The Importance of Small Business Lending in the United States

Small businesses across our nation play a crucial role in the health of our economy. As of 2019, small businesses employed 46.4% of total employees in the United States and paid 39.4% of the nation’s wages.[1] Women and racial minorities own 43.2% and 19.4% of small businesses, respectively. 

Despite their significant contributions to the U.S. economy, many small business owners have difficulty accessing credit to launch and/or grow their businesses. Small businesses may not have sufficient revenue history or other information to qualify for credit, their financing needs may not fit within the credit box of banks, or other factors. Access to credit is particularly difficult for women and minority small business owners if their business and/or personal credit histories are not well-represented in traditional credit reporting datasets.

When it comes to small business lending, community banks have an advantage over large national banks given their deep understanding of the communities they serve. As such, community banks have played a key role in small business lending. Fintech lenders also are filling the gap, leveraging alternative data, predictive algorithms, and other technologies to not only provide a more detailed picture of the financial health of a small business but also to streamline the customer experience and lower operational costs.

The Consumer Financial Protection Bureau (CFPB) has recognized the need to support equitable access to credit for small businesses, and on March 30, 2023, issued its Final Rule under Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Rule 1071”), which modified the Equal Credit Opportunity Act (ECOA) to include data collection and reporting requirements on small business lenders—including large banks, community banks, credit unions, and fintech lenders alike.

Access to credit and small business ownership are levers to build wealth. Fairer small business lending practices can enable more businesses to launch and grow, drive economic prosperity for our communities and the families of small business owners, and support greater equity within our nation.  Alternatively, the lack of fair small business lending can hamper potential growth and further create inequity for small business owners in marginalized segments of the population. 

Final Rule 1071

Final Rule 1071 was issued on March 30, 2023, with ~900 pages outlining data collection and reporting requirements for small business lenders to provide transparency into small business lending practices.  While the CFPB anticipates that it will initially release aggregate-level data, application-level data will eventually be released. The reported data will ultimately be used to enforce fair lending laws and identify business and community development needs for women and minority-owned small businesses. 

Rule 1071 applies to:

The data elements required for collection and ultimate reporting under Rule 1071 include:   

For data collected directly from an applicant, procedures must ensure that: 1) The initial request for applicant-provided data occurs prior to notifying an applicant of the final action taken on an application; 2) The request for applicant-provided data is prominently displayed and presented; 3) Applicants are not discouraged from responding to such requests; and 4) Applicants can easily respond to such requests.  Further, lenders are required to maintain procedures to identify and respond to indications of potential discouragement (e.g., low response rates for applicant-provided data).

The final rule has recordkeeping requirements, including a requirement to retain copies of small business lending application registers and evidence of compliance for three years.  

Rule 1071 also includes a requirement to maintain an applicant’s responses surrounding the applicant’s minority-owned, women-owned, and LGBTQI+-owned business statuses and regarding principal owners’ ethnicity, race, and sex separate from the rest of the application and accompanying information.

Timing of rollout varies depending on the volume of covered originations:[3]

Implications for Small Business Lenders

Small business lenders should assess Rule 1071 and the implications for their business given the risk of regulators and other entities using the publicly available data to raise fair-lending concerns. The implementation of Rule 1071 will require small business lenders to make substantial operational changes across their lending workflow and significantly increase their overall cost of compliance.[4] The effort required for data gathering, storage, analytics, reporting, and ongoing monitoring and testing will be more significant for lenders that are not accustomed to such requirements (e.g., those that do not offer consumer mortgages) and/or have manual small business lending processes with little automation. 

