[Policy] Eliminating ‘Lender Lock-in’ for SBA-Guaranteed Loan Applicants

As part of the Aspen Tech Policy program, I was one of eight Scholars selected to make a policy recommendation to the Small Business Administration federal agency. Pitching to the Senior Advisor for Delivery, Policy Advisor, and Special Advisor, I proposed a technical modification to the application processes of multiple SBA loan types, which would reduce the artificial market power of creditors and minimize the 'land-grab' tactics of locking in prospective borrowers. The full memo is below.

Executive Summary 

This memo proposes an extension to the Capital Access Financial System (CAFS) dashboard that would enable loan applicants to formally withdraw and reassign a pending application from one Lender Partner to another (with certain anti-abuse restrictions). This aims to minimize the number of prospective borrowers experiencing costly delays and/or misleading information with respect to their loan approval process. With applicants no longer locked into a single lender’s loan evaluation process, Lender Partners would be strongly incentivized to (a) process legitimate applications in a timely and communicative manner, and (b) improve the accuracy of eligibility filtering and communication at the beginning of a loan application process. 

Background 

The SBA extends the reach of its financial assistance by working with a private sector Lender Partners to handle the issuance of loans to small businesses. These lenders are bestowed discretionary authority to evaluate and approve loans, which broadens the span of financial institutions capable of participating in SBA programs [1]. The downside of this system is the imposition of unstandardized and opaque loan evaluation processes onto borrowers, which means unfortunate applicants experience delays due to a lack of processing capacity, and/or receive misleading guidance (particularly with regard to loan eligibility). Both of these situations can have a devastating impact on the borrower’s small business [2].

This problem is exacerbated by a specific administrative rule of SBA-guaranteed loan applications. That is; once a small business has initiated an application with a given Lender Partner, they are unable to easily withdraw and move their application to a different lender, regardless of the competence or integrity of the original lender. This is because there is no straightforward way for their SBA Loan number to be reassigned to a new lender. This rule was instituted to impede borrowers from ‘double-dipping’ and receiving more government aid than they are eligible for [3]. However, forcing borrowers to stick to a single lender for the whole process is a form of administrative lock-in [4] that encourages untoward Lender Partner behavior. This behavior misaligns with the SBA’s mission (to support the financial health of small businesses) in at least the following two ways: 

(1) Lenders do not have sufficient incentives to process applications in a timely or communicative manner. Lenders are not forced to abide by, or communicate, an unambiguous deadline for approval/rejection. Although commissions are realized on delivery of a successful loan, receiving this fee sooner is, in some cases, not a strong enough economic incentive for Lender Partners to invest in improving the quality of their vetting and/or communication resources. This has led to failures so egregious that there have been lawsuits pertaining to unlawful delays, such as Pronsky et al v. Prestamos. In general, having to wait months before knowing whether an application was successful imposes financial uncertainty onto borrowers. They may neither be able to plan nor make meaningful expenditures during a prolonged or opaque loan processing period. 

(2) Lender Partners are also incentivized to cast a very wide net to capture as many prospective borrowers as possible, which leads to ineligible applicants wasting their time. There are a finite number of actually eligible borrowers, and lenders are competing with other lenders to secure their business, so it makes business sense to land-grab as many potential borrowers as possible, as early as possible. If applications get delayed due to overwhelming applicant numbers as a result, that cost is largely borne by the borrowers. For example, a number of new web-based loan processors launched in response to the popularity of the Paycheck Protection Program. Many advertised online eligibility ‘quizzes’ [5], the output of which tended to be overly optimistic about the borrowers’ chances of getting a loan. This tactic has been described as a cynical method to lock in a borrower [6] based squarely on the fact they cannot reassign their loan application to another lender. Many thousands of these PPP applications were later rejected on grounds that could have been established much earlier.

Recommendation 

This memo proposes that loan applicants to any SBA loan program [7] are given the right to switch the Lender Partner that is processing their pending application. Applicants with pending loan applications would now be able to withdraw from one Lender and reassign their application to another qualified Lender Partner. All submitted documentation would be immediately transferred to the new lender. Their unique SBA Loan number would remain the same, and borrowers will still not be able to apply concurrently to another lender with the same number or attempt to duplicate their loan. 

Empowering the borrower 

There are several benefits to borrowers having the flexibility to reassign their loans to a new lender. Firstly, this new power equips borrowers with a critical countermeasure against slow, incompetent or under-resourced vetting processes. Borrowers would no longer need to stick with a lender who is underinvesting in application processing. Secondly, lender underinvestment in processing resources would no longer be externalized as a bottleneck to be borne by unfortunate borrowers.

