Banks, fintechs tussle over small-business lending authority

The banking industry is pushing back against two proposed rules from the Small Business Administration that would increase opportunities for financial technology companies to grant highly sought 7(a) loans.

One of the SBA's proposed rules would lift the current moratorium on the number of nondepository institutions, known as Small Business Lending Companies, or SBLCs, that can obtain licenses to offer 7(a) loans. If passed, the rule would give more fintechs the ability to get these licenses. Right now, there are only 14 of these SBLCs.

The other rule could loosen or remove some of the 7(a) program's requirements for how lenders underwrite loans and how borrowers may use funds. The 7(a) program provides a maximum loan amount of $5 million to small businesses, which they can use for short- and long-term working capital, to refinance current business debt, and to purchase furniture, fixtures and supplies, according to the SBA website.

While the Biden administration and fintech lenders advocate that the two proposed rules would make it easier for underserved people to get much-needed business loans, banks, credit unions and some existing SBLCs argue that the guidance poses a threat to the SBA's flagship lending program.

The conflict comes at a time when small business loan demand is increasing, with outstanding 7(a) loan totals rising for three-consecutive quarters. U.S. banks dominate the list of top 20 SBA 7(a) lenders in 2022. But some nonbank lenders, such as Newtek Small Business Finance LLC, ReadyCap Lending LLC and Harvest Small Business Finance LLC, hold top spots. Those three nonbank lenders rank third, sixth and 12th, respectively.

Issue of fraud

The National Association of Government Guaranteed Lenders, or NAGGL, is concerned that loosening lending requirements while opening the door for new SBLC licenses could increase instances of fraud in the 7(a) program. In an interview with S&P Global Market Intelligence, the group's president and CEO, Tony Wilkinson, noted that much of the Paycheck Protection Program fraud occurred in the fintech sphere.

On Dec. 1, the House's Select Subcommittee on the Coronavirus Crisis issued a new report that found that "at least tens of billions of dollars in PPP funds were likely disbursed to ineligible or fraudulent applicants, often with the involvement of fintechs."

But Funding Circle Holdings PLC, a U.K.-based online lender that provides loans to small businesses through bank and credit union partners, believes that it is unfair to compare the long-running 7(a) program to the PPP, which was created in 2020 in response to the COVID-19 pandemic and rolled out quickly.

"It's important to clarify the fact that PPP is not 7(a). The 7(a) program has operated for 40-plus years, including banks and nonbanks," said Ryan Metcalf, head of public affairs at online lender Funding Circle.

Concern for borrowers

In addition to fraud, existing SBA 7(a) lenders are also concerned about fintechs' historic lending practices.

"The bigger issue is really the integrity of all SBA loan programs. Fintechs are not bankers. They have not had any SBA experience. These are folks that are technologists. They're coders. They have slick online marketing capabilities. They're not lenders first," said Chris Hurn, founder and CEO of Fountainhead, a nondepository institution with one of the 14 SBLC licenses.

Fintechs tend to charge higher interest rates and allow more charge-offs and loan defaults than traditional 7(a) lenders, and "that could put the entire SBA loan program in jeopardy," Hurn said.

In a letter to the chairs and ranking members of the House and Senate Small Business Committees on Dec. 2, five bank and credit union trade groups, along with the NAGGL, expressed concern that the new SBLCs will not be subject to the same regulatory and compliance requirements imposed on federally supervised banks and credit unions. The groups described the proposed rules as "detrimental" to the 7(a) program.

Ami Kassar, founder and CEO of MultiFunding LLC, a company that helps businesses obtain SBA loans, said the existing 7(a) rules are sufficient as they are, and these proposed changes pose "an imminent disaster."

"The protections are in there just as much to protect the borrower as they are to protect the lender," Kassar said in an interview.

Supporting the smallest small businesses

But those supporting the SBA's proposed rules argue that expanding the number of participants and loosening the requirements would ensure that the smallest small businesses get the funds they need.

Funding Circle's Metcalf said the current rules that apply to the 7(a) program make it "a dinosaur" and need to be updated. The new guidance is an attempt to increase the distribution of smaller-dollar loans to underserved communities and to modernize the program, Metcalf said.

"The SBA intends for this policy to increase lending to the smallest and minority-owned businesses amid a steady decline in loans under $250,000 by traditional banks, which the agency has historically relied on to distribute 7(a) and 504 loans," Funding Circle wrote in an Oct. 7 news release.

The White House also supports the proposed SBA rules, arguing that the agency's objective is "to grow the number of lenders that receive its loan guarantee, thus increasing small business lending, particularly in smaller-dollar and underserved markets, where borrowers are most acutely shut out of current lending."

Lawmakers get involved

The issue has caught the attention of Congress.

The Senate Small Business Committee is set to hold a hearing on improving access to capital in underserved communities and other SBA initiatives Dec. 14, and NAGGL's Wilkinson said concerns around the proposed rules will likely be a topic of discussion. NAGGL has been lobbying against the rules, and lawmakers seem open to industry concerns.

"I think folks understand that there's a problem here," Wilkinson said. "My strong preference is always to avoid a problem rather than to clean it up."

However, Funding Circle's Metcalf believes that, despite banking industry lobbying efforts, there is bipartisan, bicameral support on Capitol Hill for lifting the moratorium. In August 2021, Sens. Tim Scott, R-S.C., and John Hickenlooper, D-Colo., introduced the Expanding Access to Credit for Small Business Act, which would widen the criteria of the SBA's 7(a) program to include fintech lenders.

"As long as we continue to build on the bipartisan support and support with the administration, I don't see any logical reason why they would not increase the amount of licenses," Metcalf said.