Taylor Sutton

Judging by their probable effects, Small Business Administration (SBA) regulations proposed on January 13th and entitled “SBA Supervised Lenders Application Process,”[1] seem to indicate a bureaucratically self-aggrandizing approach by the SBA, at least toward its small business loan program. The 7(a) Loan Program outlined within the Small Business Act,[2] allows the SBA to offer tradable guarantees of portions of certain loans made by certain lenders to small businesses. Among other things, the proposed regulations would clamp down on non-federally regulated lenders (NFRLs) by restricting interstate activity,[3] impose higher capital requirements that would supersede state requirements,[4] and afford the SBA substantial power to hold up transactions in lender stock by allowing it to veto deals involving more than 10% of the lender’s shares.[5]

Non-SBA federal regulators supervise many lenders within the 7(a) Loan Program scheme, and the SBA has regulatory authority over all small business lenders not so supervised.[6] Nevertheless, while the SBA receives mandatory reports from NFRLs,[7] the SBA leaves primary regulatory responsibility of such lenders to state regulators.[8] Among other things, these state regulators can determine capital requirements for lenders in their jurisdictions and allow lenders organized to support economic development to do so across state lines.

Within this context, the likely effects of the proposed SBA regulations suggest something about the SBA’s motivations. At present, some states permit interstate lending for economic development, and a number of NFRLs have taken advantage of this permission.[9] The proposed SBA regulations would withhold loan guarantees from interstate development loans made by these actors, undoubtedly shrinking the effective scope of the SBA’s loan program by supporting fewer small business loans, decreasing lender entry by preventing diversification through loans to different states’ small business communities, and decreasing access to small business loans in states which lack sufficient small business activity to support lending on their own. Although there are only twenty-one NFRLs, their historical importance among 7(a) lenders makes this effect troubling.[10]

Despite this likely result, the SBA justifies its regulations by pointing to lender ignorance of proper interstate practice, inadequate state regulation, and the desire to focus state-regulated lenders on the in-state development that state law supposedly favors.[11] The last of these justifications hardly merits comment: state regulators know state policy better than the SBA, and these regulators have permitted interstate lending.

The SBA’s other justifications deserve more attention. Whether or not lenders are actually ignorant of good interstate practice or state bodies inadequately regulate NFRLs, these justifications suggest that the SBA wants to protect itself from guaranteeing loans made with inadequate oversight. If lenders are making reckless interstate loans and regulators are not restraining this conduct, then the federal government could become the backstop to a program with a dangerously high risk of losses. While the SBA is wise to guard the government purse, this seems an incomplete explanation of the SBA’s regulations.

In analyzing motive, the question arises why the SBA is protecting its guarantees by choking off interstate lending rather than supervising such lending itself. Comparing the interstate lending restriction with the new capital requirement and the SBA’s proposed new transfer of stock rule provides guidance.

If the SBA’s sole concern is for the soundness of the loans it guarantees, then it could impose its own oversight of interstate lenders as a supplement to state regulation. Indeed, the SBA’s proposed universal capital requirement of $2.5 million[12] for NFRLs is a supplementary regulation of exactly this type. However, capital requirements have no direct connection to the soundness of any particular small business loan guaranteed by the SBA, which depends on oversight of debtors and potential debtors. Capital requirements are a protection for risk-averse lenders and their debtors.

In order to regulate interstate lending effectively so as to eliminate unforeseen risks related to loan guarantees, the SBA would need to conduct detailed diligence on NFLRs’ policies and practices in awarding loans to small business applicants. For example, under one New York regulatory scheme covering similar lenders, the state regulator must evaluate lenders’ loan acceptance and monitoring techniques through reporting and auditing down to the level of individual loans and their effects on economic development.[13] The SBA admits it wants to avoid this expense.[14] By imposing an interstate lending ban rather than undertaking detailed regulatory oversight, the SBA lowers its risk while other governmental bodies shoulder the burden of providing costly risk-reducing regulation.

