Current small business lending discriminates by barring loans to people with criminal histories.
The U.S. Small Business Administration (SBA) restricts access to its lending programs—which are critical lifelines for small businesses—for people impacted by the criminal justice system. These policies entrench racial disparities, are out of step with antidiscrimination law, and should be reformed.
Each year hundreds of thousands of people in the United States are released from prison. They face daunting barriers to reentry into society, including exclusion from employment, housing, and other opportunities. Due to structural inequality and systemic racism, the population released from prison is disproportionately African American and Hispanic. For example, African Americans comprise approximately 38 percent of all federal prisoners but make up only 13 percent of the U.S. population. As a result, lending policies that exclude individuals with criminal histories tend to have outsized negative effects on people of color.
Antidiscrimination laws such as the Fair Housing Act, the Equal Credit Opportunity Act, and Title VII of the Civil Rights Act can help people released from prison overcome these adverse impacts. These laws bar intentional discrimination based on race and other protected characteristics in housing, lending, and employment. They also bar facially neutral policies—those that do not explicitly target a particular group—that have a “disparate impact” on or otherwise adversely and disproportionately affect protected groups, such as racial minorities. Entities can be held liable for a disparate impact if a facially neutral policy does not advance a legitimate business need or if less discriminatory alternatives exist that would serve that business need. Although much work remains to be done, for decades the disparate impact framework has helped dismantle unnecessary and discriminatory barriers to opportunity.
Disparate impact principles have increased fair housing and employment opportunities by limiting overbroad reliance on criminal history in these contexts. For example, the U.S. Equal Employment Opportunity Commission has issuedguidance explaining that blanket employment and housing prohibitions for people with a criminal history are illegal. The U.S. Department of Housing and Urban Development (HUD) has issued similar guidance. Housing advocates have successfully challenged overbroad tenant screening policies that unnecessarily limit housing opportunities for people affected by the criminal justice system.
Unfortunately, blunt criminal history prohibitions persist in small business lending, in part because of the SBA’s criminal history criteria. As with employment and housing, access to safe credit can be vital for economic advancement. Owning a small business can increase income, wealth, and independence. Small businesses also provide employment opportunities and vital services to the communities they serve. To launch and scale business operations, small business owners need access to capital, and they primarily access that capital through borrowing.
The SBA administers two loan programs designed to increase small businesses’ access to capital: the 7(a) Loan Programand the 504 Loan Program. Although both programs provide much-needed capital to small businesses, the SBA’s current treatment of criminal history is out of sync with standard disparate impact principles, as described above.
Two aspects of the SBA’s rules are particularly problematic. First, applicants on probation or parole for any crime are categorically barred from receiving SBA 7(a) and 504 loans. Second, applicants with any prior felony must undergo a “character determination” conducted by the SBA, with no publicly available standards guiding that determination.
These policies likely have a disparate impact on applicants of color. The question, then, is whether the SBA’s criminal history rules are necessary to achieve a substantial, nondiscriminatory interest. HUD’s guidance teaches that this interest “may not be hypothetical or speculative” or be “based on generalizations or stereotypes.” The guidance also instructs that there must be evidence that the “policy actually achieves that interest.”
The SBA has a legitimate interest in ensuring that borrowers are creditworthy and will repay their loans. But as the Consumer Financial Protection Bureau (CFPB) recently observed, “there is limited evidence to suggest that criminal history decreases creditworthiness.” Indeed, given the lack of evidence, any attempt to connect applicants’ probation or parole status to their ability to repay is likely based on “generalizations and stereotypes.” Similarly, the mere fact that someone has been convicted of a felony says nothing about that person’s likelihood of future repayment.
Accordingly, the SBA’s policy is too broad and very likely runs afoul of antidiscrimination laws by not properly distinguishing “between criminal conduct that indicates a demonstrable risk” of a failure to repay and “criminal conduct that does not.”
The overbreadth of the SBA’s policy is a major issue. As the CFPB has noted, more than 1.1 million small business owners have criminal histories of some kind, and individuals returning from incarceration are 50 percent more likely to become entrepreneurs than people who have never been incarcerated. Moreover, some financial institutions have looked to the SBA’s rules in forming their own internal policies on lending to business applicants with criminal histories, indicating that the SBA’s criminal history rules have significant impact beyond just its own programs.
The SBA recently narrowed its criminal history exclusions that apply to the Paycheck Protection Program (PPP), which is designed to help businesses during the COVID-19 crisis. The SBA’s initial rule barred anyone convicted of a felony in the last five years and anyone on probation or parole from receiving a PPP loan. The SBA later narrowed the exclusion to only bar lending to individuals with felonies for “fraud, bribery, embezzlement, or a false statement in a loan application,” unless the owner was convicted of or commenced parole or probation for a felony within the previous year. Despite these improvements to the PPP rules, the SBA’s problematic standards for its bedrock programs persist.
What should the SBA do about the criminal history policies that apply to its core programs? Given the discriminatory effect that consideration of criminal history can have, the SBA should not consider it unless there is a strong, non-speculative basis to believe that doing so achieves a substantial, non-discriminatory interest.
At a minimum, this change would mean defining a tailored list of conviction types that could result in denial of a loan. This list should be no broader than the SBA’s narrowed list of financial crimes it barred for PPP loans. Even then, the SBA should conduct individualized assessments of past convictions in a way that accounts for factors germane to creditworthiness, including the nature and severity of the conduct, the time elapsed since the conduct, and the applicant’s other credit history. The SBA should be transparent about these criteria and how such assessments are conducted, and it should provide reasonable opportunities to dispute adverse determinations. Such an approach to criminal history would both expand access to credit and reduce the risk of the SBA violating the Equal Credit Opportunity Act and other antidiscrimination laws, while still meeting the SBA’s and other lenders’ interests in being repaid.
If the SBA were to adopt these changes, positive effects would ripple across the lending industry.
This essay is part of a six-part series entitled Promoting Economic Justice.