Some segments of the marketplace lending business model (a subset of the growing FinTech industry sometimes referred to as peer-to-peer lending), might become subject to additional regulation if the federal and state regulatory agencies take to heart the results of a recent Treasury Department report.
In July 2015, the Treasury Department issued a request for information seeking, “Public Input on Expanding Access to Credit Through Online Marketplace Lending.” The request posed 14 questions spanning a range of issues related to marketplace lending, including matters related to business structures, underwriting, information technology, and compliance. In response to the request, the Treasury Department received over 100 comments from industry participants, industry and consumer groups, and government entities. It also consulted with other federal government stakeholders, including the CFPB, FTC, SEC, Small Business Administration, and the federal banking regulators.
The Treasury Department analyzed the information it received and based on that information issued a report on May 10, 2016, titled “Opportunities and Challenges in Online Marketplace Lending.” The report defines and describes the current state of marketplace lending for several types of loans, including unsecured consumer loans, student loans, and small business loans. The Treasury Department adopts a definition of online marketplace lending that addresses direct lenders as well as lending platforms that operate in partnership with depository institutions that originate or issue these loans. Online payday lending and merchant cash advance businesses are expressly carved out of the scope of the report, and the Treasury Department does not do a deep dive into secured consumer lenders (auto or mortgage), since that marketplace has not developed as substantially as it has for unsecured consumer loans, student loans, and small business loans.
The Treasury Department acknowledges the potential benefits of permitting a relatively young, innovative industry certain flexibility to grow. But it tempers this tolerance with words of caution concerning the risks current marketplace lending practices pose in certain areas. The Treasury Department found that the use of new data, technologies, and business structures to identify and underwrite borrowers presents the potential for bringing populations underserved by traditional lenders back into the credit markets and might reduce the cost of credit in the long-run. However, the Treasury Department also found that the industry is subject to uncertainties resulting from the lack of stress-testing through complete credit cycles, limited transparency and flow of information to borrowers and investors, underdeveloped secondary markets, and the potential for inconsistent application of regulatory requirements.
Without formally applying any new requirements to marketplace lending (which was not the Treasury Department’s intent), the report lays out recommendations for further regulatory engagement. Those include:
- Enhancing oversight of small business lenders, potentially including broadening the application of certain consumer protection laws to business-purpose credit;
- Ensuring a sound borrower experience throughout the origination and servicing lifecycles, including developing mechanisms, such as better error resolution processes and back-up servicing arrangements, for handling poor economic climates where more delinquencies and defaults are likely to occur;
- Promoting transparency for both borrowers and investors while maintaining information security and financial privacy standards;
- Supporting partnerships between Community Development Financial Institutions (“CDFIs”) and marketplace lenders to expand access to credit beyond the scope of prime and near-prime borrowers that are currently the primary customers or marketplace lenders;
- Developing mechanisms—such as smart disclosure (release of information in machine-readable formats) and expanded data verification services—to make government-held financial data more readily available for use in underwriting; and
- Facilitating interagency coordination on marketplace lending regulatory issues across a range of federal and state agencies to balance the responsible growth of an innovative industry with concerns about compliance and suitability of new business models for down credit cycles.
The Treasury Department’s work is an early step in developing new understandings about how marketplace lending should be regulated. More factual and policy development is likely to come from the industry, consumer groups, and various government agencies. As a result, there is no certainty as to where the market for marketplace lending will find regulatory equilibrium.
There are nevertheless certain issues that seem to be rising to the forefront of discussions about marketplace lending.
First, marketplace lending appears to be driving significant interest in the distinctions between consumer-purpose and business-purpose lending, with government sources and borrower advocates articulating arguments for more granularity in regulatory approaches that take into account how many small businesses operate more like consumers than more sophisticated business enterprises. Although it is almost a certainty that there will be continued discussion on that issue, it is less certain whether the final result will be new regulation, industry self-regulation (such as through the Small Business Borrowers Bill of Rights established by a coalition of marketplace lenders and others in August 2015), or the status quo.
Second, first-tier regulatory issues appear to be rising to the surface, including fair lending, ability to repay, underwriting transparency (particularly when using big data), cybersecurity and financial privacy, and anti-money laundering compliance. These focal points would involve compliance issues under the Bank Secrecy Act (“BSA”), Equal Credit Opportunity Act (“ECOA”), Fair Credit Reporting Act (“FCRA”), Gramm-Leach-Bliley Act (“GLBA”), and prohibitions on unfair, deceptive, and abusive acts and practices (“UDAAPs”) or unfair and deceptive acts and practices (“UDAPs”). Marketplace lenders might see, for example, expanded examination and enforcement on these issues—or potentially new rulemakings or statutory developments with respect to these laws and similar state laws.
Finally, a diverse range of regulators could engage in regulation of marketplace lending, each of which oversees some segment of the industry. As noted earlier in this blog, federal agencies the Treasury Department consulted include those one would expect, including the CFPB, FTC, SEC, Small Business Administration, and the federal banking regulators. Involvement of state regulators should surprise no one, whether as part of the Treasury Department’s interagency coordination proposal or through a larger state push.
While regulation of the industry is far from a certainty, the kind of focus Treasury has brought to the industry is likely to nudge the industry closer to some form of regulation at both the federal and state level.