Federal: Comment Letter on CFPB’s Proposed Rule on Section 1071 Small Business Lending Data Collection

January 6, 2022

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Comment Intake
Section 1071 Small Business Lending Data Collection
Consumer Financial Protection Bureau
1700 G Street NW, Washington, DC 20552

Docket No. CFPB-2021-0015
RIN 3170-AA09

Re: Section 1071 Small Business Lending Data Collection, Consumer Financial Protection Bureau, Proposed Rule

I. Introduction

The American Fintech Council (AFC) submits this comment letter in response to the request for comment by the Consumer Financial Protection Bureau (CFPB or Bureau) regarding implementation of section 1071 of the Dodd–Frank Wall Street Reform and Consumer Protection Act (Proposed Rule). We thank the CFPB for the opportunity to respond to the Proposed Rule.

AFC believes that well-regulated, responsible lending products by technology-driven financial services providers are critically important for the financial health of consumers, small businesses, and the banking system as a whole. For example, by partnering with innovative fintech platforms, banks can expand access for communities and small businesses that have been traditionally underserved, creating a more inclusive and resilient financial system. The Proposed Rule presents an important opportunity to explore lending data and expand responsible small business lending, which is important to the financial well-being and the stability of the financial system in our communities. AFC respectfully submits the following comments and welcomes the opportunity to assist the CFPB in achieving this goal.

AFC supports greater transparency and expanding access to sustainable and fair credit in small business lending. Small business lending by traditional brick and mortar banks is not as inclusive as it could be. Research shows that Black and Latinx small business owners were more likely to receive financing from banks through online platforms, compared to traditional brick and mortar banks, particularly during the ongoing COVID-19 pandemic. Research by the Federal Reserve Bank of New York demonstrated that between February and April 2020 the number of Black and Latinx business owners declined by 41 percent and 32 percent respectively compared to 17 percent for white business owners. Expanding access to financing for Black and Latinx business owners is critical to helping such businesses survive and prosper. As the racial disparity problems of the Paycheck Protection Program (PPP) became known through data, the program rules were amended to include qualified lenders and banks lending through fintech platforms, which improved access.

Responsible fintech platforms and banks are proving to be a resource to a more diverse array of small businesses. A study released earlier this month by researchers at New York University (NYU), Stern, NBER, Ocrolus, and the University of Chicago further evidenced the imperative role that banks utilizing fintech platforms have played in reaching more underserved communities in the PPP program. The study found that Black-owned businesses were 12.1 percentage points more likely to obtain their PPP loan from a bank utilizing a fintech platform than a traditional bank. They also found that the automated underwriting processes utilized by banks in partnership with fintech platforms, which increasingly rely on artificial intelligence and machine learning, may help reduce racial discrimination. This, and recent studies by the Federal Reserve Bank of New York referenced above, and the US Government Accountability Office (GAO) all found that fintechs played an essential role in helping banks to better serve borrowers that otherwise may have been unfairly excluded in a time of global crisis. The structural and historical exclusion of too many Americans, including communities of color, from traditional brick and mortar banking services make it essential that other providers fill those gaps. In many cases it is partnerships between responsible banks and fintech platforms that enable this expanded access and innovation.

An important lesson from the above referenced studies is that there is room for improvement in expanding access to responsible loan products. We have seen in recent years that lending data can help banks and their fintech partners better serve the capital needs of underserved borrowers, including small businesses. AFC believes that the enactment of section 1071 will help support the goal of increasing sustainable access to credit for more small businesses.

While AFC supports the policy goals of the Proposed Rule, we also believe that modifications should be made, before the Proposed Rule is finalized, that will support responsible innovation in the banking industry, while not unintentionally stifling the efficiency and innovation that banks lending through fintech platforms are currently able to provide. We have recommendations regarding the collection of data on pricing, term length, factoring, demographic information, how the section 1071 data will be published, regulatory burden, the Proposed Rule’s thresholds and definitions, and the compliance date.

II. Recommendations

a. AFC supports the collection of all appropriate pricing data.

We recommend that the Bureau collect all appropriate pricing metrics and strongly consider how to avoid potential pricing reporting loopholes in the final rule. We agree with the Bureau’s comments on its website regarding the value of APR for making cost comparisons across product types. Despite its value in the disclosure context, we also recognize that calculating APRs on certain products, like Merchant Cash Advances (MCAs) and other sales-based financing would be more challenging for financial institutions to calculate and report to the Bureau.

