Research shows that 15% of payroll protection loans can be fraudulent

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When a payroll protection program began last year to help small businesses struggling during the pandemic, the federal government was determined to quickly withdraw money for aid, so it abandoned most of the screening lenders traditionally used when issuing business loans.

The lack of these safeguards meant that fraud was highly likely. But how much of the $ 800 billion allocated by the program was stolen illegally?

BUT new academic working paper The information released on Tuesday estimated that about 1.8 million of the program’s 11.8 million loans – more than 15 percent – totaling $ 76 billion had at least one indication of potential fraud, the researchers concluded.

“There have been many anecdotes about fraud, but the complexity of the anecdotes is that they are very difficult to piece together and assess what is happening,” said Samuel Krueger, assistant professor of finance at the University of Texas. at the Austin McCombs Business School and one of the authors of the article. “We wanted to find patterns in the data.”

The study blames many bad loans on one particular group of lenders: financial technology firms known as fintechs that focus on digital lending. Nine out of 10 lenders with the most suspicious loans fell into this group.

“Some fintech lenders seem to specialize in bad loans,” the authors write. The study says that together, fintech companies provided about 29% of the loans under the program, but they accounted for more than half of the suspicious loans.

The payroll protection program, which ran intermittently from April 2020 to May 2021, relied on banks and other lenders to provide government-guaranteed loans that are meant to be forgiven if borrowers followed the program’s rules. Government watchdogs have long warned of the high risk of term loan fraud; Ministry of Justice more than 500 people charged with an improper borrowing requirement for hundreds of millions of dollars.

Dr. Krueger and two other university researchers, John M. Griffin and Pratik Mahajan, identified a set of four primary and five secondary signs of a suspicious aid loan. Among the red flags are businesses that claim to pay workers significantly more than their industry does, and corporations and other formally structured businesses that do not have government registration. Then they combined credit records released by the Small Business Administration, which ran the program, along with other data sources such as registers and industry payroll data, to find loans with anomalies.

The researchers admitted that the $ 76 billion sum contains several false positives because not every worrying loan is inappropriate. For example, one of their indicators is the issuance of several loans to several businesses located at the same residential address. This is often a warning sign, according to program researchers and lenders, some of whom have said they have paid more attention to such loans. But there are also legitimate reasons why a household can have more than one home business.

Researchers’ stricter credit counts with at least two suspicious characteristics identified 1.2 million potentially fraudulent loans totaling $ 38 billion.

“We’ve been pretty conservative in our approach to the whole analysis, so we’re probably missing out on billions,” said Dr. Griffin, a professor of finance at the university. “It looks like the cost of this program was high.”

Dr. Griffin, Team Lead Researcher, owner of four companies who provide consulting work on financial fraud investigations. According to him, no one has contracts related to the salary protection program.

Specifically, the study cites two lenders, Capital Plus and Prestamos CDFI, who report fraud on about half of their loans. Both of these lenders disbursed almost all of their loans through Blueacorn, a loan intermediary who attracted borrowers with a marketing blitz and sent them to their partners. Two other major online lenders, Cross River Bank and Harvest Small Business Finance, also had an exceptionally high percentage of suspicious loans, the researchers said.

All four lenders said they strongly object to the study’s methodology, data and findings. At the same time, they stressed that the populations they focus on – especially sole proprietors and tiny companies, including those without traditional business banking relationships – are inherently more risky.

“We have made every effort to weed out inappropriate applications,” said Jose Martinez, President of Prestamos CDFI. “My team is working day and night to support the smallest of small businesses, and we are proud of the work that has been done to ensure that critical emergency funds reach all the right candidates.”

Mostly large banks limited lending under the Payroll Protection Program existing customers, choices that have reduced the likelihood of fraud, but disproportionately excluded businesses owned by women and people of color. Online lenders and financial technology were often the only available option for those without commercial bank accounts and lines of credit. The issuance of loans to persons with no previous relationship with the lender, especially in the absence of strict underwriting, significantly increases the risk of fraud.

“Cross River is a government registered FDIC insured bank with strong regulatory standards,” said Phil Goldfeder, a spokesman for the bank. “Unlike other lenders who prioritized their clients, Cross River took the SBA’s call to action and did not restrict the program to existing clients.”

Before the study was published, Blueacorn sent a letter to Jay Hartzell, president of the University of Texas at Austin, to object to the researchers’ approach. Blueacorn said that, based on interim data released by the Small Business Administration prior to the completion of the PPP, the study took into account loans that its lenders initially approved but later canceled due to suspicious characteristics. Nearly 157,000 applications – about 16 percent of all Blueacorn approved loans – were canceled by lenders prior to disbursement.

“As we analyzed the growing volume of loan applications, we studied, adapted and improved our fraud detection capabilities and protocols,” Blueacorn CEO Barry Calhoun said in a written statement. “Along the way, we partnered with the SBA and other authorities to ensure the integrity of PPPs while ensuring that traditionally neglected populations have access to the funds they need and deserve.”

The researchers hoped their work would help inform the ongoing political debate about the effectiveness of the Wage Protection Program.

“Our evidence, along with evidence that PPP saved a relatively small number of jobs due to the high costis providing increasing evidence that PPPs appear to be poor at allocating capital, ”they write. “The sheer volume of tens and hundreds of thousands of suspicious loans issued by many fintech lenders suggests that many lenders either encouraged such loans, turned a blind eye to them, or applied weak supervision procedures.”

The Small Business Administration did not comment.

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