The Federal Reserve Bank of Cleveland recently issued a special report on the results of online focus groups it conducted with the Federal Reserve Board “to better understand small businesses’ perceptions of online alternative lenders and the short-term, small dollar credit products they offer.”

Coming on the heels of the Treasury Department’s request for information regarding online marketplace lending, the report is another demonstration of the growing awareness of regulators that marketplace lending is gaining traction and another signal that these lenders are likely to face increased regulatory scrutiny.

“Alternative Lending through the Eyes of ‘Mom & Pop’ Small Business Owners: Findings from Online Focus Groups,” is based on focus groups conducted online with 44 small businesses from across the United States and in a wide range of industries. To qualify for the study, a business was required to have two to 20 employees and annual revenues of less than $2 million.

The study’s key findings were:

• Participants not experienced or unfamiliar with online lenders had initially negative impressions of online lenders, while participants who had applied to or borrowed from an online lender were generally more positive. The impressions of participants less familiar with online lenders became more positive after actually visiting lender websites. Participant concerns about data security and privacy arising from the websites’ collection of businesses’ financial information “was a turn-off for participants across the board.”
• Many participants expressed uncertainty about costs and features of mock loan products and wanted more information to make products easier to compare.
• The lack of standardization in how online lenders present their products was “problematic” for many participants, with a majority indicating that they wanted clearly stated information about product features and an easier way to compare products. Participants suggested expressing interest rates as APRs, explicit listings of all fees, and required statements about payment policies, including late fees and prepayment penalties.

The report also includes a list of issues raised by the study “that may help guide policy discussion and inform future research and data collection on small business borrowing.” Such issues include how standardized product disclosures would affect small business owners’ borrowing decisions and how online alternative lending will change the nature of small business banking. With regard to the latter issue, the report notes the rising prevalence of partnerships between traditional banks and online alternative lenders and potential fair lending concerns that such partnerships could raise.

Notably, the methodology behind the report draws conclusions about whether small business owners understand the terms of various finance products without showing them real-world disclosures such as loan agreements. Instead, the report relied entirely on participant reviews of website marketing material and “mock product comparisons” which appear to bear no relation to actual products in the marketplace. As a result of its significant shortcomings, the report should not be viewed as support for a claim that more regulation of online lenders that provide financing to small businesses is needed.

Nevertheless, in light of the report’s findings, online lenders may want to review and evaluate the clarity of their disclosures and their data security practices. As the report notes, the consequences of a data breach for an online lender can be costly because “potential borrowers might well become reluctant to share the type of information that online lenders may depend on.”