We support the Bureau’s proposal to collect all appropriate pricing data, including all fees associated with origination, annual charges, and other fees and charges. We encourage the Bureau to continue to acknowledge that APR may have value, such as in the context of Truth in Lending Act disclosures for aiding small business customers in their decision-making. We recognize that the Bureau may determine that collecting APR is beyond the scope of section 1071 data collection at this time. However, we support collecting appropriate pricing data to determine the accurate pricing of diverse commercial finance products and how those products and prices serve small businesses.

b. Collect term length of MCAs based on actual payment.

We recommend that the Bureau collect term length of MCAs alongside the term length data collected for other forms of financing. The MCA pricing data the Bureau proposes to collect would be of limited meaning without an associated term length.

The proposed rule establishes the importance of term length data for carrying out the goals of section 1071: “As with the consumer lending market, the pricing and sustainability of closed-end credit transactions for small businesses are associated with term length, and without awareness of the term of the loan, data users will have less of an understanding of the types of credit being made available to applicants. Credit with a one-month term may differ not just in degree but in kind from credit with a 60-month term.” (emphasis added)

The need for term length data is equally applicable to MCAs. A data user cannot effectively compare the costs of an MCA with other products if they do not know that one was actually paid within nine months and the other within fifteen months.

Where MCAs differ from loans, as the proposed rule notes, is that these products do not have fixed terms. MCAs are generally short-term, and many will be paid off within a reporting period. For MCAs that are only partially paid during a reporting period, the term could be estimated by projecting the same pace of payment observed during the reporting period. We recognize the potential imprecision of this method given that the term of an MCA will be determined by the small business customer’s pace of sales, which may vary significantly month-over-month. Nevertheless, we believe that the customer’s actual payment history is the most reliable data from which to estimate the ultimate term length.

This data is especially important to the goals of section 1071 because MCA products are used frequently by minority-owned businesses. A 2019 Federal Reserve Bank of Atlanta report entitled Small Business Credit Survey Report on Minority-Owned Firms found that, “minority-owned firms more frequently applied for potentially higher-cost and less-transparent credit products” including MCAs and factoring products. By collecting pricing information and term length data, the proposed section 1071 rules can help enhance the transparency of such products.

c. The Bureau should further consider including factoring in data collection.

Factoring is a significant source of financing for many small businesses. This form of financing also may have advantages in serving certain parts of the market, such as for businesses that may not otherwise be able to access credit based on their own credit profile. This merits further understanding by data users. Factoring is also identified in Federal Reserve Bank of Atlanta research as a “potentially higher-cost and less-transparent credit product” that has a disproportionate impact on minority-owned business, and Black-owned businesses in particular. “Black-owned business applicants applied for factoring more frequently compared to white-owned firm applicants (7 percent and 3 percent, respectively).”

We support the broadest inclusion of different types of financing products, potentially including factoring, to best support innovation. Section 1071 can encourage innovation by shedding light on what product types are effectively and affordably serving small businesses.

Factoring is a widely diverse category of financing, as discussed in the Proposed Rule, and product structures differ significantly. For example, some factoring products are nonrecourse, while others include recourse and thus are more akin to credit. We encourage the Bureau to continue considering the differences between various factoring product structures. For data collection of eligible factoring financing, we note that, because factoring products are generally very short term, often 30, 60, 90, or 120 days, the term and costs of these products will often be fully known within a single reporting period, and so can be reported. For these factoring accounts not fully repaid within a single reporting period, the expected term can be established by the date on the invoice factored, and the price established in the factoring agreement based on that expected date of repayment.

d. Race, ethnicity, and other demographic information.

We support the collection of demographic data and recognize its key role in discerning and improving access to credit. However, our members have expressed concern that if an applicant declines to provide ethnicity and race, reporters would be required to guess at an applicant’s ethnicity and race by visual observation or surname. Requiring a bank to guess at an applicant’s race or ethnicity is highly problematic and will likely result in a significant decline in the validity and integrity of the data being collected and reported. We recommend expanding the Proposed Rule’s safe harbor for collection in these circumstances, if the reporter must essentially guess on the applicant demographics using visual identification, surname, or statistical models such as Bayesian Improved Surname and Geocoding (BISG).

e. The Bureau should carefully publish the information it receives so that consumer privacy is protected and ensure that data reported accurately depicts the lending landscape.

