Banks approved fraudulent loans to capture origination fees: evidence from the Paycheck Protection Program

Purpose - The Small Business Administration (SBA) has estimated that a significant proportion of loans issued during the Paycheck Protection Program (PPP) were fraudulent. This paper aims to make strides to understand incentives that may have led to the approval of fraudulent loans. Design/methodology/approach - The authors study the publicly available PPP loans data set, focusing on nonemployer businesses which make up about 51% of all loans. Because of the way businesses of this type were instructed to apply for loans, it is possible to deduce the monthly/annual profit each loan was claiming. Findings - The authors find irregularities in the pattern of claimed profit by nonemployer businesses on PPP loans. There is a significant buildup of claimed profit just slightly under the threshold for the maximum loan claim, which does not align with estimates of average nonemployer business profitability. Research limitations/implications - As it is not possible to verify individual business profits with publicly available data, the authors cannot identify or count loans, which are likely to be fraudulent. The focus on nonemployer businesses allows for the identification of reported profit, at the cost of eliminating most of the highest value loans from consideration. Practical implications - Especially in areas with a high density of small banks, large numbers of potentially fraudulent loans were issued. In planning future disaster relief programs, the SBA must consider incentives, which led to fraudulent behavior during the PPP. Social implications - Proponents of the PPP argue that it is impossible to completely eliminate fraudulent behavior due to the rapid nature by which the funds had to be distributed to avoid job loss. Nonetheless, the SBA estimates that up to 1/6 of the funding issued may have gone to fraudulent loans. Responsibility was placed on the banking system as regulators of the loans. However, the origination fee structure of the program, combined with limited liability to banks, may have produced adverse incentives. Originality/value - Previous research on PPP fraud primarily identifies businesses and business owners as bad actors during the program. The authors argue that misuse of funds was not the only source of fraud during the program. Misrepresentation of business profits may have been widespread. Therefore, banks must have approved loans with misrepresented profit figures.