Recently, I served as a panelist at a Consumer Financial Protection Bureau (CFPB) symposium on Section 1071 of the Dodd-Frank Act, which requires the CFPB to centralize collection of small business lending data and make it public. At the symposium, I advocated for streamlining the added administrative requirements for financial institutions that will likely raise the cost of granting credit to small businesses at a time when they face a credit gap.
There are more than 30 million small businesses in the U.S. accounting for at least half of our nation’s GDP. Our wellbeing depends on ensuring they have access to capital to support growth. However, a recent Federal Reserve survey shows that 64% of small businesses face financial challenges and more than two thirds of them use their own personal funds to support their businesses.
Historically, credit has not worked well for small businesses. However, it has worked well for other markets, such as mortgages and large corporate lending, and there is an opportunity to model small business credit on other markets that do function well.
Why is there a credit gap between small businesses and other markets? There are several reasons, including:
- Insufficient data on payment records and general financial information
- Lack of workflow systems to enable efficient loan processing
- Lack of standardization of small business loans, making it challenging to pool them for low-cost capital.
Minimizing Costs and Burdens
At PayNet, an Equifax company, we focus on lowering the cost of processing small business credit applications to help close the credit gap. The manual underwriting process can take up to 100 hours and cost $5,000 per application. Given the number of inter-departmental handoffs, application to adjudication can often take 30 days or longer.
With this construct in place, the typical institution can handle a volume of just 10 loan applications per analyst, per month; and at an average booking rate of 50%, this means the underwriting cost per loan booked averages $10,000. This process puts a burden on the lender as well as the borrower, keeping much-needed capital away from the businesses that need it most.
Section 1071 – Getting the Data Right
With Section 1071, we have an opportunity to centralize collection of small business lending data, which would then be made public. If it is carefully planned and done right, a Section 1071 database could help solve the problems associated with the credit gap. However, that will not come without careful planning and a streamlining of the additional processes associated with small business lending data collection.
In our analysis, we estimate Section 1071 will increase the cost of credit applications by about 10% – due to implementation of a new credit application process, staff training, and the cost of the separating underwriting and data collection. The elevated costs of credit underwriting needed to meet 1071 requirements, combined with the expense of portfolio reviews, requires more efficiencies or we risk a lending pull-back that could worsen the growing credit gap.
We’ve identified three innovations that can reduce the costs and burdens of Section 1071:
- Standardizing the credit application process
- Just as online lending has scaled through standardization of the credit application process, the small business lending process can be made easier and faster by adding five to seven simple data fields to the credit application and leveraging technology to enable autofill of the application.
2. Creating a data dictionary of required reporting
- A data dictionary will provide clarity on what each field means, what data should be entered and how to analyze it. The dictionary would ensure more seamless data aggregation, which is critical for effective data analysis.
3. Standardizing extract software reporting
- Standard file formats and packaged software programs remain key tools to minimize added costs and burden of reporting to the CFPB Repository. Such formats and software can be linked up to accounting systems or credit application systems to safely encrypt and extract the data.
Done Well, Section 1071 Could Help Close the Small Business Credit Gap
We see $3.5 trillion in loans falling into the small business loans category, as defined by the CFPB. This is a huge volume of data to get right. And, data is devilishly hard to look at, making Section 1071 a complicated process.
However, by implementing the above innovations, we can get the data right while significantly reducing the costs and burdens of collecting and reporting it. By doing so, Section 1071 can deliver the insights that finally will help us close the small business credit gap. Our nation’s livelihood depends on it.
Learn more about the small business credit gap here.