By contrast, the capital requirement and the stock transaction rules demand much less effort from the SBA. State regulators already impose their own capital requirements, and the SBA already receives financial reports from lenders, so the new capital requirement represents the SBA reaching out to impose a centrally-determined rule while incurring almost no new monitoring costs itself. Moreover, under the proposed capital requirement and stock transaction regulations, the SBA could prevent transactions involving only 10% of a lender’s stock. Monitoring such transactions is not hard, and the ability to veto them gives the SBA enormous leverage to regulate lenders in an essentially ad hoc and reactive manner by holding up deals until it can extract concessions.

Considering the proposed regulations together, the SBA appears to be engaged in bureaucratic jockeying at the expense of small business lenders (and potentially small businesses). Where it can do so with little cost, the SBA is increasing central control over lenders. Where it faces high costs, it is accepting less small business-friendly outcomes in order to saddle different bureaucracies with some of those costs. Of course, this observation should not distract from the potential benefits that may nevertheless justify the SBA’s regulations: safer loan guarantees without forcing lenders to comply with multiple sets of regulations and stronger lenders vetted by more muscular central monitoring. It should, however, make us cautious about the SBA’s approach to the 7(a) Loan Program.



[1] SBA Supervised Lenders Application Process, 85 Fed. Reg. 1783 (proposed Jan. 13, 2020) (to be codified at 13 C.F.R. 120). The comment period remains open until March 13, 2020.

[2] In particular, 15 U.S.C. § 636(a) (2018).

[3] 85 Fed. Reg. at 1784.

[4] Id. at 1785.

[5] Id. at 1786.

[6] 15 U.S.C. § 650(a)(3) (2018) (“The Administrator is authorized--with respect to non-Federally regulated lenders to regulate, to examine, and to enforce laws governing the lending activities of such lenders under [section 7(a)] in accordance with the purposes of this chapter.”). The SBA also has more limited regulatory authority over even federally-regulated lenders. 15 U.S.C. § 650(a)(2) (2018).

[7] 13 C.F.R. § 120.464 (2019).

[8] The SBA merely retains the discretionary option to monitor these lenders. See 13 C.F.R. §§ 120.1000–1600 (2019).

[9] The SBA notes that two non-federally regulated lenders sought to extend a majority of their 7(a) loans in different states and that 21% of all 7(a) loans by non-federally regulated lenders occur in different states. 85 Fed. Reg. at 1790.

[10] The number of total 7(a) lenders has declined over time, but, using the available 2018 number of 1,810 to divide the 2020 number of NFRLs (21), one obtains a conservative estimate of the percentage of 7(a) lenders that are NFRLs: about 1.2%. See Id.; Cong. Research Serv., R41146, Small Business Administration 7(a) Loan Guaranty Program 44 & n.43 (the report contains multiple pages numbered 44). In 2008, an auditor described NFLRs and Small Business Lending Companies (which non-SBA federal regulators also do not oversee) as “among SBA’s highest producing and highest risk lenders.” Memorandum from Debra S. Ritt, Assistant Inspector for General Auditing, Office of Inspector Gen., to Eric Zarnikow, Assoc. Adm’r for Capital Access, Small Bus. Admin., et al., Oversight of SBA Supervised Lenders i (May 9, 2008) (https://www.sba.gov/sites/default/files/oig_bllo_8-12.pdf). Although together these types of lenders totaled less than one hundred, they accounted for “about 18 percent of SBA’s total 7(a) loan portfolio.” Id. at ii–iii.

[11] 85 Fed. Reg. at 1784–85.

[12] Id. at 1785.

[13] See N.Y. Comp. Codes R. & Regs. tit. 21, §§ 4250.8, .12 (2020). The regulator has the further open-ended authority to demand “other information [it] may require.” Id. at § 4250.12.

[14] 85 Fed. Reg. at 1784. Although the SBA projects steadily increasing administrative expenses, it also projects a leveling off of oversight expenses. See Cong. Research Serv., supra note 10, at 44 (appearing under the title “Administrative Expenses”). That is despite the fact that SBA’s auditors failed to conduct 30% of their planned oversight reviews from 2015 through 2017. Small Bus. Admin., Office of Inspector Gen., Report No. 20-03, Audit of SBA’s Oversight of High-Risk Lenders 4 (Nov. 12, 2019).