The Online Lending Trap


Predatory Online Lenders Attract State Regulationimages

The online lending industry, which provides much-needed finance to consumers and small businesses, is also catching the attention of regulatory authorities in several states. Many of these new financial institutions work in a transparent manner, making funds available to those who are ignored by the traditional banking system. But, some of them charge astronomical rates of interest that result in putting consumers into a debt cycle from which they cannot extricate themselves or which threaten the very existence of the businesses that borrow funds.

California, New York, and Illinois are at the forefront of efforts to issue regulations thatwill protect borrowers and rein in online lenders who advance money based on their perceived ability to recover their dues rather than the ability of individuals or small businesses to repay. Last year, Mayor Rahm Emanuel of Chicago launched a campaign to help business owners avoid the predatory lending practices of merchant cash advance companies and other high-cost lenders.

More recently, New York’s state Assembly has introduced legislation requiring its Department of Financial Services to study online small business lending and prepare a report by January 1, 2018. The scope of the study includes determining whether online lenders are offering credit at reasonable and transparent interest rates and fees and offering payment terms that can be met by borrowers.

The Department of Financial Services has also been directed to go into the type of underwriting conducted before issuing credit and to check whether lenders verify borrowers’ credit data before providing funds.

Why has the New York state assembly turned its attention towards online lenders? The justification for introducing the bill says that “in the absence of a reliable source of traditional lending, small businesses have increasingly turned to largely unregulated online lenders to acquire loans.” The bill aims to ensure that the lending process followed by these lenders would have “clear terms and rates” and be “honest.”

A recent report in Bloomberg BNA states that California is collecting data from the largest online lenders to enable state officials to draft a non-bank lending statute to be used as an enforcement and regulatory tool. The details collected from 13 of the country’s biggest online lenders have been used to make a report that was issued on April 8. This report reveals that individual and small business borrowing from online lenders grew from $1.99 billion in 2010 to 15.91 billion in 2014.

California’s Department of Business Oversight has now sought further details. It has asked for information about tie-ups between online lenders and traditional financial institutions. It also seeks to know whether California’s fair lending laws are being complied with and details about lenders’ approval procedures.

A study by the Opportunity Fund, California’s largest microfinance lender, found that small businesses that borrow from online lending companies pay an average APR of 94%. Of the 150 loans made by 54 different small business lenders, one carried an APR of 358% while 24 loans had interest rates that averaged 178%.

Another report by the Woodstock Institute studied 15 loans by online lenders to Chicago businesses. It found that five loans carried rates between 26% and 60%, four loans were granted at rates of 324% or more and the remaining had interest rates of 94% or more.

But legislation by states to regulate the online lending industry may still take some time to be implemented.

Article written by SBFI