A bill pending in California aims to tame the disorderly, confusing and largely unregulated world of online small-business lending by mandating that borrowers receive standard price disclosures.
The measure proposed by Sen. Steve Glazer, a Bay Area Democrat, would be the first of its kind in the nation. Glazer pushed it through the state Senate last month by forging a bipartisan coalition of 16 Democrats and five Republicans.
The bill, which passed the Senate without a vote to spare and has failed to garner much support from either the online lending industry or its critics, still faces a tough fight in the state Assembly. But if the measure does get enacted in California, it could serve as a blueprint for other states.
The legislation tackles the question of whether commercial lenders should be required to disclose the price of financing in a way that enables borrowers to compare multiple offers. Just as nettlesome is the question of how any such comparison metric should be calculated.
Online lenders generally favor self-regulation over government-imposed rules, but various industry-written disclosure regimes that have sprung up in recent years have failed to impose order on a market that is frequently compared to the Wild West.
By contrast, in the consumer finance industry, federal regulations require lenders to disclose the loan’s annual percentage rate, which shows what the total cost of credit would be on a yearly basis.
This approach has its share of critics — short-term lenders typically argue that APRs can be misleading — but it does provide a basis for borrowers to make comparisons.
There is no standard disclosure regime in commercial lending, since business owners are generally thought to be more financially savvy than consumers.
But over the last decade, the push for more borrower protections has grown louder as banks have pulled back from lending to smaller, less-sophisticated businesses, and online lenders have rushed to fill the void. In many cases, the products offered by these newer entrants are expensive and hard to understand.
“While innovation is creating more opportunities for small businesses to grow and thrive, it is also making it easier for bad actors to take advantage of them through hidden fees or unclear loan terms,” Karen Mills, a former head of the U.S. Small Business Administration, said in an email.
A 2016 paper co-written by Mills, who is currently a senior fellow at Harvard Business School, found that short-term lines of credit from online small business lenders often have APRs approaching 50%, while APRs on merchant cash advances often range from 60% to 70%. The study noted that few lenders disclose the APR, which makes it difficult for business owners to comparison shop.
Cost is one reason why small-business borrowers tend to be less satisfied with online lenders than with banks or credit unions. A 2017 survey of small businesses by the 12 Federal Reserve banks found that just 35% borrowers approved by online lenders were satisfied with their experience. That compared with a 49% satisfaction rate at large banks, a 73% satisfaction rate at small banks and a 74% rate at credit unions.
The legislation that is pending in California includes an exemption for banks and credit unions, and they have stayed on the sidelines of the legislative debate. But numerous other interest groups are opposing the bill.
In its original form, the legislation would have required small-business lenders to disclose a consumer-style APR. But that proposal drew jeers from companies that offer merchant cash advances, a form of financing in which the customer agrees to pay a fixed percentage of their certain revenues over a period of time.
After receiving input from the Small Business Finance Association, an industry group whose members include merchant cash advance firms, Glazer agreed to replace the APR with a different rate, which is known as the estimated annualized cost of capital. The bill would apply to small businesses that borrow $500,000 or less.
“We appreciate Sen. Glazer sort of taking an innovative approach to this bill,” said Steve Denis, executive director of the Small Business Finance Association. “He really worked hard on developing a new metric that is a better tool for small businesses, and that’s why we ended up supporting it.”
Other industry groups are more critical.
Scott Talbott, senior vice president of government relations at the Electronic Transactions Association, said that the bill’s formula is untested, and he argued that the legislation will not make it easier for borrowers to compare multiple offers.
Members of the Electronic Transactions Association include PayPal, Amazon and Square, all of which offer financing to merchants.
Also opposing the bill is the Innovative Lending Platform Association, whose members include OnDeck Capital and Kabbage. Since 2016, the group has been calling for small-business lenders to adopt its own standard disclosure form.
Even nonprofit lenders that are critical of high-cost credit providers have not been convinced to support the legislation.
Opportunity Fund, a nonprofit lender based in San Jose, said that while the legislation has a lot of strong elements, its key disclosure metric is misleading.
“Small-business owners deserve tested, comparable disclosures that allow them to make well-informed decisions about financing,” the firm said in an email.
For his own part, Sen. Glazer argued that California needs to act to protect small-business owners because Washington has proven unwilling to rein in unscrupulous practices. “My expectations for federal action are very low,” he said.
Glazer also emphasized that he does not want to restrict small-business lending. “It’s simply to provide fair disclosure,” he said.