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Newsletter | August 9, 2023

The Small Business Administration Needs To Increase Its Capacity, Not Lending Authority To Fintechs

FintechGovernment CapacitySmall Business Administration
The Small Business Administration Needs To Increase Its Capacity, Not Lending Authority To Fintechs

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Last week marked the 70th anniversary of the Small Business Administration’s establishment. The milestone — which was celebrated by SBA Administrator Isabella Casillas Guzman ringing the closing bell at the New York Stock Exchange — received little coverage. That is despite the fact that the agency has spent the weeks preceding its July 30th birthday very much in the news over the issue of pandemic relief fraud. This dynamic of general disinterest, aside from questions of scandal, however, is par for the course for an agency which has, for the most part, remained largely overlooked for the majority of its existence. 

The SBA was established by then-president Dwight D. Eisenhower in 1953 with the passage of the Small Business Act. Fashioned out of the ashes of Herbert Hoover’s Reconstruction Finance Corporation, the SBA was tasked with supporting upstart businesses through the provision of loans, management, and technical assistance. From the beginning, the agency also had a role in assisting disaster victims, an authority that would come to catapult the SBA to the forefront of public attention almost overnight in 2020. 

Both the Trump and Biden administration relied heavily on the SBA to respond to the economic devastation unleashed by the COVID-19 pandemic. The passage of the CARES Act in late-March, 2020 authorized the agency to disburse nearly $350 billion in emergency funds (to small businesses) through its Paycheck Protection Program. Just for context, in 2019 the agency had only guaranteed around $30 billion in loans total.

An immediate eleven-fold increase in lending responsibilities (which does not take into account the other pandemic relief programs that the SBA was also tasked with administering) is a hard ask for any government agency. But was especially so for the SBA, which Alexander Sammon described in his excellent piece on the agency as “limp[ing] around, brutally underendowed, a frequent target for elimination by Congress, showing up in the public consciousness only as a scandal generator.”

It should come as no surprise then to learn that the SBA was unable to meet its newfound obligations on its own and thus had to rely on private entities for assistance. Again, Sammon writes: “Even in a normal year, the SBA is in no position to handle its own 7(a) lending. So it followed its familiar model: contracting lending out to private banks and financial firms (including upstart financial-technology companies, which earned new validation as vital lenders despite sitting outside the regulatory perimeter).”

The decision to tap fintech firms to help administer the SBA’s pandemic relief programs would only serve to further damage the agency’s reputation. By December, 2022, the House Select Subcommittee on the Coronavirus Crisis had released a report detailing how “two unvetted and unregulated fintechs that, together, facilitated nearly one in every three PPP loans funded in 2021,” failed to prevent fraudulent applications from receiving funds. The two firms, Blueacorn and Womply, were subsequently banned from working with the SBA in any capacity. 

Yet despite such a terrible first impression, fintechs may still find themselves with the ability to issue loans through the SBA. That is if the industry is successfully able to lobby for the full implementation of a new agency rule. The rule, which actually went into effect on May 12th, put an end to the SBA’s forty-year long moratorium that limited the number of small-business lending companies authorized to participate in its 7(a) lending program. 

This rule change is part of a broader move by the Biden administration — largely spearheaded by Vice President Kamala Harris — to address disparities in federal investments to underserved entrepreneurs and minority-owned small businesses. Thus the rationale for extending SBA authority to fintechs is to “grow the number of lenders that receive its loan guarantee, thus increasing small business lending, particularly in smaller-dollar and underserved markets…” Fintechs firms also market themselves as suitable for such roles because they supposedly leverage alternative credit data in their underwriting processes that are more amicable to underserved borrowers.  

Setting aside the fact that these fintech firms have abused their data driven insights to the detriment of the very same borrowers they claim to aid, the SBA’s history of leveraging public-private partnerships to facilitate more equitable lending has largely failed. Again, Sammon:

“The Minority Lending Program set up in the Nixon years never matched its promise: SBA loans to African American business owners sunk from 38 percent of the SBA’s minority-lending portfolio in 1980 to 9 percent in 2004; loans to Latinos were cut in half. (Loans to Asian small business, by contrast, skyrocketed during this period to about two-thirds of the entire program.) […] A critical change in SBA policy accompanied (and perhaps caused) those minority-lending shifts. In the early 1980s, the SBA decided to save money on staffing by switching from a direct lender to a guarantor of loans originated by private banks. It just so happened to save the agency from the firing squad of the Reagan Revolution, as private banks intervened to protect the generous guarantees, and the fees they were wringing out of the program. But it also led to black-business access to SBA loans deteriorating, mirroring private banks’ disinterest in servicing minority communities.”

We at Revolving Door Project are unsurprised that the fintech industry is gaining traction within the Biden Administration — we warned about this in a February 2021 report by Max Moran and Timi Iwayemi. Our report detailed the risks from AI, the potential abuse of consumers by under-regulated fintech firms, and the zeal of fintech to place their retainers within the then nascent Biden-Harris Administration. It’s worth a read — and underscores why our work at RDP is never done, since the SBA has admittedly not been something we have been able to dedicate limited staff resources to bird-dogging consistently.

Thankfully, the fresh memory of fintech-enabled pandemic relief fraud has garnered organic bipartisan pushback against the rule change. A bill — proposed by the Senate Small Business and Entrepreneurship Committee Chairman and ranking member, Sens. Ben Cardin (D-MD) and Joni Ernst (R-IA) — seeking to limit the number of new nonbank small-business lending corporations passed the committee in an 18-1 vote in mid-July. The near unanimous support for a bill that, beyond reining in fintech participation in 7(a), also made permanent the SBA’s Community Advantage Pilot Program is a welcome sign. However, the bill is now up for a full Senate floor vote, where it will surely be greeted with lobbying efforts by the fintech industry to weaken its effects.

Limiting the potential for future partnerships between the SBA and underregulated financial institutions, while simultaneously improving the agency’s own efforts to facilitate more equitable lending is a step in the right direction. More must be done in this regard, but it cannot happen if the agency remains chronically underfunded. Rebuilding the agency’s capacity should be the top priority for any lawmakers wishing to see the SBA return to form as a vital part of America’s small business ecosystem.

Image Credit: “Fintech, money, finance” by Tech in Asia is licensed under CC BY 2.0

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