We need common sense regulations to keep the most predatory brokers in check, and here are a few steps that Washingtoncan take right now:First, let’s strengthen federal oversight
The truth is that some brokers actually do help, offering sage counsel to small business owners to help them find the loan that best suits their needs. These respectable brokers typically earn modest fees of 1% to 3%, and that fee is paid by lenders without having any impact on the cost of the loans to borrowers.
But, small business owners are increasingly likely to encounter brokers who are out for themselves. In fact, unscrupulous players have emerged like wolves in sheep’s clothing, and are deliberately building tricks and traps into the loan process to pad their pockets and ensnare borrowers in a cycle of high-cost debt. For example, just last week a small business owner applied for a loan on the Fundera platform and was quoted an interest rate of under 30%. A few days prior that borrower had applied for the same loan product, but had gone through a broker who quoted a rate of 45%. The 15 percentage point difference is what the broker was pocketing for himself as his “finder’s fee”, and would have been passed onto to the unsuspecting borrower entirely unbeknownst to them.
That’s partly because banks are increasingly less focused on small businesses as a Harvard Business School working paper that I recently co-authored underscores. In the past two decades, small business loans have fallen from half of all banks loans to just about 30%. But, a new crop of online lenders have stepped in to fill part of this void, originating $3 online payday loans Texas billion in loan capital in 2013 and growing at high double-digit rates.
Second, let’s cap the percentage points that brokers can surreptitiously add to small business loans
About half of loans originated at some of the most prominent online small business lenders come from brokers, many of whom cut their teeth in the run-up to the subprime mortgage crisis. The prevalence of brokers in online lending is a big reason why interest rates at some of the most prominent online lenders can reach as high as 130%. Luckily many of the best online lenders are trying to distance themselves from brokers, and have made progress in pushing their share of the market down from as high as 70% just a few years ago.
But, as finding creditworthy borrowers isn’t easy, brokers are likely to remain a feature of the burgeoning alternative lending industry for the foreseeable future. That’s going to be a dangerous dynamic because there isn’t much that small business borrowers can do to protect themselves. Right now, brokers operate in a veritable Wild Wild West, governed merely by a tattered patchwork of state-based rules. In most states nearly anyone can be a broker to businesses: there’s no test to pass, no code of ethics to follow. Most states don’t even have a cap on interest rates that can be charged to businesses.
The Consumer Financial Protection Bureau (CFPB) should consider taking action at the federal level. The agency, while originally conceived as a consumer-oriented body, was given authority to oversee data collection on small business loans under the Dodd-Frank Act. And, fresh off hard-won disputes that have increased transparency for consumers in the student loan, credit card and mortgage industries, the agency may be best equipped to be the cop on the beat in online small business lending, too. In a letter sent to CFPB in May, Senator Sherrod Brown of Ohio rung the alarm that protections are needed from predatory tactics in online lending. The Dodd-Frank Act made it more difficult for mortgage brokers to charge usurious rates in the aftermath of the subprime crisis, and it deserves consideration in the small business lending industry as well.