For more than thirteen years since the passage of the Dodd-Frank Wall Street Reform and Protection Act (Dodd-Frank), some in the lending community have been dreading the implementation of the small business data collection rule. The rule, required by Section 1071 of Dodd-Frank, was intended by Congress to provide greater transparency into the origination of small business loans, the demographics of applicants and borrowers, and the financial cost of the loans made. The purpose was clear. Congress wanted to facilitate and expand coverage for the enforcement of the nation’s fair lending laws and to foster the ability of communities, government entities and creditors to identify community development needs and opportunities for women and minority-owned small businesses.
On March 30, 2023, the Consumer Financial Protection Bureau (CFPB) finally issued a rule amending its regulations that implement the Equal Credit Opportunity Act (ECOA) pursuant to Section 1071 of Dodd-Frank. Instead of working with the regulatory and advocacy communities to implement the final rule expeditiously, some of the largest banking trade associations sought instead to try to stop implementation. As a result of those efforts, the rule is currently enjoined based upon orders issued by federal district courts in Texas and Kentucky. At the same time, other members of these same trade associations have been individually looking at their own small business lending portfolios to see what they could do to better monitor for discrimination, mitigate risks, and expand the diversity and ensure the sustainability of their small business lending portfolios.
There is only one major speed bump left on the winding road before these compliance deadlines are a certainty. The Supreme Court will issue a ruling later this term in CFPB v. Community Financial Services Association of America, Limited (CFSA) (Docket No. 22-448) on whether the CFPB is constitutionally funded. For those reading the tea leaves, based upon the oral arguments on October 3, 2023, it appears very likely that the Supreme Court will rule in favor of the CFPB. Once the Supreme Court issues its ruling, the district courts’ orders enjoining the rule will likely dissolve and compliance will eventually be required. Under the banks’ best-case scenario, implementation will be delayed for several months to accommodate the implementation pause caused by the trade associations’ lawsuit enjoining the rule. In short, the rule is likely to survive the legal challenge but may still take some time to be implemented. It has also weathered a conservative political effort to rescind it under the Congressional Review Act.
Lenders cannot afford to rest on their laurels. The lending community now needs to focus, if they have not already done so, on compliance. Depending on the size of the lender, implementation and reporting would have been originally required between October 24, 2024 (for lenders making 2,500 or more small business loans a year) and January 1, 2026 (for lenders making between 100 and 500 loans a year). There is no assurance on how long those dates may be delayed. If there’s one thing lenders agree on, it is that implementation is complicated, and compliance will take time and resources. Lenders should make the most of this pre-implementation period.
Now is the time for lenders to stop resisting and start embracing this rule. There will be several benefits from doing so. First, responsible lenders will benefit from the marketplace information provided by peers that will allow them to identify lending opportunities and remain relevant in the communities that they serve. Second, it is a legal and regulatory fair lending requirement that will be enforced by federal agencies. Taking a proactive compliance approach now will help ensure that an institution is not caught flat-footed with implementation and operational issues down the road. Third, this data will ultimately serve as the basis for fair lending enforcement actions not only by federal agencies but also scrutiny from nonprofits, media outlets, politicians, and private plaintiffs. Just as Home Mortgage Disclosure Act (HMDA) data has helped identify discriminatory practices, including redlining, in the home mortgage market, the data that results from the new rule will be used to identify similar practices in the small business lending sector. Being thoughtful now about lending practices in general will help ensure that your institution is reaching a broad range of communities and presenting an accurate and comprehensive picture of your lending activities.
As with HMDA, the final rule for small business data collection and reporting brings in information on applicants and on loan products. Some of these overlap with what would be collected by mortgage lenders for HMDA: a unique loan identifier, application date and recipient, credit purpose, loan amount originated or approved for HELOC, action taken and action taken date, denial reasons, pricing information, census tract and demographic information. There are also some details that differ, including types of credit purposes (e.g., working capital, overdraft, and business startup), gross annual revenue (rather than income, as in HMDA), NAICS (industry classifier), time in business (rather than time in employment or occupation), and whether the business is minority owned, women owned, or LGBTAI+ owned. The ownership type is self-reported and may include a “966” response – applicant does not wish to provide. Demographic information collected on up to four principal owners includes race, ethnicity, and gender (as it would in HMDA). There are some subcategories for race and ethnicity that are more detailed than found in HMDA. Lenders are not required to make their own judgment call on the demographic information if applicants choose not to provide it.
Businesses with gross annual revenues of $5 million or less in the preceding fiscal year will report under 1071, assuming they had more than 100 covered originations in each of the two previous calendar years. Once this data is publicly available, it will be able to be used for analyses similar to the mortgage redlining analyses now being conducted by the financial regulatory agencies. Up until implementation, while regulators can request all of the data used by lenders in its underwriting and pricing decisions with respect to small business loans, (analogous to HMDA+ data for mortgages), they have been unable to perform any peer comparisons. This dataset will allow those analyses of the geographic dispersion of small business lending.
In addition to helping small business lenders identify community development opportunities by reviewing the peer data that will become available and enhancing their own Community Reinvestment Act compliance, the transparency provided by the rule will greatly benefit consumers and help to close the racial wealth gap. Minority and women small business owners are often victims of discrimination. As the National Community Reinvestment Coalition found in studies related to the Payment Protection Program (PPP) business lending patterns during the pandemic, women, and particularly women of color, were discouraged from even applying for small business loans as compared to White business owners. They often had fewer lending products to choose from, less information about each loan product and were even denied access from applying because they were not an existing customer, a restriction some banks did not apply to White male business owners.
Discouragement in the small business lending sector is not only illegal discrimination under the ECOA and its implementing Regulation B, but also particularly impactful to minority communities. Like homeownership, starting and sustaining a small business is an important means of passing wealth on from one generation to the next. Sometimes it is the only means, given how expensive it is to buy a home in today’s market. By supporting fair lending and transparency in small business lending, banks will help eliminate discouragement and ensure the businesses in the communities they serve will thrive and continue to borrow and deposit money there.
For all of the above reasons the small business lending community needs to look at their data and participate constructively in the rollout of this important sunshine rule. The long and winding road of the small business data collection rule is coming to an end, and they need to be ready to comply.
