We have written at length about the broad criminal history restrictions imposed by the U.S. Small Business Administration in its business loan and disaster assistance programs. These restrictions, which first came to the public’s attention during the pandemic, have limited the availability of federally guaranteed bank loans to small businesses in developing communities, and stymied efforts to close the racial wealth gap through minority entrepreneurship. The SBA’s restrictive lending policies have never been justified by empirical evidence linking criminal history and creditworthiness, and may raise issues under the federal Equal Credit Opportunity Act.  It now appears that those policies are under review within the agency.

Several weeks ago we reported on the SBA’s proposal to amend its rules on lending criteria to eliminate language that the agency has relied on for many years to support policies restricting federally guaranteed loans based on a business owner’s criminal history. We expressed the hope that this rule change would augur and end to the SBA’s consideration of  criminal history as an independent basis for denying credit.

The SBA’s proposed amendment became final on April 10. While we remain guardedly optimistic that the new rule will have the hoped-for effect where the SBA’s own policy and practice is concerned, at the same time the agency’s comments accompanying the final rule seem to signal an expectation that banks will still consider a loan applicant’s criminal history in deciding whether to make a loan even if the agency does not. It appears that we will have to wait for the agency to issue implementing procedures and revised application forms before the full effect of this rule change can be assessed. [See the note at the end of this comment for subsequent SBA changes in its operating procedures.]

The final SBA rule covers a variety of subjects related to its guaranteed loan programs — notably expanding the range of financial institutions that will be authorized to make SBA loans.  But its key provision from CCRC’s perspective is its omission of the words “character” and “reputation” from the lending criteria specified in 13 CFR 120.150(a). It is this language that has been relied on in SBA operating policies to limit eligibility for both business loans and disaster assistance to business owners who have a criminal history.  This is because the SBA’s operating procedures have in past years required loan applicants to have “good character,” defined exclusively in terms of an applicant’s criminal history.  (The SBA imposes similar criminal history restrictions in its federal contract preference program, where they are similarly justified in terms of an applicant’s necessary “good character.”)

In comments describing the new rule, the SBA explains why it relies on a “good character” standard: “For SBA, ‘character’ is used to determine whether an individual may have past criminal history or activities that may pose a risk to repayment ability.” 88 Fed. Reg. 21077. This is not the first time that the SBA has proposed that “past criminal history” may present an independent credit risk. See Defy Ventures v. U.S. Small Bus. Admin., 469 F. Supp. 3d 459, 476 (D. Md. 2020)(“The SBA explained that the criminal history exclusions were based on ability to repay . . . and potential for misuse of funds.”).

While the SBA’s comments express a preference for “objective measures” in assessing credit risk that result in “less variability” than criteria like character and reputation that are “subject to individual interpretation,” at the same time they propose that “SBA Lenders may continue to make their own credit decisions based on the criminal background of an applicant and its associates.” 88 Fed. Reg. 21077.

Stepping back to assess the effect of the new rule, the good news is that it appears the SBA will no longer bar banks from making loans to otherwise qualified applicants based on their criminal history. The less good news is that the agency seems to expect banks and other lending institutions to step into the void and apply their own restrictions on loans based on an applicant’s criminal history.

We do not know whether, left to their own devices, private lenders would disqualify loan applicants based on criminal history alone, or what standards lenders will apply without the guidance and protection afforded by the SBA “good character” policies.  There does not appear to be any industry-wide standard to guide banks and other financial institutions in their business lending policies, though we hope they are beginning to consider these issues.

The SBA also took the opportunity in these comments seemingly to reaffirm its existing rule making a business ineligible for a federally guaranteed loan if any 20% owner is on probation or parole, in prison, or has unresolved criminal charges.  Id., citing 13 C.F.R. 120.110(n).

It remains to be seen if the SBA will take further actions to facilitate borrowing by justice-affected entrepreneurs, notably what guidance will offer to its approved lenders in their “credit decisions based on the criminal background of an applicant.”  At present, the SBA’s operating procedures now include broad inquiries about loan applicants’ past criminal history and mandatory FBI background investigations, but no formal standards for its “good character” determinations. Until we see whether and how the SBA plans to amend the administrative mechanisms through which it has historically enforced its own criminal history restrictions, we cannot determine the full implications of its elimination of “character” as a formally applicable loan criterion, including what standards banks will be encouraged to apply in considering criminal history as an independent measure of creditworthiness.

NOTE, 7/25/23: Since this analysis was published in April, the SBA issued revised operating procedures (SOPs) governing its 7(a) and 504 loan programs that omit the “character determination” that has in the past acted to winnow out many otherwise qualified loan applicants. This new SOP is to be effective August 1, 2023.

In addition, shortly after the “affiliation” file became final, the SBA indicated an intention to propose yet another rule governing its small business loans, to eliminate most inquiries about criminal history on the application form, instead asking “a straightforward question on incarceration and verifying the response using a third-party database check.” The SBA described this change in policy as “continu[ing] to allow SBA lenders to follow their own policies on criminal background checks.” As of July 25, 2023, the SBA had not issued this proposed additional rule, and the application forms for 7(a) loans containing extensive inquiries about criminal history had not been amended.

On May 16, 2023, the chairs and ranking members of small business committees in the House and Senate wrote to the Administrator of the SBA asking her to “pause” the new rule until a new head of the SBA’s office responsible for implementing the new rule could be appointed. We understand that as of July 25 no response to this letter had been received.