We are concerned about how the CFPB may publish certain data. First, we urge the Bureau to continue to keep the personal information of small business owner loan applicants private. Second, we urge the Bureau to consider how data may be read if not publicly reported carefully. For instance, banks that lend through fintech platforms often receive more loan applications in volume than brick and mortar banks, who tend to mostly lend to applicants that are already members of the bank. With a higher volume of applications going through these online-only channels, rejection rates are more likely to be higher as well.

Additionally, several research studies by the National Community Reinvestment Coalition (NCRC) have shown that small business owners interested in accessing credit are often discouraged from applying in traditional, branch-based banking. This research also evidences that Black and Latinx business owner applicants are treated differently in some cases, leading to higher rates of discouragement. Because of this discouragement, and the different processes for receiving an application by banks using fintech platforms vs. traditional branch-based banks, the data may appear to show higher approval rates at traditional branch-based banks when in fact a form of pre-screening has already taken place. For this reason, we encourage the Bureau and data users to consider apparent approval rates only in the context of whether the application was received online or in person.

We also would like the final rule to clarify that when the applicant does not accept an approved loan, that this will not be counted as a “denied” loan due to the applicant ultimately deciding to not accept it. Although we have discussed the various studies that show bank lending through fintech platforms tends to be more inclusive, the data as publicly reported can be misconstrued. It is important that this rule shine a light on the entirety of the small business lending experience, including collecting data that may shed light on discriminatory practices such as discouragement at the pre-application stage, and other non-credit related issues that unfairly suppress access to credit. It is also important that this information be published in a way that does not inadvertently create an incomplete picture of legitimate nondiscriminatory business practices.

f. Reducing regulatory burden.

Banks and fintech platforms have utilized technology and other innovations to greatly expand access to lending to small businesses—and particularly so for women- and minority-owned businesses.

However, developing systems and operational practices to comply with these complicated rules will be time consuming, expensive and may detract from capital and resources that would otherwise contribute to the expansion of capital to small businesses through new and improved products. Some of our members are concerned that the complexity of this proposed rule may have a chilling effect on banks and other financial institutions that want to participate in this market. Practically speaking, the additional costs and burdens of complying with this new rule may result in less, not more, access to credit for women- and minority-owned businesses.

We note that this burden may fall harder on more traditional financial institutions that rely on paper documentation and older data systems, as compared with fintech platforms that may be more accustomed to capturing, storing, and transmitting data quickly and at lower cost.

At the same time, some of our members also believe that the data collected through section 1071 will increase access to capital, especially by women- and minority-owned businesses, by encouraging the development of small business financing products that more effectively serve these underserved segments. This may occur not only through increased accountability for financial institutions to serve these segments, but also by encouraging wider adoption of the products, practices, and innovations that the data reveals are effective.

Some of our membership believes the Proposed Rules implementing section 1071 should be narrowly tailored and limited to the intent and scope expressly outlined in section 1071. For example, some members believe the Bureau should consider only requiring the collection of the statutorily mandated data points. The additional discretionary data points proposed by the CFPB (e.g., pricing, time in business, North American Industry Classification System or NAICS codes, and number of employees) will often be unfamiliar to the applicant or difficult to obtain and will result in additional complexity, confusion, and significant operational and regulatory costs. These members believe statutorily mandated data points are sufficient to meet the objectives of section 1071, and the Bureau’s expanded data points should be limited to ensure that the practical impact of the final rule does not practically result in a decrease in access to capital to small business.

Additionally, AFC recommends the CFPB find ways to streamline the reporting process of information that financial institutions are already doing (for instance Home Mortgage Disclosure Act or Community Reinvestment Act reporting), so that they will not have to duplicate reporting efforts when not necessary.

g. The Bureau should either eliminate the NAICS code reporting requirement or expand the NAICS code safe harbor for NAICS code errors in reporting.

The proposed rule would require financial institutions to report the full six-digit NAICS code, or in instances where the NAICS code could not be collected, the financial institution reporting “not provided by applicant and otherwise undetermined.” While AFC supports the current safe harbor proposed in the rule, if NAICS data collection remains in the final rule, we have some concerns.

