Illuminating Discrimination Against Small Businesses

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Proposed rule would target discrimination in small business lending by requiring disclosure of demographic data.

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Small businesses are a primary engine of the U.S. economy, providing a steady income and path to wealth creation for tens of millions of U.S. residents. But when it comes to ensuring loans to these businesses comply with fair lending laws, regulators have been flying blind.

Despite federal law that prohibits discrimination in lending based on race, sex, and age, among other factors, regulators have traditionally had little access to the demographic data of small business borrowers. This gap has left regulators unable to enforce laws prohibiting bias in lending and to address discrimination against minority and female small business owners.

But regulators will soon have an opportunity to close this gap.

The Consumer Financial Protection Bureau (CFPB) is currently drafting a rule that would implement Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act. Section 1071 requires the CFPB to gather demographic data from lending institutions about the owners of the small businesses to which they lend. Congress passed the Dodd-Frank Act in 2010, but the Bureau has never issued the rule called for in Section 1071 to create a process for lending disclosure.

This lack of implementation of Section 1071 may have heightened longstanding disparities in lending to small business owners based on race and gender. In one study, researchers conducted “secret shopper” tests in which small business owners of different races applied for loans. The results showed lenders rejected Black and Hispanic small business owners at higher rates than less-qualified white borrowers.

Female-owned small businesses were also less likely to receive loans than those owned by men in similar tests.

The COVID-19 pandemic exacerbated these trends, with a study of Florida businesses showing that Black-owned restaurants were 25 percent less likely to receive government assistance checks from the federal Paycheck Protection Program than white-owned restaurants.

Although these studies are far from comprehensive, they do suggest the presence of discrimination in lending markets. The lack of complete data, however, makes it difficult for federal regulators to determine precisely where and how discrimination occurs.

Improved disclosure could help ameliorate the difficulty regulators face in identifying discrimination. The Home Mortgage Disclosure Act (HMDA), for example, requires lenders to disclose the demographic data of every borrower, allowing regulators to pinpoint patterns of discrimination.

Although the CFPB did start a rulemaking process during the Obama Administration that would have required lenders to disclose the demographic information of their small-business borrowers, the work halted under the Trump Administration. A resulting lawsuit led to a court-ordered deadline of March 2023 for the CFPB to issue a rule that requires disclosure.

The CFPB is poised to issue its final rule before that March deadline. The proposed rule, though, has already received some pushback from business groups that claim that it will harm small community-owned banks by imposing onerous compliance and reporting costs. The American Bankers Association (ABA), for example, has called for raising the currently proposed threshold of including lenders that have made at least 25 credit transactions in the preceding two years to include only those who made at least 500 credit transactions in that time frame.

But limiting the number of institutions subject to the reporting requirement could undercut the purpose of the proposed rule: granting regulators access to comprehensive data that allows them to identify lending discrimination.

One analysis showed that excluding banks that made under 50 credit transactions in the preceding two years would exempt from the disclosure requirement as much as $40 million in annual loans made in a handful of southern states—and likely hundreds of millions of dollars of additional loans nationally. Raising the threshold to 100—still well below the ABA’s suggestion of 500—would result in over $500 million in loans exempt from the same southern states.

Although limiting the number of banks included in the regulation could exclude many loans from the coverage of the rule and limit the rule’s effectiveness, a compromise that the CFPB might consider would be to exclude lenders holding assets below a specified level. The regulation implementing the HMDA features such a test, exempting financial institutions with under $50 million in assets from the law’s disclosure requirement.

Applying a similar asset-based threshold under the proposed regulation could balance concerns about potential burdens on small community banks with the regulation’s goal of promoting disclosure. CFPB Director Rohit Chopra has indicated support for targeting the disclosure requirement at larger financial institutions, citing the need to keep community banks profitable and promote continued competition in the financial sector.

Regardless of the exact threshold used to determine coverage, the proposed regulation aims to have the effect of shining a light on racial and gender-based disparities in lending to small businesses. The CFPB regulation’s impact could even possibly rival that of the HDMA—which provides data both to the federal government and to private plaintiffs, who have used it to bring numerous lawsuits against mortgage lenders engaged in discriminatory practices. If it works, it will help reduce discrimination from a key engine driving the U.S. economy.