandoning all size-dependent exceptions altogether and adopting the lowest of the proposed activity levels. The regulation applies to all financial institutions that have carried out at least 25 “covered credit transactions” for “small businesses” in each of the previous two years.
Any loan, line of credit, credit card or cash advance from merchants, including agricultural loans and those also covered by HMDA, would be considered a “covered loan transaction”. In particular, the Bureau proposed in its SBREFA breakdown to exclude cash advances from traders but declined in the proposal, concluding that the segment is growing and presenting a uniquely fair credit risk.
As in its SBREFA outline, the Bureau would adopt the Small Business Administration’s definition of “small business”, except that the Bureau’s definition would use a simplified size threshold of $ 5 million or less in gross annual income. This deviation requires SBA approval, which Uejio expressed with confidence.
The debt collection obligation of the proposal is always triggered when a lender, who is subject to the rule below the activity threshold, receives a “covered loan application”. This term is broadly defined to include “any verbal or written request for a covered credit transaction made in accordance with the terms of [the] Financial institution for the type of loan requested. ”Revaluation requests, renewal requests, and renewal requests are not considered requests (unless additional loan amounts are requested), as are requests and prequalification requests.
The rule would require collecting 21 data points
The law sets out thirteen specific data points that must be collected by lenders, which the Bureau calls “mandatory data points”:
- Whether the applicant is owned by a minority
- Whether the applicant is owned by women
- Unique identifier for each application
- Application date
- Credit type (i.e. product type, guarantees and term)
- Loan purpose
- Amount requested
- Amount approved or extended
- The action on the application (i.e. created, approved but not accepted, rejected, withdrawn, or incomplete)
- Action date
- Gross annual sales
- The race, gender, and ethnicity of the principal owners
The collection of information about the main owner Race, gender, and ethnicity is a major change from the SBREFA breakdown, suggesting that the Bureau would likely suggest that such information be collected based solely on applicants’ self-reporting. As the Bureau recognized at the time, “the visual or surname-based reporting requirement in connection with small business lending could create unjustified compliance burdens.” The proposal reverses course and would require lenders meeting with a principal owner to determine the ethnicity and race of the principal owner if the applicant declines to provide this information. Under the law, the data collected on the race, gender, and ethnicity of the principal owners – as well as whether the company is owned by minorities or women – cannot be shared with underwriters unless access is not restricted.
The Articles of Association also authorized the Presidium to request additional data that serve the purposes of the Articles of Association (so-called “discretionary data points”). The discretionary data points proposed by the CFPB are in line with this administration’s priority for fair lending enforcement:
- Time in business
- NAICS code
- Number of employees
- Application process (e.g. in person, by telephone, by post, online)
- Applicant (e.g. directly or through a third party)
- Reasons for rejection (with nine specific reasons and a text field for each other reason)
- Number of major owners (i.e. 0-4)
The SBREFA structure provided for the first four above; the last four were included in the proposal. It should be particularly emphasized that the price data is granular: in the case of fixed-rate loans, the interest rate; for floating rate loans, the margin, index value and index name; in the case of cash advances from merchants and similar products, the difference between the advance amount and the amount paid; and for all transactions, origination fees, brokerage fees, whether the fees were paid directly to the broker or to the financial institution for delivery to the broker, interest-free fees charged in the first year, whether the financial institution has an early repayment penalty as per its policy and whether it has imposed a prepayment penalty.
Is everything published?
Lenders must collect the data annually and report it to the bureau, which publishes the data on its website – subject to changes or deletions determined in the interests of data protection. The Bureau has not yet proposed any changes or deletions, but intends to issue a policy statement on its approach after receiving a full year of data.
In the meantime, however, the Bureau has made it clear that it will disclose the identity of financial institutions and is generally not convinced that competitive or reputational damage to financial institutions or increased litigation are grounds for refusing to disclose information. Instead, the Bureau has indicated that its main concern is to avoid the risk that an applicant could be re-identified based on certain data points.
How will the rule affect small business lending?
The proposal would apply to thousands of small business lenders offering a wide range of products. The Bureau acknowledges that collecting and reporting this information will impose costs on lenders, some of which are likely to be passed on to borrowers.
However, the most significant impact of the regulation will be the eventual publication of the data by the Bureau. In his view, releasing granular data on specific credit decisions will further the legal goals of facilitating fair credit enforcement and the development of businesses and communities. However, concerns about reputational damage and increased fair credit screening can also lead lenders to eliminate subjective elements of underwriting that are a traditional and often appropriate feature of small business underwriting. If the rule ultimately leads, as one commentator put it, “prices artificially flattened”, the rule could result in a small business credit market that is less innovative and less prone to actual credit risk than today’s market.
The public has 90 days to comment on the CFPB’s proposal.