Here are some recommendations for you to consider as your organization gets ready for Rule 1071:

1. Don’t underestimate the level of effort required to be compliant.  Even if your organization has experience with the data gathering and reporting required for consumer mortgages, the nuances of small business lending are significant and the data supporting lending decisions can be more complex. It is likely that you will need cooperation and collaboration across various business groups and stakeholders unaccustomed to such data collection and reporting requirements. This complexity increases if your organization provides multiple credit products to your small business customers. 
2. Dedicate resources, develop processes, and leverage technology to capture, clean, and store accurate data. Some considerations:
   • Ensure data is complete and correct.  Modify your applications and other forms where necessary.  Limit applicant-provided “open text” data and consider the use of defined choices that the applicant can select where possible.
   • Craft demographic-data questions carefully and monitor response rates by division, location, loan officer, etc.
   • Establish and maintain strict firewall procedures to restrict access to certain data from employees involved in the credit decision. Maintain data records for at least three years, allowing for audits and regulatory reviews.
   • Update your internal policies and procedures to reflect the new data collection, reporting, and retention requirements.
3. Once you have the data collected in usable form, conduct preliminary testing to see if there are any potential fair lending concerns so you can remediate them in advance of public disclosure. This analysis should be conducted by product, division, industry vertical, location, loan officer, etc. as appropriate. Remediation of potential fair lending concerns could involve testing the specific variables used in the lending decision, automating more of the lending process, analyzing previously declined applications to determine if other models and/or information could have been used to approve the applicants at the same risk, and other strategies. 
4. Establish a robust compliance management system to oversee the implementation of Rule 1071 and monitor ongoing adherence to its requirements. This may include appointing a fair lending officer, conducting regular fair lending analysis, and remediating any identified issues on an ongoing basis. Ensure your existing reporting systems can accommodate the new data and reporting formats that will be necessary to support compliance. Automate and build the compliance process and supporting infrastructure the right way from the start, to allow your team to focus on what it does best—cultivating relationships and serving the financial service needs of small business owners.
5. Consider the development and/or extension of automated processes and models aligning with your credit strategy. Any part of the process or decision involving human intervention increases the risk of error or bias. Conduct fair lending testing during model development and iterate/refine before the models are put into production.  
6. Consider the use of new data and/or scores to allow for a more holistic view of the health of a small business since credit-worthy small businesses may not be adequately represented within traditional data sources/scores.  If you are considering the use of new data, leverage automated fair lending testing tools to understand the fairness of the data and its impact on women and minority business owners.
7. Develop strategies and documentation of your fair lending compliance approach (data evaluation, model development, testing, monitoring) that will stand up to regulator inquiries.
8. Develop training for staff who touch on any of the new processes related to 1071 compliance.  Communicate that fair small business lending practices help to support small business growth, community economic prosperity, and potential new business/ lending opportunities for your organization. 

Continuing the Conversation

Rule 1071 is important to help support fair access to credit for women and minority-owned businesses— creating more opportunities for business and economic growth and narrowing of the wealth gap. By strengthening small business lending practices as an industry, we can support access to credit and influence the success of small business owners, improve relationships and loyalty with these customers, and create incremental capital flow and new lending opportunities. 

However, the implementation of and ongoing compliance with Rule 1071 will require significant efforts from small business lenders. Rest assured that small business lenders do not have to navigate this journey on their own and there are industry resources to help along the way. As an industry, we will need to orchestrate the right people, data, processes, and technology to help manage the cost of compliance with Rule 1071. The effort we make in the near term is justified to support new opportunities for lenders and economic prosperity for all small business owners, regardless of their race, ethnicity, gender, or sexual orientation.

Please contact me if you found this of interest and would like to continue the discussion!

[1] https://advocacy.sba.gov/wp-content/uploads/2022/08/Small-Business-Economic-Profile-US.pdf

[2] https://www.consumerfinance.gov/about-us/newsroom/cfpb-proposes-rule-to-shine-new-light-on-small-businesses-access-to-credit/#:~:text=%E2%80%9CSmall%20businesses%20are%20the%20primary%20job%20creators%20and,means%20by%20which%20families%20and%20communities%20build%20wealth.

[3] https://files.consumerfinance.gov/f/documents/cfpb_sbl_info-sheet-regarding-compliance-dates.pdf

[4] A lawsuit has been brought forth by Texas-based Rio Bank and Texas Bankers Association asserting that the new reporting requirements will drive away smaller lenders in the space and therefore eliminate available products for small businesses, including those owned by women and minorities.  https://www.bankingdive.com/news/texas-bank-trade-group-rio-lawsuit-cfpb-small-business-data-collection-rule/648831/

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