Regulation Of Online And Alternative Marketplace Lenders

    October 31, 2016

    One area in which alternative marketplace lenders (such as Best Offer Capital) are often criticized by the mainstream lending industry is what mainstream banks and other financial institutions consider to be the lack of regulation which applies to alternative marketplace lenders.  The argument misses the point in multiple respects. First, there are both state and federal laws which cap the interest rates that can be charged to borrowers, including small business borrowers.  Second, many alternative marketplace lenders are also taking voluntary proactive measures to agree to regulations which will protect their borrowers. 

    State and Federal Laws Which Apply to Alternative Marketplace Lenders.

    First, most states have usury laws which prohibit loans that are made above certain interest rates.  These are laws which were in many cases specifically enacted to put caps on the interest rates which can be charged on commercial loans, including loans to small businesses.  For example, the state of Texas has caps on interest rates that apply to any loan made to a resident of that state, whether the borrower is an individual or a corporate entity incorporated in Texas. Commercial loans are authorized by Chapter 306 of the Texas Finance Code and cannot bear more than 18 percent of interest annually although the loan may float with inflation to 24 percent. Commercial loans exceeding $250,000 can bear up to 28 percent.  These requirements apply regardless of whether the lender is an online, alternative marketplace lender or a bank making a small business loan.  Therefore, alternative marketplace lenders making loans to small businesses are indeed regulated by state and federal laws which regulate their loans. 

    There are also federal laws which apply to alternative marketplace lenders.  For example, Section 5 of the Federal Commission Trade Commission Act, such lenders cannot engage in unfair or deceptive trade practices.  In addition, many states have their own laws that prohibit unfair or deceptive trade practices, which would apply to lenders which are deemed to do business in a particular state.  In addition, certain other federal laws may also apply to an alternative marketplace lender depending on its particular business model.  For instance, the Equal Credit Opportunity Act prohibits credits from discriminating against applicants for credit on the basis of race, color, religion, national origin, sex, age or marital status.  It also requires creditor to provide notice to an applicant for credit of the reasons for denial or adverse action taken with respect to an application for credit. 

    A more extensive discussion of the various state and federal laws which may apply to alternative or online lenders prepared by trade association the Electronic Transactions Association can be found here.

    Self Regulation Efforts by Alternative Lenders

    Finally, and as recently reported by the New York Times, some alternative lenders are taking voluntary steps to subject themselves to caps on interest rates and other forms of self-regulation.  As mentioned in the report, a coalition of small business and other lenders called the Responsible Business Lending Coalition have agreed to and published a bill of rights for their borrowers.  This bill of rights calls for clear disclosures, no hidden penalty fees and high confidence that a borrower will be able to repay the loan, among other things.  Several similar organizations have been formed by some of the leading online and alternative marketplace lenders.  These organizations are taking similar steps, such as agreeing to caps on the interest rates on the loans they offer.  Therefore, the industry itself is taking steps to protect borrowers and make sure that all lending which takes place in this market space is as transparent and borrower-friendly as possible.

    Takeaways

    Despite some claims of banks or other mainstream financial institutions to the contrary, alternative and online lenders are indeed regulated both by federal and state laws, such as state anti-usury laws as well as the Federal Trade Commission Act. These laws often protections for borrowers, such as caps on the interest rates that can be charged to borrowers as well as providing requirements that

    The alternative and online lending industry is taking proactive steps to develop responsible lending standards for itself. Several industry organizations have agreed to develop common standards for the protection of borrowers, such as caps on interest rates offered to borrowers.

    Businesses Credit Scores

    Just like individual consumers in the United States have individual credit scores, businesses also have credit scores.  Business credit scores differ significantly from personal credit scores in terms of the methods in which the credit scores are determined and the credit bureaus which determine the creditworthiness of a business.  New businesses understandably may lack a business credit score, which can lead to such businesses having difficulty getting financing from traditional marketplace lenders.  Nonetheless, alternative marketplace or online lenders are more than willing to fill this void and extend a variety of types of financing to small businesses in need of financing to expand their operations or for any other purpose.

    How Business Credit Scores Differ from Personal Credit Scores

    Business credit scores differ significantly from personal credit scores in multiple respects.  First, personal credit scores range from 300 to 850, while business credit scores utilize different scoring formats based upon the business credit bureau in question.  Perhaps the biggest difference between business credit scores and personal credit scores is that there is no standardized scoring format used by the three major business credit bureaus, Experian, Equifax and Dun & Bradstreet.  Most of the consumer credit bureaus utilize some form of a standardized scoring format called the FICO score after the credit bureau which developed this scoring format, the Fair Isaac Corporation.  Meanwhile, there is no standardized credit scoring format which is used by the business credit bureaus.  Instead, each of the the three main business credit bureaus utilizes its own individualized methodology for assessing a business’s credit score.  Finally, under the federal Fair Credit Reporting Act, every consumer in the United States is entitled to a free copy of his or her personal credit report from each of the three personal credit bureaus each year, while business owners have no such right and must pay the three business credit bureaus for copies of their business’s credit report.

    How Business Credit Scores and Personal Credit Scores Are Alike

    Although they differ in many respects as discussed above, there are a number of similarities between business credit scores and consumers’ personal credit scores.  As with personal credit scores, the better a business’s credit score is, the more creditworthy the business credit bureaus typically consider that business to be.  Much like with consumer credit scores as well, there are several main business credit bureaus that rate the creditworthiness of businesses.  The players in both industries are largely the same, as alluded to above.  In the personal credit score context, the three main credit bureaus are TransUnion, Equifax, and Experian.  Meanwhile, the three main business credit bureaus are Experian, Equifax and Dun & Bradstreet.

    The Impact of a Business’s Credit Score on Its Ability to Get Financing

    Many times if a small business has just been started or has never borrowed funds before, then it naturally will have a low or no credit score.  This could result in the business being turned away by mainstream lenders, who are more inclined to look at a business’s credit score in making their decisions on small business loan applications. 

    However, this is not to say that newer businesses with no business credit score or a low business credit score have no option when it comes to obtaining financing for business purpose.  Many online and alternative marketplace lenders understand that new business often lack a business credit score due the fact that they are new business which has not had the opportunity to develop a credit history or a credit score.  Therefore, owners of small businesses who have been denied financing by a bank or other mainstream lender should look to alternative lenders for their financing needs.

    Takeaways

    The determination of business credit scores differs significantly from that utilized for consumer credit scores in the United States. In addition, there are a large number of other differences between business and personal credit scores. 

    New businesses which may lack a business credit score due to a lack of any credit history are not necessarily out of luck when it comes to obtaining financing for purchasing equipment, expanding their business, financing their day to day operations or opening new locations. Instead, alternative marketplace or online lenders are often willing to extend credit to new businesses which may lack a credit score.  Thus, small business owners who are looking to obtain financing for any purpose will want to expand their search to alternative marketplace lenders when looking to obtain financing for their small business financing needs. 

    Read Sherriyan's other blog entries >

Please Wait