April 2, 2018
5 minutes to read
Opinions expressed by Contractor the contributors are theirs.
A recent trial against small business fintech lender Kabbage Inc., accusing it has partnered with a bank to offer interest rates above legal limit, stresses need for increased regulatory oversight of growing number of lenders online who sign agreements with small businesses.
US banks are licensed either by their state’s banking commission or by the US Treasury Department. Office of the Comptroller of the Currency (OCC) and are regulated by the federal government either by the OCC, the US Federal Reserve System (Fed) or the Federal Deposit Insurance Corporation (FDIC).
Once a bank has a charter, it serves an important community purpose: it takes deposits and lends that money to keep money moving through the economy – dynamic economists call the multiplier effect.
Done correctly, the economy grows sustainably; done badly, it can cause a recession. If banks take deposits and accumulate cash, the economy could contract, and if banks lend regardless of the borrower’s repayment capacity, high defaults could lead to credit freezes. The banking regulator’s oversight is trying to ensure that nothing in this delicate balance does not go awry.
Online lenders are increasingly under scrutiny.
The recent Massachusetts federal case brought by a small business against Kabbage (and his partner Celtic Bank) shows why non-bank fintech lenders should be regulated. The lawsuit alleges that Kabbage used his relationship with Celtic – which “rented” its balance sheet to Kabbage – as a basis for charging interest rates that violate usury laws. Usury laws differ from state to state, but in the majority of states it is illegal for a non-bank lender to charge more than 29% interest per year on a loan.
The case against Kabbage is just one of many allegations that online lenders charge interest rates that strain their customers with unsustainable loan payments. New York State is consider regulating online lenders after lawmakers discovered there was “significant potential for unscrupulous online lenders to exploit consumers through predatory practices such as unusually high interest rates, failure to disclose hidden fees and unclear loan conditions “.
New York State is not alone in facing these concerns: research paper prepared for the Fed Board of Governors, writes that 20% of small businesses seek financing from a fintech or online lender, compared to 52% from small banks and 42% from large banks. Small businesses with sales of less than $ 100,000 requested loans from online lenders 30% of the time.
The report concludes that most of those who take out loans online do not meet the criteria for taking out traditional loans and that these lenders do not disclose important loan terms like the APR or clearly identify terms as basic as frequency of payments.
When a borrower does not have enough liquidity and accepts loan terms that he does not understand with interest rates that far exceed the usury limit, business failure becomes a likely outcome. .
But online lenders are not the only option.
For many of these businesses, there are two alternative and much more responsible options: micro loans and US Small Business Administration (SBA) loans.
Micro-loans are offered by non-bank, mission-based, not-for-profit lenders who receive funding from private foundations, the SBA, and local banks as part of their efforts under the Community Reinvestment Act . They offer loans to smaller businesses that are not yet ready for bank financing, either because their needs are simply too low, or because they have risk characteristics that exceed the risk profile of the banks.
Loans range from $ 500 to $ 350,000 or more, with interest rates slightly above bank rates and terms consistent with conventional loans. And in addition to loans, these nonprofits typically offer ongoing technical assistance to help businesses assess business plans, and understand ways to better manage their finances.
The other option is SBA guaranteed loans, which come in two forms: the 7 (a) program and the 504 program. 7 (a) loans are offered by banks and SBA regulated lenders and are partially government guaranteed, for amounts up to $ 5 million for most business purposes. The 504 loans, which can be used to purchase owner-occupied real estate or capital goods, have part of the funding from a conventional bank loan in the senior position and part from a secured bond. 100% by the SBA in second position.
To get an SBA loan from a bank, a business goes through an underwriting process that examines the 5 Cs of credit – capital, collateral, terms, creditworthiness, and cash flow. While banks typically require strength within the five Cs to qualify for their conventional loans, an SBA loan offers more flexibility.
SBA loans allow banks to approve a loan with less collateral or a lower down payment (if cash flow allows repayment), offer a borrower a longer repayment term, resulting in tailored lower payments. to the company’s cash flow or, in some cases, to guarantee the company’s repayment forecasts. And in most cases, banks cannot by law charge more than Prime + 2.75% on loans over $ 50,000.
Some companies complain about the frustratingly slow bank underwriting process, especially when compared to the yes / no decision an online lender can take in minutes. However, the # 1 goal of any traditional small business lender is to make sure a loan never hurts the customer. A loan must benefit the health of the business, so ensuring that it does requires careful analysis and consideration.
While a traditional bank underwriting process can be frustrating for small businesses, the added speed provided by online lenders can come at a real cost to the business – and even your life savings. So beware!