US Treasury Intent on Improving Online Marketplace Lending

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The US Treasury Department has issued a white paper “Opportunities and Challenges in Online Marketplace Lending”.

Online marketplace lending refers to the segment of the financial services industry that uses investment capital and data-driven online platforms to lend either directly or indirectly to consumers and small busi­nesses.

This segment initially emerged as a “peer-to-peer” marketplace, with companies giving individual investors the ability to provide financing to individual borrowers. As products and business models have evolved, the investor base for online marketplace lenders has expanded to institutional investors, hedge fund, and financial institutions. In recognition of this shift in investor base, the market is no longer accurately described as a “peer-to-peer” market.

Treasury now refers to these companies as “online marketplace lenders.” In its white paper, it provides an overview of the evolving market landscape, reviews stakeholder opinions, and provides policy recommendations.

It also acknowledges the benefits and risks associated with online marketplace lending and highlights certain best practices applicable both to established and emerging market participants.

Several common themes emerged, including the following:

  1. Use of Data and Modelling Techniques for Underwriting is an Innovation and a Risk: While data-driven algorithms may expedite credit assessments and reduce costs, they also carry the risk of disparate impact in credit outcomes and the potential for fair lending violations. Importantly, applicants do not have the opportunity to check and correct data potentially being used in underwriting decisions.
  2. An Opportunity Exists to Expand Access to Credit: The online marketplace lending is expanding access to credit in some segments by providing loans to certain borrowers who might not otherwise have received capital. Distribution partnerships between online marketplace lenders and traditional lenders may present an opportunity to leverage technology to expand access to credit further into underserved markets.
  3. New Credit Models and Operations Remain Untested: New business models and underwriting tools have been developed in a period of very low interest rates, declining unemployment, and strong overall credit conditions. However, this industry remains untested through a complete credit cycle.
  4. Small Business Borrowers Require Enhanced Safeguards: Commenters drew attention to uneven protections and regulations currently in place for small business borrowers.
  5. Greater Transparency Can Benefit Borrowers and Investors: Responses strongly supported and agreed on the need for greater transparency for all market participants including pricing terms for borrowers and standardized loan-level data for investors.
  6. Secondary Market for Loans is Undeveloped: Although loan originations are growing at high rates, the secondary market for whole loans originated by online marketplace lenders is limited.
  7. Regulatory Clarity Can Benefit the Market: A large number argued that regulators could provide additional clarity around the roles and requirements for the various market participants.

The white paper also introduces a number of recommendations for consideration by the federal government and private sector participants:

  1. Support more robust small business borrower protections and effective oversight;
  2. Ensure sound borrower experience and back-end operations;
  3. Promote a transparent marketplace for borrowers and investors;
  4. Expand access to credit through partnerships that ensure safe and affordable credit;
  5. Support the expansion of safe and affordable credit through access to government-held data; and
  6. Facilitate interagency coordination through the creation of a standing working group for online marketplace lending.

The white paper identifies potential trends that will require on-going monitoring. These include the evolution of credit scoring, the impact of changing interest rates, potential liquidity risk, increasing mortgage and auto loans originated by online marketplace lenders, potential cybersecurity threats, and compliance with anti-money laundering requirements.

Critically, the business models and data-driven algorithms supporting this industry have largely developed in favourable credit conditions. Treasury believes it is important to consider policies that could minimize borrower risks and increase investor confidence in a less favourable credit environment.

A few other points of note:

  • The Consumer Financial Protection Bureau (CFPB) began accepting consumer complaints against marketplace lenders in March
  • The US Supreme Court is embroiled in a case that has major implications for online marketplace lenders: Madden -v- Midland Finance. At issue is whether the National Bank Act, which pre-empts state usury laws regulating the interest a national bank may charge on a loan, continues to have pre-emptive effect after the national bank has sold or otherwise assigned the loan to another entity
  • The ousting of the chief executive of LendingClub after a board review will increase the pressure for further regulatory scrutiny of the online marketplace/peer-to-peer lending businesses

Looking forward, it’s not “what you are” but “what you do” which is likely to determine the regulatory and governance framework for online marketplace lenders; and the expectations of directors and senior executives.

Consumer protection will be centre stage of the evolving regulatory agenda.

The views and opinions expressed in this article are those of the author and do not necessarily reflect the opinions, position, or policy of Berkeley Research Group, LLC or its other employees and affiliates.

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