Statement of the Hon. Dean Phillips on Fintech and Transparency in Small Business Lending
Washington, July 13, 2022
Increasing the flow of capital to American small businesses is one of this committee’s foundational goals. When entrepreneurs can secure financing on reasonable terms, they create jobs, expand their business, and move the economy forward.
Unfortunately, most American business owners feel they can’t adequately access capital. According to a 2022 Federal Reserve Survey, 59% of Small Employer Firms said they had unmet financing needs.
So, we must find ways to fill this gap and deliver more funding to small firms on safe and responsible terms.
Massive developments in financial technology, commonly known as FinTech, have shown real promise for expanding access to credit for small firms. Over the years, entrepreneurs have flocked to FinTechs for their capital needs. One study found that by 2016, non-bank lenders had a market share of close to 60 percent in the small business lending sector.
During the Paycheck Protection Program, we witnessed the ability of FinTechs to make small-dollar PPP loans to small businesses – particularly those in underserved communities – more effectively than traditional banks. Small businesses often turn to Fintechs for their speedy approval process, more diverse financing options, and alternative metrics for creditworthiness.
However, while fintech lending has helped many entrepreneurs, concerns are growing that industry practices may harm and even target small businesses. For instance, the speed at which fintech lenders deploy capital can come at a substantial cost. A conventional bank loan typically carries an APR of 4 to 13 percent. For Fintechs, APR for online loans and other financing products can start at 7 and climb higher than 100%.
These terms aren’t always clear to small businesses, as many online lenders provide little or no information upfront to prospective borrowers about the loan or product and often use metrics other than APR to disclose the cost of capital.
Some online lenders also engage in predatory practices that put small businesses at risk.
For example, Merchant Cash Advances allow a lender to receive a fixed percentage of future sales until the financing is repaid. The extremely high-interest rates and daily repayments associated with MCAs can cause businesses to enter into an out-of-control debt spiral.
Furthermore, many MCA lenders require borrowers to sign an obscure legal instrument known as a confession of judgment to get the money. By signing, borrowers waive their legal rights regarding any legal dispute that might arise.
When a court enforces the confession of judgment, it locks a small firm into that unsustainable debt cycle and ultimately forces the business to close. Small business advocates also worry about the lack of transparency around fintech underwriting. The data and algorithms that control automatic underwriting can pull unrelated information like who an applicant follows on social media or the number of criminal records in an applicant’s zip code. These underwriting practices lack transparency and have the potential to unfairly deny credit to protected groups or make those products more expensive.
As the FinTech sector evolves, Congress must keep pace and ensure industry practices aren’t unfairly taking advantage of entrepreneurs, especially those who may be vulnerable to abusive practices.
Today, I look forward to discussing the benefits and risks of FinTech lending for small businesses and what this committee can do to both protect and expand opportunities for entrepreneurs.