Summary
The Biden Administration has recognized that small businesses, particularly minority-owned small businesses lack adequate access to capital. While SBA has operated its 7(a) Loan Program for multiple decades the program has historically shown poor results reaching minority-owned businesses and those in low- and moderate-income communities. Recently, the SBA has leveraged innovative fintech lenders to help fill this gap.
While the agency has finalized a rule that would allow fintech companies to participate in the 7(a) Loan Program, there are significant concerns that new entrants would put the program at risk due to a lack of internal controls and transparent evaluation. To help increase lending to low- and moderate-income communities while not increasing the overall risk to the 7(a) Loan Program, SBA should establish a mentor-protégé program and conditional certification regime for innovative financial technology companies to participate responsibly in the SBA’s 7(a) Loan Program and ensure that SBA adequately preserves the safety and soundness of the program.
The Challenge
The Biden Administration has recognized that small businesses, particularly minority-owned small businesses lack adequate access to capital. While SBA has operated its 7(a) Loan Program for multiple decades, the program has historically shown poor results in reaching minority-owned businesses and those in low- and moderate-income communities. According to a 2022 Congressional Research Service report, “[i]n FY2021, 30.1% of 7(a) loan approvals ($10.98 billion of $36.54 billion) were [made] to minority-owned businesses (20.8% Asian, 6.0% Hispanic, 2.6% African American, and 0.7% American Indian)”.
SBA has made a concerted effort previously to increase 7(a) small business lending to underserved communities by establishing the Community Advantage (CA) 7(a) loan initiative. Launched as a pilot program in 2011 and subsequently reauthorized, the CA loan initiative has been successful in encouraging mission-driven nonprofit lenders to underserved communities; however, the impact has been relatively small when compared to the traditional 7(a) loan program. In FY 2022, the CA Pilot Program approved just 722 loans totaling $114,804; whereas the general SBA 7(a) Loan Program approved 3,501 loans totaling $3,498,234,800–an order of magnitude of difference.
The COVID-19 pandemic created an unprecedented demand for assistance to the country’s small businesses, as they were forced to close their doors and saw their revenues dwindle. Congress responded to this demand by passing the Coronavirus Aid, Relief, and Economic Security (CARES) Act, which established one of the largest government-backed lending programs ever, the Paycheck Protection Program (PPP). During the PPP, fintech lenders, which for this policy memo includes technology-savvy banks and nonbank financial institutions that operate online and through mobile applications, proved uniquely adept at serving small businesses in traditionally underserved communities, even without specific guidance to do so from the SBA.
Many of the borrowers assisted by fintech lenders did not have pre-existing borrowing relationships with a financial institution and were therefore deprioritized by traditional financial institutions offering PPP loans, who favored lending to small businesses with existing relationships. Previously published research showed that not only did fintech lenders receive more applications from businesses from Black and Hispanic-owned businesses, but also extended a significant amount of lending to these businesses. Fintech lenders therefore expanded the impact of the PPP to underserved borrowers and successfully bolstered the efforts of mission-driven lenders, such as Community Development Financial Institutions and Minority Depository Institutions. For example, Unity National Bank of Houston, a Minority Depository Institution partnered with Cross River, a tech-focused bank that partners with fintech companies, to increase its lending from 500 loans to nearly 200,000 loans by leveraging Cross River’s lending technology. Similarly, Accion Opportunity Fund, a large Community Development Financial Institution, partnered with Lending Club, another tech-focused lender, to improve both entities’ lending operations to borrowers that were underserved during the first round of the PPP. However, Community Development Financial Institutions and Minority Depository Institutions often face challenges procuring and implementing the technology needed to help scale their nontraditional lending activities, which limits the efficacy of their mission-driven lending in an increasingly internet-based lending environment.
In an effort to increase access to capital and build on the efforts of fintech companies that successfully provided capital to small businesses in the Paycheck Protection Program, SBA has proposed lifting its moratorium on non-depository lenders participating in the program. SBA and the Biden Administration have shown real progress in removing the moratorium on Small Business Lending Company (SBLC) licenses to include fintech companies, which would expand the eligible participants in the program for the first time in 40 years.
