The Treasury Department recently issued a white paper detailing its findings on the current state of the online marketplace lending industry and offering policy recommendations, including a call for increased regulation of the industry.
The report was informed by a request for information (“RFI”) issued by the Treasury Department in 2015 (see our earlier post on the RFI), along with input from other federal regulators, namely the Consumer Financial Protection Bureau (CFPB), the prudential banking regulators, the Federal Trade Commission (FTC), the Small Business Administration (SBA), and the Securities and Exchange Commission (SEC). The Treasury Department defined an “online marketplace lender” as a company that no longer only connects individual lenders with individual borrowers, but that uses technology and data availability to leverage sophisticated networks featuring institutional investors, partnerships with financial institutions, direct lending, and securitizations.
Marketplace Lending Trends The Treasury Department identified the following themes among the roughly 100 responses it received:
- Regulatory clarity would benefit the online lending market. The Treasury Department characterized the views on the role of federal government involvement as “diverse,” with some responses calling for a strong government role to supervise lenders and to regulate participants in a manner similar to financial institutions. Many respondents called for regulatory clarity, including better understanding of regulatory applications for consumer and small business protections, cybersecurity, fraud, true lender designations, and Bank Secrecy Act / anti-money laundering requirements.
- Use of new data and risk modeling in underwriting may be a risk. As a “core element” of online marketplace lending, the use of data-driven algorithms is an innovation that expedites credit assessments and lowers the cost of credit, but carries the risk of disparate impact and potential fair lending violations.
- Marketplace lending may expand access to credit. The marketplace lending industry may be expanding access to credit to underserved markets, including to subprime consumers, small business, and student loan borrowers. The Treasury Department stated that further examination is needed to assess opportunities for expanded access to credit across consumer, student, and small business lending.
- The new underwriting and credit models remain untested. The new credit models and underwriting methods used by online marketplace lenders have been developed and utilized in a period of low interest rates, and have yet to be challenged through a complete credit cycle.
- Small businesses likely need better safeguards. Small business borrowers do not receive the same protections under consumer protection laws as borrowers of personal loans, other than protection under contract law and the fair lending protections under the Equal Credit Opportunity Act. Consumer advocates argued that micro and small business borrowers should be treated as consumers with enhanced safeguards.
- Greater transparency to benefit borrowers and investors. Different online marketplace lenders disclose different amounts of information to borrowers and investors. Respondents to the RFI called for clear communication of APRs and lending terms, and greater disclosure and access to asset-backed security or individual loan data for investors. Some responses called for standardized terms and disclosures for borrowers.
- The secondary market for loans is currently undeveloped. Online marketplace lenders do not currently benefit from an active secondary market for loans, which would allow more accurate mark-to-market loan portfolios and an increase in the size and frequency of securitizations.
Policy Recommendations The Treasury Department included the following recommendations:
- More small business borrower protections and oversight. Citing low borrower satisfaction ratings from one survey and finding that small business loans under $100,000 share common characteristics with consumer loans, the Treasury Department suggests that Congress develop legislation to improve small business borrower protections.
- Facilitate interagency coordination. The report recommends an inter-agency working group to identify areas where “additional regulatory clarity could protect borrowers and investors and expand access to credit.” The proposed working group would include the Treasury Department, CFPB, Federal Deposit Insurance Corporation, Federal Reserve Board, FTC, Office of the Comptroller of the Currency, SBA, SEC, and a state bank supervisor representative.
- Ensure “sound borrower experience” and processing operations. The industry should adopt standards to ensure a “sound borrower experience” and develop back-up servicing plans in case a participant closes or a system platform fails. Participants should “exercise prudence” during collections efforts when borrowers are in economic distress.
- Promote a transparent marketplace. The Treasury Department urges the industry to adopt standardized representations, warranties and enforcement mechanisms; reporting standards for loan origination data and portfolio performance; securitization portfolio performance transparency (and a private sector registry for tracking transaction data that is available to the public); and market-driven pricing methodology.
- Expand access to credit through CDFI partnerships. The report suggests that subprime borrowers, including “no file” or “thin file” consumers, are currently underserved by the industry. Industry participants should consider partnerships or initiatives with community development financial institutions (CDFIs), and leverage CDFI data to facilitate access to credit for underserved populations.
- Increase access to government data to support safe and affordable credit. The report suggests two potential applications of open government data: smart disclosure and data verification. Industry participants could use smart disclosure of pricing and other data in standard machine-readable formats to allow third-party companies and nonprofits to easily create comparison shopping sites. Marketplace lenders should also use government data to verify financial capacity as part of their underwriting process. As an example, the Treasury Department suggested that online marketplace lenders use the publically available Income Verification Express Services from the Internal Revenue Service to confirm a borrower’s ability to pay.