In response to the U.S. Department of the Treasury’s (“Treasury”) July 20, 2015 request for information on online marketplace lending (the “RFI”), Treasury issued its white paper on marketplace lending “Opportunities and Challenges in Online Marketplace Lending” (the “White Paper”) on May 10, 2016. The White Paper outlines the risks and potential of this emerging form of credit, makes specific policy recommendations and identifies certain trends for future monitoring.
The White Paper defines marketplace lending as financial services that use “investment capital and data-driven online platforms to lend either directly or indirectly to consumers and small businesses”. While less developed than in the U.S., Canada also has a nascent marketplace lending industry, composed both of domestic and foreign-based marketplace lenders. The White Paper identifies a number of considerations that will also be relevant to the Canadian market and Canadian regulators.
Findings from Stakeholder’s Responses to RFI
The White Paper identifies the following broad themes from the submissions received from consumer and small business advocates, investors, financial institutions, academics, online marketplace lenders and trade associations:
- marketplace lending is expanding access to credit for small businesses and borrowers who may not have access to other credit sources;
- the use of algorithms to process credit applications constitutes an innovation that may expedite credit assessment, but which may also carry the risk of disparate credit outcomes that violate fair lending;
- the online credit model is untested, since it has not operated through a complete credit cycle, and has developed in a context of favourable economic conditions;
- small business borrowers engaging in marketplace lending may require additional regulatory protection;
- borrowers and investors would benefit from greater transparency in the terms set by online lending services;
- the secondary market for loans remains under-developed due to the low number of issuances and lack of transparency, which increases risk for lenders and escalates borrowing costs; and
- marketplace lending requires regulatory clarity regarding the roles and requirements of market participants and regulators.
The White Paper recommends:
- More robust small business borrower protections and effective oversight. While small business loans are in many respects similar to consumer loans, small business borrowers are not afforded the same protections as consumer borrowers. Treasury recommended that the U.S. federal government should provide more robust small business borrower protections and effective oversight. This distinction exists in Canada as well, in that small business borrowers generally do not benefit from the same protections as consumer borrowers (with some very limited exceptions in some provinces for loans extended for farming or fishing purposes, or in Quebec, loans extended to professionals, artisans, farmers and sole proprietors in certain circumstances). It will be interesting to see whether Canadian legislators will similarly consider expanding protections for small business borrowers, although given the splintered nature of the federal/ provincial regulatory framework, common initiatives in this area seem unlikely.
- Sound borrower experience and back-end operations. The marketplace lending industry should ensure sound borrower experience and back-up servicing operations by adopting standards that address the whole lending process, from customer acquisition to delinquency or default. Most marketplace lending platforms service loans only until the loans become delinquent and then outsource the servicing to collection agencies. The White Paper suggests that a robust industry-driven regulatory framework is key to ensure the stability of marketplace lending in credit climates that are less favourable than the current one.
- Transparent marketplace for investors and borrowers. Online lending platforms require greater transparency in order to grow into a well-developed lending market. This could be achieved through standardization of loan products (including representations, warranties and enforcement mechanisms), consistent reporting standards for loan origination data and ongoing portfolio performance, loan securitization performance transparency and consistent market-driven pricing methodology standards. The White Paper encourages financial services industry groups to independently establish loan-and-pool level disclosures and reporting standards. The White Paper also recommends the creation of a publically available private registry tracking data on transactions, which would include data on the issuance of notes and securitizations, and loan-level performance.
- Partnerships between marketplace lenders and financial institutions. The White Paper recommends expanding access to credit for underserved segments of the market through the partnership between online platforms and financial institutions, in particular community banks. Community banks have a strong understanding of local credit markets, and could increase their efficiency and lower costs by partnering with online platforms to make use of online platforms’ underwriting technology and back-end operations. While Canada does not have the same model of community banking as found in the U.S., a somewhat similar role is played by credit unions in Canada and we have already seen examples of partnerships between credit unions and online lenders, such as the partnerships between Grow Financial and B.C. credit union First West and Saskatchewan credit union Conexus.
- Greater access to government held data. Better access to government held data could lead to better consumer access to affordable credit by allowing investors and entrepreneurs to develop innovative products and services. The White Paper mentions two particular forms of data that could assist marketplace lending: “smart disclosure” (the release of government data in formats that can be easily processed by third party software) and “data verification” (the capacity to scrutinize government data, allowing for more accurate assessments of the material provided by consumers in their credit applications).In particular, the White Paper suggests the U.S. Internal Revenue Service offer an application programming interface (API) to automate income verification express services to lenders to automate the sharing of borrower tax data in a simple, fast, secure way. Canada has embraced open data principles and participates in the international Open Data Working Group through its involvement in the Open Government Partnership and is a signatory to the G8 Open Data Charter. The Canadian Open Data Portal currently contains data sets from Industry Canada and Customs and Revenue Canada on things as diverse as insolvency statistics, survey results on financing and growth of small and medium enterprises and credit conditions. The Open Data Portal contains information on working with the data and APIs.
- Creation of a standing working group for online marketplace lending. The White Paper recommends the creation of a standing working group on online marketing place lending bringing together federal and state agencies, to ensure interagency coordination. Such an approach may also be worth considering in Canada, where, similar to the U.S., marketplace lending could fall under the jurisdiction of multiple regulators and legislators.
Trends to Monitor
The White Paper also notes several trends that should be closely monitored to understand how the marketplace lending industry evolves in the context of a potentially less favourable credit environment. These include the following:
- the evolution of credit scoring;
- the impact of changing interest rates;
- potential liquidity risk;
- increases in the volume of mortgage and auto loans originated by marketplace lenders;
- cybersecurity threats; and
- compliance with anti-money laundering requirements.
As can be seen from the White Paper, even in the U.S. where marketplace lending is much more established than in Canada, regulators are still grappling with how best to regulate and where the risks lie. The White Paper suggests some specific recommendations to address potential risks, while still noting that certain areas should be closely monitored in the future. It is clear that potential regulation of this space will continue to evolve in the future and should be closely monitored by relevant stakeholders.