Online small business loans, offered by startups like Funding Circle or Kabbage, the recently-public OnDeck, or even PayPal and Square (none of which are banks), are one of the few areas of the financial services business that is growing rapidly. And it's doing so without much in the way of national standards, instead operating under a patchwork of state and some federal rules.
A collection of lenders, loan brokers, think tanks, and activist groups have gathered to work out a "Borrowers' Bill of Rights" for the industry. It's an attempt to self-regulate a business that can see annual interest rates on loans approach 100%, and where fly-by-night operators can steer small businesses into an endless cycle of fees and expensive loans.
"Some lenders are very legitimate and very well run and others frankly rely on lax regulation to take advantage of small businesses," Sam Hodges, the co-founder of Funding Circle and its U.S. managing director, told BuzzFeed News. Funding Circle has originated $1 billion in loans to small businesses.
"We see businesses all the time who are throttled by merchant cash finance, high rate and high effective cost credit products, it's a real problem in this space," he said.
Joining Funding Circle in coming up with the Borrowers' Bill of Rights are Lending Club, a publicly traded online lender that specializes in personal loans but is expanding into business loans, Fundera, a loan marketplace, the Aspen Institute, Accion, a small business lending network, along with other advisory firms, loan marketplaces and advocacy groups.
Goldman Sachs analysts estimate the small business lending market is worth about $186 billion, and the biggest online small business lender, OnDeck, has originated over $2 billion in loans since it was founded in 2007. The Goldman research showed that alternative lenders are more likely than traditional banks to approve small businesses for financing.
But the growth of small business lending by non-banks means there's a regulatory gap.
"Small business owners are seeing the number of alternative sources for financing their companies grow at an unprecedented rate, and while this is a good thing in terms of increasing access to capital, borrower protections have not caught up," said Karen Mills, who used to lead the Small Business Administration.
The bill of rights is a set of principles that lenders can adhere to, and not a formal set of laws. It includes mandating transparency of interest rates and fees, commitment to only making loans businesses can pay back, non-discrimination, collections without harassment, and keeping borrowers out of debt traps that get them stuck in a cycle of fees. The lenders, activist groups, and intermediaries plan to announce the initiative in Washington D.C. on Thursday.
"We as an industry can start self-regulating," Hodges said. "Right now a broker or small business lender can say whatever they want," Hodges explained that putting together a set of principles could help isolate the lenders and brokers that do not publicly adhere to them.
"Could there be some distant point in future where there's a regulator focused on on small business lending?" Hodges asked. "Maybe. It's far off, so it's incumbent on market participants to figure out best way to self regulate."