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Today's Trends in Credit Regulation

Rumblings for Enhanced Business Lending Regulation
By Catherine M. Brennan

Over the last few years, Congress and President Barack Obama have both expressed concern in media reports and through legislative initiatives regarding access to capital to small business and for small business lending. As part of this concern, policymakers have noted that for many small businesses, particularly sole proprietorships, there may be no functional difference between business-purpose and personal-purpose credit. The most recent indication of this concern appeared in Section 1071 of the Dodd-Frank Wall Street Reform and Consumer Protection Act, enacted last summer.

Section 1071 amends the federal Equal Credit Opportunity Act – which applies to business-purpose credit and imposes specific requirements in connection with business credit applications – to require that financial institutions collect and report information concerning credit applications made by small businesses, effective July 21, 2011. In a move that should give lenders to small businesses some relief, the Consumer Financial Protection Bureau’s General Counsel issued a letter in mid-April that made clear that the Bureau must issue implementing regulations before the Bureau will expect financial institutions to collect and report this data. In the letter, General Counsel Leonard J. Kennedy noted that Congress intended Section 1071 to “produce reliable and consistent data that can be analyzed by the Bureau, other government agencies, and members of the public to facilitate enforcement of fair lending laws and identify business and community development needs” in a manner analogous to the Home Mortgage Disclosure Act. Thus, for now, lenders to small businesses need not concern themselves with immediate implementation of the data requirements.

In the meantime, business-purpose lenders continue to monitor other developments that may impact their lending models. For example, the Credit Card Accountability Responsibility and Disclosure Act of 2009 (“CARD Act”), signed into law in May of 2009, required the Federal Reserve Board (the “Board”) to study and issue a report on the use of credit cards (i.e., open-end accounts) by businesses with not more than 50 employees (i.e., “Small Businesses”) and the credit card market for Small Businesses. The Board issued its report in May of 2010. The review included:

1. The terms of credit card agreements for Small Businesses and the practices of credit card issuers relating to Small Businesses;

2. The adequacy of disclosures of terms, fees, and other expenses of credit card plans for Small Businesses;

3. The adequacy of protections against unfair or deceptive acts or practices relating to credit card plans for Small Businesses;

4. The cost and availability of credit for Small Businesses, particularly with respect to non-prime borrowers;

5. The use of risk-based pricing for Small Businesses;

6. Credit card product innovation relating to Small Businesses; and

7. The extent to which Small Business owners use personal credit cards to fund their business operations.

In its report to Congress, the Board noted that consumer credit cards and small business credit cards offer many similar features, such as rewards programs, balance transfer programs, and introductory rate promotions. The fees and pricing structures, as well as other terms such as grace periods, also appear to be similar across the two products. Several card issuers told Board staff that they house their small business credit card function within the same business unit as their consumer credit card function because of the similarities between the two products.

However, the Board noted, favorably for business-purpose credit card lenders, that significant differences exist between consumers and small businesses and the ways in which each group uses credit cards, leading to some important differences between consumer and small business credit card programs. First, small businesses and consumers differ markedly in their propensity to use credit cards for borrowing purposes (in other words, to carry a balance from month to month). Second, small businesses tend to spend more in any given month than consumers; leading small businesses to demand relatively large credit lines. At the same time, card issuers assume more risk for these larger lines of credit, and also have greater difficulty in assessing the risk posed by a small business at the time of application than the risk posed by an individual consumer applicant. Card issuers can look to the leading credit reporting bureaus and credit scoring models to evaluate consumer applications, while small business credit reporting and scoring is not as well established and virtually non-existent for newer firms. Many small business credit card applicants may have little or no credit history, making small business risk assessments difficult and imprecise. The Board, which has reviewed small business lending in the past as well as in response to the CARD Act, signaled that although it would not act presently to further regulate small business lending, it would act should it see the need for such intervention.

Issuers of business-purpose credit cards, as well as originators of other types of business-purpose credit, should continue to monitor developments at both the federal and state levels to ensure that their compliance efforts continue to meet what federal and state law regulation requires.

Catherine M. Brennan is a partner in the Maryland office of Hudson Cook, LLP. Cathy can be reached at (410) 865-5405 or by email at cbrennan@hudco.com.

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