Are fintechs charging minorities more for business loans?
WASHINGTON — Minorities are more likely to turn to a financial technology firm when seeking a business loan, but they may pay higher interest rates, according to the preliminary results of a congressional investigation released Monday.
Rep. Emanuel Cleaver, D-Mo., launched an inquiry into the online lending space earlier this year.
“The initial findings are clear as day, and my investigation suggests that minority entrepreneurs are more likely to borrow from online fintech lenders,” Cleaver said. “However, we need to further understand whether lenders are aggressively targeting or offering higher interest rates relative to borrower credit risk.”
Cleaver sent letters to Lending Club, Biz2Credit, Fora Financial, Prosper, and Lend Up in June. Based on those responses, staff who reviewed the letters said that minorities may be charged higher rates. One of the companies that reviewed the rates said the difference in rates wasn't substantial, but did not provide data backing up that point.
Cleaver expressed concern that online lenders are focused on the owner’s individual credit report, rather than on the track record of the business. In some cases, lenders appear to be determining the race of the borrower even when it’s not on the application.
“While respondents noted that data on race was not specifically collected in the application process, some firms conducted backwards-looking economic analysis to estimate the racial makeup of their borrowers,” according to a release announcing the initial results of the investigation.
Rob Levy, a managing director at the Center for Financial Services Innovation, said that businesses generally have to be bigger before a credit decision can be disentangled from the credit history of the owner, but “any of the bias that is in the credit system would show up in the business loan.”
Lawyers also said that reviewing an individual’s credit files before making a small business loan presents other risks.
“When folks are looking to take out a small business loan, often the credit profile of the owner becomes relevant and due to the fact that you are suddenly looking at the credit profile of an individual versus a business, you then introduce the possibility for greater risk from a fair lending perspective,” said Kevin Petrasic, a partner at White & Case.
“You can run the risk of crossing the line of making a business lending decision based on the performance of the business to making a business lending decision that takes into account certain aspects of an individual’s own personal profile that is being evaluated for purposes of the loan but not calibrated to assess and filter out discriminatory lending biases.”
Cleaver initially sent letters to only five companies, but his chief of staff, John Jones, said the industry response was broader as they learned about the congressman’s interest.
Based on those responses, Cleaver’s staff found that some of the companies were doing a fair lending analysis to guard against a potential bias in their lending algorithms. Others didn’t provide any detail on what they were doing to prevent discrimination against protected classes.
“The congressman has been encouraged by how open many of the actors in the industry have been about providing information,” said Jones in an interview. “He does not want to penalize good actors, however, there may be bad actors in this space and Congressman Cleaver believes these actors should be held accountable and if there are questions, they should be answered.”
While some of the companies said they relied on a third party to verify that they weren’t charging minorities higher rates, one acknowledged that non-whites were paying higher rates for the loans. Cleaver’s staff did not specify which firm did so.
Rick Fischer, a partner at Morrison Foerster said “nobody would be foolish enough to intentionally discriminate anymore,” but added that there are risks when companies start using alternative data.
“When you are using new types of data and information that hasn’t really been tested from a disparate impact, it is possible that some risk, some liability, could arise,” said Fischer.
There has been growing concern that in the push to adopt algorithms to help make credit decisions, lenders run the risk of unintentionally discriminating against borrowers. In such cases, a lender could still be held liable.
“When it comes to using alternative data or credit-scoring algorithms for lending decisions, regardless of what the company’s intent, it often can’t predict the ultimate outcome from the standpoint of potential discriminatory impact,” said Ashley Hutto-Schultz, an attorney at Hogan Lovells.
Still, fintech advocates argue that while algorithms aren’t perfect, they can do a good job of making credit available to underserved communities and offering loans that financial institutions don’t.
“Fintech lenders have really stepped up to fill the gap in small business lending post-crisis,” said Loyal Horsley, another lawyer at Hogan Lovells. “While community banks are still the main providers of credit to small businesses, new businesses that want small loans, especially less than $250,000, may be best served by using a fintech lender.”
Of the firms reached out to by Cleaver, most were willing to broadly share information. But at least one appeared reluctant. A letter from Fora Financial, viewed by American Banker, offered only a statement of principles when asked about its lending practices and pressed for more data. Attempts to reach Fora Financial for comment were not successful.
Cleaver has already engaged with the Consumer Financial Protection Bureau, encouraging the agency to extend its oversight of the new lending platforms.
But he is also calling on the Treasury Department to write new regulations. It should “provide guidance to fintech firms on how they can use better practices to promote investment in lending to diverse communities,” Cleaver said.
Cleaver said he sees the potential for fintech companies to offer loans to underserved groups, but wants the industry, which is still in its infancy, to adopt better practices.
“Creating jobs and wealth in our country, while also reducing inequality, is impossible without fair and transparent small business lending,” said Cleaver.