Raising the possibility of regulation, the Department of the Treasury has published a Request for Information (RFI) regarding online marketplace lending (also called peer-to-peer lending), seeking public comment on the various business models and products offered by such lenders to both small businesses and consumers, 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. The Treasury also asked for information on the customer acquisition process—What kind of marketing is used? Are relationships with traditional financial institutions leveraged?—and input on the balance of how the use of electronic data can help automate processes and decrease costs but presents risks not found in traditional lending. The comment period for the "Public Input on Expanding Access to Credit Through Online Marketplace Lending" RFI will be open until the end of August, providing stakeholders with the opportunity to weigh in on the fast-growing industry, a topic that looks to be the subject of future regulation by the Treasury. Although the questions suggest that the Treasury generally has a favorable view of marketplace lending, this Treasury initiative will draw the attention of other regulators, and likely is the beginning of significantly greater regulation of the online marketplace lending industry.
Could increased regulation of online marketplace lenders be on the horizon? A new Request for Information (RFI) issued by the Department of the Treasury could signal the agency's interest, given the wide-ranging scope of its inquiry.
Defining "online marketplace lending" as "the segment of the financial services industry that uses investment capital and data-driven online platforms to lend to small businesses and consumers," the Treasury focused the RFI on three topics: the various business models and products offered by online marketplace lenders to consumers as well as small businesses; the potential for such lending to expand access to credit to underserved market segments; and how the regulatory framework should evolve to support the "safe growth" of the industry.
The Treasury acknowledged the value of online marketplace lending, which "has filled a need" for borrowers facing barriers to access to affordable credit from traditional lenders. Online marketplace lenders are developing product structures and underwriting models that make loans to non-prime borrowers and small businesses possible at lower rates and with reduced transaction costs, offering a new source of financing for historically underserved markets, the RFI noted.
Why take a closer look at online marketplace lending now? Although it remains "a very small component" of the lending market, "it is a rapidly developing and fast-growing sector that is changing the credit marketplace," the Treasury explained. "In less than a decade, online marketplace lending has grown to an estimated $12 billion in new loan originations in 2014, the majority of which is consumer lending."
The RFI identified three types of companies operating in the industry: balance sheet lenders that retain credit risk in their own portfolios and are typically funded by venture capital, hedge fund, or family office investments; online platforms that sell securities to obtain financing to enable third parties to fund borrowers and do not retain credit risk; and bank-affiliated online lenders funded by a commercial bank, often a regional or community bank, that originate loans and directly assume the credit risk.
Some of the companies also partner with banks, the Treasury said, where the bank acts as the lender to borrowers that apply on the platform and the loans are sold to second-party investors or the marketplace lender. Despite the different business models, online marketplace lenders have several similarities, including providing funding through online loan applications, operating without retail locations, using electronic data sources and technology-enabled underwriting models to determine a borrower's credit risk, and providing faster access to credit.
Given all of these different business models and types of lenders, how should policymakers be thinking about market segmentation, the Treasury wondered, and in what ways do different models raise different policy or regulatory concerns? Are lenders designing their models and products for different borrower segments (consumers or small businesses, for example, or even more specifically, new small businesses or consumers seeking to consolidate existing debt)?
Significantly, the RFI also sought details on whether platform lenders should be required to have "skin in the game" for the loans they originate or underwrite as well as more information on investors, such as their operational arrangements and methods of finance.
The use of electronic data helps online marketplace lenders automate their processes and decrease the costs passed on to borrowers. But what role do all of the electronic data sources play in issues such as the evaluation of identity, fraud, and credit risk for lenders, and do the data-based processes create new opportunities or risks not found in traditional lending, the RFI asked.
A key line of inquiry for the Treasury: whether online marketplace lending is expanding access to credit for historically underserved market segments. Additional questions in the RFI explored the customer acquisition process, such as marketing used to reach new customers and partnerships with traditional financial institutions, community development financial institutions, or other types of businesses.
While online marketplace lending offers "significant benefits and value to borrowers," the RFI questioned whether harms might also be present—such as privacy considerations, cybersecurity threats, consumer protection concerns, or other related risks—and if existing statutory and regulatory regimes sufficiently address these issues.
The RFI also requested information on how borrowers are assessed for their creditworthiness and repayment ability. "How accurate are these models in predicting credit risk? How does the assessment of small business borrowers differ from consumer borrowers?" the Treasury asked.
Some online marketplace lenders may be subject to existing regulations promulgated by the Federal Trade Commission or the Consumer Financial Protection Bureau, the RFI noted, and relationships with traditional financial lending institutions may also trigger regulatory oversight. Have participants in the new industry taken any steps toward compliance and what issues are raised with online marketplace lending across state lines?
Those commenting on the RFI could also discuss how marketplace lenders manage operational practices (loan servicing, fraud detection, and credit reporting, for example) and how such practices may differ from those at traditional lending institutions, including any tasks outsourced to third-party service providers.
Speaking of banks, the Treasury sought information on the advantages and disadvantages of their participation in the market and how changes in the credit environment might impact online marketplace lenders. Does a secondary market currently exist, and what are the advantages and disadvantages of such a market, the RFI asked.
Finally, the RFI concluded with a catchall question, asking what "other key trends and issues" policymakers should be monitoring as the market continues to develop.
Comments will be accepted until August 31.
To read the Department of the Treasury's RFI, click here.