Some of our members believe that reporters should not have to collect NAICS. NAICS codes are complex, and a business can have multiple NAICS codes. There is no central way to verify the accuracy/applicability of a NAICS code. Based on some of our members’ experience with PPP loans, many applicants were unfamiliar with what a NAICS code was or how to determine it. This will create additional confusion and frustration by the borrower, including delayed application processing, and additional time and operational burden by banks to ensure the information is gathered and entered.

If the Bureau requires reporting of NAICS code in the final rule, further clarification on this requirement is needed to provide guidance in instances where applicants have unintentionally provided an inaccurate NAICS code and financial institutions are forced to rectify this information throughout the application process. Being provided with the incorrect NAICS code produces a number of unanticipated hurdles for the reporting financial institution to correct, many of which are time consuming and resource draining.

If the Bureau does require reporting of NAICS code, we strongly support the SBREFA Panel recommendation set forth in the CFPB’s NPRM, which would require reporting financial institutions to only collect the two-digit NAICS code, rather than the six-digit NAICS code to ease this burden. We find this is a better solution to the two-digit safe harbor proposed. We fully support the SBREFA Panel’s recommendation in this capacity as well as the goal put forth of minimizing unnecessary burdens, especially for smaller financial institutions. The collection of the two-digit code creates a practical, unambiguous policy that benefits applicants, lenders, and the Bureau, and ultimately achieves the intended policy goal, without creating unnecessary and heightened costs.

If the CFPB elects not to simplify the requirements for collection of NAICS codes, a safe harbor should be expanded beyond the first two-digit code for instances where there are discrepancies in this reported information. Where an institution in good faith reports a NAICS code, believed to be accurate based on the attestation and information provided by the applicant, but was provided with inaccurate information, a reporting financial institution should not be deemed to be in noncompliance with the regulation.

h. Definitions/Thresholds.

Some of our members maintain that the Bureau should reconsider the definition of "small business" under the proposed rule and align the definition of “small business” with the standard that is already in place under federal law (e.g., 12 C.F.R. § 228.42(a)). Specifically, they believe that the definition of “small business” should be defined as a business with gross annual revenues of $1 million or less. These members recognize that this threshold has the potential to miss the collection and reporting of data for certain small businesses that may have gross annual revenues of greater than $1 million. However, most small businesses that are intended to be aided by this rule would be captured by utilizing a definition of gross annual revenues of $1 million or less. Conversely, they believe that using $5 million or less in gross annual revenues as the definition of “small business” will be significantly overinclusive and will skew the data being reported. Defining “small business” as $1 million or less in gross annual revenues has been the standard for determining whether a business is a “small business” for years and will be a far more effective and streamlined way to capture data that will result in fulfilling the stated intent of identifying the business and community development needs and opportunities for women-owned, minority-owned, and other small businesses.

On the other hand, some of our members strongly agree with the $5 million or less threshold that has been proposed by the Bureau and urge its adoption in the final rule.

i. Implementation and Compliance Date.‍

Developing systems, processes, testing, training, and other operational considerations to prepare for compliance with the final rule will be incredibly complex and will take more time to prepare than the proposed 18 months. Some of our members recommend an implementation period of 36 months to ensure that all impacted parties can effectively execute on all the required compliance changes. Otherwise, such a short implementation timeline runs the risk of resulting in systems, processes, and technical errors that may harm the banks that are responsible for complying with the new rule and those small businesses that the final rule aims to help.

III. Conclusion

AFC believes that this rule will allow the Bureau and industry to address questions and reported problems in small business lending. We support the use of data to inform industry how to responsibly and sustainably expand access to credit to more small business owners. We believe a more inclusive and responsible lending space is good for industry, consumers, and the economy. Continued unwarranted skepticism towards fintech and financial innovation only harms those that have already been left out by legacy systems and processes and continues to unnecessarily perpetuate the inability for greater access. The governing policy framework must not only encourage financial institutions to build solutions utilizing new technologies, but also provide the flexibility necessary for innovative solutions to flourish. An unduly burdensome, resource-intensive framework that constrains an institution’s ability to build effective solutions that lower costs and expand access stifles innovation and harms the people the policies seek to protect. We support a regulatory framework and the programs implemented by participating institutions that provide enhanced protections weeding out fraudulent behavior or practices that are detrimental to the financial health of small businesses and consumers.

The American Fintech Council and our membership continue to show consumer protection and innovation work hand-in-hand to create a more competitive, efficient, and inclusive financial system.