Predatory Small-Business Lending: Market and Regulatory Failures

Small businesses are the mainstay of the U.S. economy, but they face particular challenges in acquiring financing because of a set of informational problems. It is difficult for lenders to obtain reliable information about small businesses’ finances, and even when they can get information, credit modeling is difficult because of small businesses’ heterogenous nature.

These informational problems frustrate quick and efficient evaluation and pricing of credit risk. Consequently, despite the large number of lenders in the market, many small businesses, particularly new, very small, or riskier enterprises, struggle to get any financing offers, and when a small-business borrower does get a financing offer, it rarely has an alternative.

Small-business borrowers thus often face a situational monopoly that leaves them vulnerable to supracompetitive pricing and other predatory lending practices. Regulation, however, provides scant protection because business lending is exempt from most federal and state regulation. As a result, small businesses operate in a world in which there is neither market-generated protection from competition nor regulatory protection.

This Article puts a spotlight on the abusive practices that have emerged in small-business lending: misleading price disclosures, supracompetitive pricing, and aggressive collection techniques that deny borrowers due process. The Article proposes a comprehensive small business-lending regulatory regime, modeled on elements of consumer credit regulation, to address these problems.