Illinois could be the first state to regulate predatory lending to small businesses, an emerging threat that some have called the next credit crisis.
The bill, SB 2865, targets many of the complaints that small business owners and researchers have made in recent years about loans made by online lenders and other non-traditional institutions. The legislation, which amends the Illinois Fairness in Lending Act, would require more transparency from lenders regarding the annual interest rate and terms applied to the loan.
“Many of the so-called four D’s of predation -- deception, debt traps, debt spirals and discrimination -- stem from a lack of transparency,” Chicago Treasurer Kurt Summers told the state Senate's financial institutions committee last week. “Today in Illinois, a company selling timeshares for $100 a month is required to have more clearly articulated loan terms in their contracts than an online lender would for a $200,000 business loan.”
The legislation, which the full Senate is now considering, would also set standards for making the loan, such as requiring lenders to consider a business owner’s ability to pay. Specifically, the measure would prohibit loans to a small business if the monthly loan payments would exceed 50 percent of the borrower’s net monthly revenue.
The bill only applies to loans of $250,000 and smaller. Loans of that size are generally limited to small businesses. Banks, saving and loans, credit unions and community banks are exempt from the bill because they are already regulated.
The legislation aims to target the swiftly growing but largely unregulated nontraditional lenders mostly found online. Depending on different estimates, anywhere from $5 billion to $25 billion in nontraditional loans are made to small businesses each year.
These kinds of lenders have thrived as banks have become more reluctant to make what they see as a potentially risky loan. So, although the economy and access to credit has improved since the 2008 recession, many small business owners have been unable to receive a loan. According to the Federal Deposit Insurance Corp., bank commercial loans of $1 million and less have declined each year since the financial crisis and are still 20 percent below pre-recession levels. Meanwhile, loans of more than $1 million, which are more profitable for banks than smaller loans, have recovered completely.
Many alternative lenders are are similar to -- or even the same outfits -- that have profited from payday lending schemes that offer quick cash for consumers in exchange for triple-digit interest rates and myriad hidden fees.
For example, when small businesses are looking for loans, they sometimes find that an alternative lender may quote a 10 percent interest rate, but that may actually be a monthly rate -- meaning the actual annual percentage rate is 120 percent. Sometimes the lender will demand a certain percentage of the daily sales of a business until the loan is repaid, a move that can make it hard for a business owner to make other needed payments.
Last year, work by the Federal Reserve Bank of Cleveland and the Federal Reserve Board found that many small business owners were confused by the terms of lending offers, which can make it nearly impossible to determine if the loan is actually affordable. One auto dealership owner in New Jersey, for example, noted that lenders present their loans “in the most confusing way possible.” The lenders' websites are full of bright colors and testimonials from nice people, the owner added, but they don’t give applicants all the information they need.
Still, the Fed study also found that small businesses preferred the ease of interacting with alternative lenders. Critics of the Illinois bill, like the Coalition for Responsible Business Finance, have charged that the proposed legislation’s “prescriptive underwriting standards, complex regulatory mandates, and expansion of civil and criminal liability will prevent small businesses from getting the capital they need to grow.”