On October 23, 2022, the U.S. Small Business Administration published for comment a rule that would significantly expand the availability of federally guaranteed loans to entrepreneurs with a criminal history. This rule, if finalized, could also transform the SBA’s role in support of urban community development.

The proposed rule, titled ”Affiliation and Lending Criteria for the SBA Business Loan Programs,” 87 FR 64724 (Oct. 23, 2022), eliminates language in the SBA’s formal lending criteria that the agency has relied on for many years to restrict loans to justice-affected business owners.

We have written at length over the past several years about the broad record-based restrictions in the SBA’s lending and contracting programs, restrictions that first became controversial during the pandemic, and that have never been justified by evidence of a link between criminal history and credit risk.

While the proposed SBA rule covers a variety of subjects, its key provision from CCRC’s perspective is its omission of the words “character” and “reputation” from the criteria for small business loans in 13 CFR 120.150(a). It is this language that has been relied on for the “good character” policies in the SBA’s operating procedures affecting both business loans and disaster assistance. In turn, these procedures define “good character” exclusively in terms of a person’s criminal history.

Our past analyses of the SBA’s operating procedures indicates that a potential borrower who reveals any past conviction on loan application forms (including convictions that have been expunged or pardoned) is unlikely to qualify for an SBA-approved bank loan or SBA disaster assistance.  Banks are not permitted to proceed with a loan application if an applicant reveals any past felony conviction, no matter how dated and minor, until the SBA launches an extended inquiry to determine whether the applicant has “good character.” applicant. Even if an applicant makes it this far in the loan process (and most are deterred from even applying given the questions on the form), banks may in turn be deterred from proceeding given how long the SBA “good character” process takes.

The standards that go into “good character “ determinations are not published anywhere, though we know that they are all made in one regional office.  A FOIA request filed by the Washington Lawyer’s Committee revealed that the SBA made over 900 good character determinations in 2020-2021 but did not retain documentation of them. Indeed, the SBA maintained that it was unable even to find a record of 2/3 of these determinations.

We recently applauded the SBA’s removal of “good character” from its rule certifying veteran-owned businesses for preferential treatment in contracting, as we had urged in a comment supported by 25 civil rights and advocacy organizations.  We think this aspect of the proposed rule on lending criteria would be a similarly positive step to make business capital fairly available to business owners despite their criminal history.

The proposed revision of the rule would effectively eliminate the regulatory basis for disqualifying prospective borrowers based solely on their criminal record, and undercut the SBA’s ability to consider criminal record as an independent basis for denying credit. Our analysis has identified similar disqualification standards in the SBA’s disaster loan program, and the revised rule would apply to those loans as well. As the SBA proposes to revise and simplify the lending criteria, they would focus on objective standards of creditworthiness instead of relying on vague notions of “character” and “reputation” that have made it difficult for justice-affected entrepreneurs to qualify for the SBA’s federally guaranteed loans.

In describing the purpose of the revised lending criteria, the SBA explains that it hopes to “expand access to capital for small businesses and drive economic recovery,” and that “allowing [lenders] to use credit scoring models for credit underwriting will result in more lenders making more smaller loans because the costs for making the small loans will decrease.”  The SBA expects that its revised rule will expand the universe of lending institutions that will be authorized to dispense SBA loans, including in particular lenders like fintechs that are not federally regulated.

The proposed rule generated over 100 comments, with many SBA-certified lenders objecting to the simplified loan criteria, and specifically to the agency’s proposed expansion of the program to non-depository lending institutions (including fintechs) and removal of the “character” test in the current rule. A comment filed by the National Association of Government Guaranteed Lenders expresses concern that the proposed revision of the lending criteria will remove “the historical program guardrails” that have “ensured prudent lending throughout the program’s history.” Another by the American Bankers Association states that the revised criteria “may negatively impact the performance of loans made under the 7(a) Program, threaten the integrity of the program, and lead to increased borrower and lender fees.”

Senator Benjamin Cardin, who chairs the Senate’s committee on Small Business and Entrepreneurship, and Senator Corey Booker, have together written to the SBA urging the agency to limit its program restrictions based on criminal record — although their letter also recognizes the importance of maintaining the program’s traditional “guardrails.” Their letter was sent before the SBA’s October publication of its revised eligibility standards.

We are studying the comments, and hope to be in a position to report further in the near future.