Expanding access to capital and support for small businesses is a key priority for the Biden Administration. Specifically, the Administration noted the importance of expanding underserved small business’ access to capital. They recommended expanding the SBA’s 7(a) program by extending SBLC licenses to nonbank lenders, which include fintech companies, as one promising strategy. To this end, SBA has established a strategy of expanding its lending network by leveraging fintech companies. The SBA previously issued a proposed rulemaking to remove the moratorium on SBLC licenses and add three new categories of SBLC licenses.
However, policymakers and some industry participants have cast serious doubts on fintech companies’ participation in SBA’s 7(a) Loan Program, due to weak internal controls of unpartnered fintech companies and subsequent fraud issues experienced during the Paycheck Protection Program. Further, these critics have cited concerns with the agency’s ability to properly oversee these fintech companies due to a lack of ability to manage the fraud risks associated with developing or expanding a lending program that includes unpartnered fintech companies. Overall, the agency has shown that both it and fintech companies should improve their engagement together to ensure that the many program requirements are adhered to, and that SBA improves its abilities to mitigate potentially new or unique risks to the 7(a) Loan Program.
The Plan of Action
To solve the aforementioned issues, SBA should establish a mentor-protégé program and conditional certification regime for innovative nonbank financial technology companies to participate responsibly in the SBA’s 7(a) Loan Program. By creating a mentor-protégé program and conditional certification regime, SBA can continue to encourage the expansion of the 7(a) Loan Program to lenders that have shown their willingness and ability to lend to traditionally underserved small business borrowers, while ensuring that the agency adequately preserves the safety and soundness of the 7(a) Loan Program.
In the proposed mentor-protégé program, SBA would conduct an initial assessment of the fintech applicant and provide a conditional certification contingent on the fintech’s participation in the mentor-protégé program. To ensure that only the most well-suited fintech companies are allowed to engage in the 7(a) program, SBA should conduct a fair lending assessment. This would include a gap analysis of the company’s lending processes, akin to the existing interagency fair lending examinations conducted by the federal banking regulators. Further, SBA should require fintech companies to complete a “Community Lending Plan” detailing the specific small business lending activities the fintech company intends to complete in traditionally underserved areas. SBA would conduct a review of applications it receives and match them with banks that are established 7(a) lenders.
To help ensure that both mentors and protégés develop throughout the program, SBA would need to create program criteria for both mentor banks and protégé fintech companies. Mentor criteria should focus on ensuring that mentor banks assist and grow the knowledge of their fintech proteges. Thus, both mentors and protégés should be required to complete periodic progress reports. Further, mentors should conduct their own periodic assessments of the fintech protégé’s compliance and lending processes to ensure that the fintech is able to comply with existing 7(a) Loan Program requirements and not create an undue risk to the program. These criteria should be determined based on the expertise of the Office of Capital Access and Office of Credit Risk Management with advice from SBA’s 8(a) Business Development Program staff. Lastly, to ensure that mentors and protégés can speak candidly about their experience with the other participant, SBA would need to create communication portals for both entities that are walled-off review by either participant.
Recognizing the potential apprehension existing 7(a) lenders might have to eventually increasing competition to the 7(a) lending market, the SBA would need to incentivize banks to provide mentorship services to fintech companies by providing participating mentor banks with Community Reinvestment Act (CRA) credit and an increased SBA guarantee threshold for the bank’s 7(a) loans. By pursuing these two incentives, the SBA would provide banks with clear business and regulatory benefits from participating in the mentor-protégé program.
Based on a review of the SBA’s 2023 Congressional Budget Justification, SBA has accounted for much of the increased cost that would stem from expanding the 7(a) Lending Program to additional SBLCs. SBA noted that part of its $93.6 million request for fiscal year 2023 was to attract new lenders that participated in the Paycheck Protection Program. Similarly, SBA identified the need to continue building its oversight of Paycheck Protection Program and Community Advantage lenders. To this end, SBA requested an additional $13.9 million in small business lender oversight. Establishing the 7(a) mentor-protégé program would likely require only a small amount of additional funds relative to the 2023 requested amount. To account for the additional programmatic and administrative requirements needed to establish the 7(a) mentor-protégé program, SBA should include an additional $500 thousand to $1 million to its future Congressional Budget Justifications.
