Why it matters
Regulatory oversight of online marketplace lending is moving forward, with representatives from the Department of the Treasury sharing six "central themes" drawn from comments on the agency's Request for Information (RFI) about the industry issued earlier this year. Speaking separate conferences in New York, Treasury Counselors Antonio Weiss and Anjan Mukherjee both said the agency gathered several takeaways based on the comments, from the scope of the current market (mostly prime and near-prime borrowers) to fair lending concerns raised by the use of nontraditional data in credit underwriting decisions. The officials also discussed risk retention, the growing number of partnerships between online marketplace lenders and traditional financial institutions, and encouraged industry to look beyond the small number of servicing and collection firms currently being used in order to improve borrower experience. As the Treasury continues to analyze the comments received from the RFI, they said the agency will continue to work with state and federal regulators "to ensure that innovation in lending proceeds within a framework that protects borrowers and preserves safety and soundness."
In July, the Department of the Treasury published a Request for Information (RFI) posing 15 distinct questions regarding online marketplace lending, seeking comment on the various business models and products offered by such lenders to both small businesses and consumers. The Treasury also asked about the potential for the market to expand access to credit to historically underserved segments and how the regulatory framework should evolve to support the "safe growth" of the industry.
After a comment period open through the end of September, the Department received 104 responses from individuals, businesses, advocates, and trade associations at the Information Management Network Conference on Marketplace Lenders. Manatt submitted a comment letter which is available by clicking here.
Treasury Counselors Antonio Weiss and Anjan Mukherjee appeared at separate events last week giving a preliminary readout of the RFI submissions and the Department's reactions. Mukherjee was interviewed by Manatt Partner Brian S. Korn at the American Banker's Marketplace Lending conference.
The officials emphasized that the Treasury "will seek to foster, not impede, innovation that increases competition and broadens access to affordable credit for creditworthy borrowers and businesses. But we will also be vigilant in ensuring that innovation does not undermine important privacy and consumer protection priorities. And we plan to continue our work in close dialogue with our regulatory partners."
Six themes emerged from the comments, according to the officials.
Online marketplace lending is currently serving mostly prime and near-prime borrowers consolidating debt from credit cards or student loans, Weiss said. While this allows borrowers to obtain lower-cost loans, it means expanding access to those "further down the credit spectrum remains largely an aspirational goal," he acknowledged, as many lending platforms have minimum credit score requirements, effectively barring participation by low- and medium-income households.
One area that does seem ripe for growth: lending to small businesses, which receive 90 percent of their financing from banks and are often looking for credit to grow their businesses. "Marketplace lending has the potential to unlock access to the capital markets for these borrowers," Weiss said.
The second theme found in the comments: the new underwriting models have yet to be tested through a full credit cycle. "It is too soon to tell … if these alternatives perform better than traditional models at predicting creditworthiness, particularly in a more difficult economic environment," Weiss noted.
The Treasury also received comments on a related point: consumer protection concerns regarding compliance with fair lending obligations given the increasing amount of nontraditional data used in credit underwriting decisions. "Just because a credit decision is made by an algorithm, does not mean it's fair," Weiss said. "Advocates expressed concern that the new credit models are a 'black box' and applicants have no recourse if the information being used is incorrect."
Many commenters emphasized the need to establish a level playing field, Weiss said, and policymakers should be mindful of the regulatory framework already in place so that the same standards of transparency and accountability, for example, apply to both bank and nonbank lenders.
Transparency was another theme highlighted by commenters. "For small businesses, transparency requires standardized all-in pricing metrics, so that a business understands a loan's true cost and can make like-to-like comparisons across different loan products," Weiss said. "For consumers, transparency should encompass clear terms and conditions, on both mobile and desktop devices, and simple payment plan options. And for all borrowers, it should include standardization of disclosure and credit performance. For investors, transparency means, at a minimum, standardized representations and warranties."
The fifth theme: the growing number of partnerships that online marketplace lenders are forging with banks, community development financial institutions (CDFIs), and other businesses. These relationships can allow banks to leverage the new models while giving marketplace lenders access to new customers. "As these partnerships develop, they may bring the benefits of new credit models to borrowers in low-income communities, who could potentially have the most to gain from access to more affordable credit," Weiss said.
Finally, many commenters referenced risk retention, albeit with a wide range of views. Some argued for transparency on loan pricing, product features, and performance in lieu of holding credit risk; others asserted that noneconomic interests, such as reputational risk from making bad loans, already serve as "skin in the game" for lenders; while some comments advocated for the necessity of risk retention.
With the themes laid out, Weiss explained the next steps in the process. Although the Treasury is not a regulator in this area, the agency is analyzing the comments from the RFI, working with regulatory partners "to better inform our collective understanding of the issues," and continuing to monitor developments in the marketplace.
For his part, Mukherjee offered that the Treasury, as Chair of the Financial Stability Oversight Council, a financial regulatory consortium created by Dodd-Frank, might suggest additional regulation to the primary regulators of banks, consumer lenders and securities issuers. The Department might also push for legislative change in order to provide clarity and transparency—including perhaps in response to the recent Second Circuit decision in Madden v. Midland Funding.
"Our guiding principle will remain to seek the broadest possible access to safe, affordable and sustainable credit," Weiss told attendees. "We will be mindful to preserve and promote the American entrepreneurial spirit in the growing financial technology industry. However … we must not allow innovation to undermine consumer protections, privacy concerns, and other important policy priorities. We will need to find a balance."
In the interim, industry should "lead efforts to ensure safety and soundness, transparency, and equal borrower protections," Weiss urged. He cited a lack of innovation in backend operations, with a heavy reliance by marketplace lenders on a small number of servicing and collections firms.
"As we've learned in mortgages and consumer loans, poor servicing can have devastating effects, especially for struggling borrowers," Weiss said. "We encourage entrepreneurs to focus attention on constantly improving the borrower experience, from customer acquisition straight through to collections in the event of delinquency or default."
Mukherjee made the important point that the change in Administration which will occur in January 2017 may not spell the end of the regulatory push in the space. He said each transition team works with the incoming Administration to transition work in progress. "Of course, tone at the top is meaningful, so it may depend on who wins the election."
To read Treasury Counselor Weiss's prepared remarks, click here.