Better incentives for lenders

Implementing this recommendation would mean that applicants are no longer irreversibly locked-in. As a result, Lender Partners and associated businesses (i.e. online loan processors) would be strongly incentivized to:

(a) Process legitimate applications in a timely and predictable manner, lest they lose the borrower and associated commission to another Lender Partner. The power of applicants to judge the efficiency and clarity of correspondence of the loan approval process, and subsequently withdraw, would encourage lenders to process applications more quickly and efficiently, and communicate more effectively with applicants.

‍(b) Improve early eligibility filtering, given the presence of a genuine time-limit to resolve each applicant’s loan approval one way or another. The commercial upside of casting a wide net to lock in as many potential borrowers as possible is reduced if those borrowers can leave a process that has more applications than it can handle. Therefore, this recommendation disincentivizes Lenders Partners from over-extending and capturing more applicants than their processing resources can resolve in a reasonable timeframe. This also would reduce the number of applicants who were ineligible and should never have applied in the first place.

Implementation

CAFS Dashboard Augmentation

This proposal extends the feature set of an online tool already in existence – the Capital Access Financial System (CAFS). The CAFS dashboard currently enables loan applicants to view/edit their applications and submit supplementary documentation [8]. Applicants with pending loan applications – i.e. those who have already been assigned an SBA number – would see an option to Reassign Loan Application to New Lender Partner. The user flow would then require applicants to confirm the lender from which they are withdrawing, and then reassign their application to another qualified lender. All submitted documentation, for example the SBA 7(a) Borrower Information Form, would be immediately transferred to the new lender, as is, preventing loan applicants from tweaking answers in the hope of tipping the balance towards eligibility.  The applicant’s SBA loan number would remain unchanged, but would now be formally linked to a different Lender Partner. Applicants would not be able to duplicate their number or apply concurrently to two lenders, given that the CAFS dashboard is the only way to switch lenders, and the corresponding SBA databases would keep track of all application reassignments from one lender to another. 

Abuse-resistant Parameters

To avoid loan applicants exploiting this feature to shop around for loan approval, the following restrictions should be placed on the dashboard:

1. Applicants may only withdraw and switch lender after their application has been pending with that lender for a minimum number of days. Applicants may only switch lender a maximum number of times per year or specific loan cycle, whichever is shorter.
2. If a pending loan application is rejected by a lender, the application reassignment feature is no longer available to the applicant for that loan cycle. 

The constraints should be determined for production based on behavioral research (see Budget). Furthermore, the SBA may determine that some degree of ‘shopping around’ helps level the playing field between larger and smaller creditors. In such a case, the restrictions can be relaxed accordingly. 

Delivery 

The recommended feature extension to CAFS is implementable by in-house software developers and would not require external funding, but would require resource reallocation. This proposal recommends a budget that covers: 

• a front-end engineer to make simple additions to the CAFS dashboard user flow.
• a back-end/full-stack engineer to ensure (a) applicants’ lender updates are written to the relevant canonical database, and (b) stored applicant information and documentation is delivered securely and immutably to the new Lender Partner.
• augmenting educational resources for borrowers - e.g. to explain the cost/benefit of switching lenders.

Additionally, the switching mechanism will require further research into current behavioral trends in order to tune the anti-abuse restrictions above. Finally, this change to the administrative rules will require counsel to ensure that SBA programs will not be made legally vulnerable.

Footnotes

[1] Loan approval discretion increases the number and variety of organizations that can participate in SBA programs, since the risk tolerance, balance sheets, secondary insurance and other business constraints of private lenders/creditors are non-uniform, so they could not be forced to follow the same exact standards. 
[2] For example, Q4 Physical Therapy (Westborough, Mass.) claims to have received varying and directly contradictory guidance on how their taxes should be prepared from Bank of America – see Fraud Checks and Errors Slow Small-Business Relief Loans, NY Times (2021). 
[3] One study by the SBA found that duplicate loan numbers led to 4,206 applicants receiving $692m worth of duplicate loans for borrowers with the same tax identification number and business address - see Duplicate Loans made under the Paycheck Protection Program. 
[4] Administrative lock-in is a form of artificial and excessive market power, which has been shown to lead to suboptimal outcomes in the small business credit markets. See Natalie Bachas, Ernest Liu , and Constantine Yannelis; Market Power in Small Business Lending (2019).
[5] For example, this Facebook advertisement aimed at self-employed persons from Blueacorn mentions a 60 second eligibility quiz.
[6] Propublic reports that ‘scores’ of prospective loanees were listed as loan recipients but never received any funding. 
[7] This recommendation would apply to programs such as the 7(a) loan program, CDC/504 loan program and Microloan program, and also to future iterations of the Paycheck Protection Program and Economic Injury Disaster Loan program.
[8] See this guide to setting up a new Capital Access Financial System account.