‘Winter Is Coming’ For SME Alt-Lending Regulation

While the alternative lending industry was largely viewed by regulators and many experts as a niche market, the high-profile IPOs of Lending Club and OnDeck late last year jolted expectations and brought alternative financing players onto the mainstream. Still, regulators have largely decided not to pounce on the market on the acknowledgement that alternative lenders play a positive, crucial role in providing SMEs with access to working capital, in turn supporting economic growth.

But experts have begun to warn that the day of that light regulatory touch on alt-lenders are numbered, and the market is likely to see a rough road ahead.

Generally, lawmakers understand the need for SMEs to access working capital as a way to strengthen the economy. But a new report from American Banker highlights several practices among alternative SME lenders that are likely to attract legislative scrutiny, including “tying multiple business loans to the same collateral, fair lending issues and interest rate disclosures,” the publication said.

A Regulatory Threat

According to experts, many alt-finance players are expecting the Consumer Financial Protection Bureau to emerge as a regulatory threat. But the biggest fear of all, perhaps, is that just how the CFPB or other authorities may crack down on the market is unknown.

Part of alternative lenders’ strategy to avoid a major authoritative crackdown so far is their effort to avoid state-specific lending rules while enjoying the fact that federal caps on lending rates don’t apply for SME financing. The states themselves similarly haven’t capped those rates.

But several practices in the industry could be the first targets. One of the largest regulatory loopholes for alternative lenders, reports said, is that the federal legislation that requires lenders to disclose consumer interest rates does not apply to SMEs.

“It is effectively the Wild West in the small-business space,” the head of policy and advocacy for SME loan comparison site Fundera, Brayden McCarthy, told American Banker. McCarthy is now advocating for the establishment of a small-business borrower bill of rights to increase transparency in the industry. “It is shocking the number of borrowers that don’t realize their personal assets are at stake.”

Indeed, small businesses are becoming increasingly vocal about hidden fees they encounter when working with an alternative lender. More eyebrows are being raised, too, about the practice for some alternative lenders to not disclose these fees until the application phase is completed and SME borrowers are ready to sign.

Loan stacking has also earned some negative reaction. The practice sees lenders tie the same collateral to multiple lines of credit, sometimes because they have not acknowledged a borrower’s existing debts. But this practice can also occur because SME borrowers deceive a lender. Loan fraud has worried industry experts in other ways, too. Funding Circle co-founder Sam Hodges spoke at a Congressional hearing on P2P lending earlier this month, during which he raised the issue of applicants posing as established businesses when applying for a loan.

Maintaining Positive Ties

According to American Banker, unnamed sources within the alternative finance sector have said they are in touch with CFPB officials in an effort to maintain communication between the industry and the regulator, and to remind authorities of alt-lenders’ ability to often provide SMEs with cheaper financing than banks can.

Reports said that alternative lenders are also looking to remain in authorities’ good graces by providing information about how they use their data to the National Economic Council. Financial analyst PayNet, which provides data to alternative lenders, is tied to a new industry group run by PayNet co-founder and president Bill Phelan. That group, American Banker said, aims to represent the industry as a united, collective whole to lawmakers.

According to a spokesperson for the Treasury Department, Dan Cruz, authorities are keeping an eye on the industry, but recognize the importance of maintaining relationships with its players.

“More data is needed to fully understand how these lenders and their products compare to traditional banking products for small businesses,” he said, adding that the Treasury has been paying attention to alternative lenders since its 2013 event, which included presentations from OnDeck and Lending Club. “While online marketplace lending for small business is still relatively new, it does appear to be providing new options for small businesses to access capital.”

Still, the industry is bracing for a crackdown sooner or later. “I think everyone knows winter is coming,” said Fundera’s McCarthy on SME lending regulation. “It’s just a matter of time. But the question is: Who’s going to get out ahead of it, and do what’s fair instead of what’s easy?”