Success of the mentor-protégé program depends on robust program requirements and continuous monitoring to ensure the participants are adhering to the goal of responsibly expanding capital access to underserved small businesses. To accomplish this endeavor, SBA should leverage the internal expertise of its Office of Capital Access and Office of Credit Risk Management, while also coordinating with prudential and state financial services regulators to adequately understand the novel business models of fintech companies applying to and participating in the program. Interagency coordination between state and federal regulators will ensure that the 7(a) program’s integrity is maintained at the macro and micro levels.
Conclusion
Expanding small business lending to low- and moderate- income communities is an especially important endeavor. Few opportunities for real social and economic growth exist in these traditionally underserved communities without robust access to small business credit. While the importance of expanding access is clear, SBA has a responsibility to ensure that its flagship 7(a) Loan Program remains safe, sound, and available for the benefit of all small businesses. The recent decision to finalize rulemaking that would expand allowable lenders to the 7(a) Loan Program must come with careful consideration of which lenders should be able to participate. Incorporating fintech lenders presents an opportunity to solve the issues of small business lending to traditionally underserved communities. However, given the concerns identified throughout the rulemaking process and after its finalization, SBA should work diligently to ensure that only the best-suited entities are allowed to become 7(a) lenders. To help ensure that this occurs, they should create a mentor-protégé program that will afford fintech companies the best opportunity to succeed in the program while maintaining the safety and soundness that is so important to the overall success of the 7(a) Loan Program.
How might your proposed action fit in within the broader priorities of the administration or relative agencies?
Expanding access to capital and support for small businesses is a key priority for the Biden Administration. Specifically, the Administration noted the importance of expanding underserved small business’ access to capital by expanding the SBA’s 7(a) program through extending SBLC licenses to nonbank lenders, which include fintech companies. To this end, SBA established a strategy of expanding its lending network by leveraging fintech companies. The SBA previously issued and finalized a rulemaking process to remove the moratorium on SBLC licenses and add three new categories of SBLC licenses.
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What government agency, office, or body will lead this effort?
Success of the mentor-protégé program depends on robust program requirements and continuous monitoring to ensure the participants are adhering to the goal of responsibly expanding capital access to underserved small businesses. To accomplish this endeavor, SBA should leverage the internal expertise of its Office of Capital Access and Office of Credit Risk Management, while also coordinating with prudential and state financial services regulators to adequately understand the novel business models of fintech companies applying to and participating in the program.
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What are the parameters of the program (establishment, oversight, etc.)?
The SBA can conduct an initial assessment of the fintech applicant and provide a conditional certification contingent on the fintech’s participation in the mentor-protégé program. Further, the SBA should develop program criteria for both mentor banks and protégé fintech companies and application portals for both entities. SBA would conduct a review of applications it receives. The SBA would incentivize banks to provide mentorship services to fintech companies seeking to gain SBLC certification by providing CRA credit banks and an increased SBA guarantee threshold for the bank’s 7(a) loans.
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Why should we rely on for-profit fintech lenders, rather than non-profit or mission-led lenders to expand funding to underserved communities?
Providing equitable access to capital for underserved communities in our country will require actions beyond the scope of this policy recommendation, including changes to the regulations that govern community banks, fintech lenders, CDFIs, and other mission-driven lenders. Fintech lenders have a proven ability to contribute to this expansion of capital access, given their collective performance as PPP lenders. In addition, fintech lenders have an ability to scale the solutions that they provide quickly, something that CDFIs and other mission-led lenders have traditionally struggled to do well.
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Why reform 7(a) as opposed to creating a new, fintech-specific lending program at the SBA?
Fintech lenders compete with conventional lenders for market share; the SBA should take care not to create programs that give one competing group an advantage over another. Creating a bespoke program, tailored to the needs of fintech lenders, would run the risk of creating more than an incidental competitive advantage. Instead, this program proposal advocates for utilizing a mentorship model that helps build strategic partnerships to accelerate access to capital for underserved groups, without creating separate rules or carve-outs.
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