On May 10, 2016, the U.S. Treasury Department released a white paper entitled, “Opportunities and Challenges in Online Marketplace Lending.” The white paper is the result of a request for information that elicited more than 100 industry responses, and it reviews the benefits and risks of online marketplace lending before making policy recommendations to the government and industry participants.
The white paper defines “online marketplace lending” as “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.” The industry began as a “peer-to-peer” marketplace, where companies would facilitate individual investors’ provision of financing to individual borrowers. The marketplace has expanded beyond the peer-to-peer market to include larger institutional lenders, but online marketplace lenders generally have certain common characteristics: they generally provide small, unsecured loans with short terms, make credit decisions comparatively quickly, do not have retail branches, and rely on non-traditional data sources to evaluate a borrower’s credit risk, like real-time business accounting, payment and sales history, and online small business customer reviews. The market is currently driven primarily by prime and near-prime consumer unsecured loans, student loans, and small business loans, and according to the white paper, origination volumes could reach $90 billion by 2020.
The significant growth and unique lending approach that has characterized online marketplace lending has caught the attention of the Treasury Department, and other regulators, and the white paper makes several observations concerning trends and what the Treasury Department believes should be done to ensure that this evolving market remains safe and sustainable. Though the white paper is not overtly part of any regulatory change concerning the online marketplace, several of its concerns and recommendations are particularly interesting because they may hint at areas for potential regulatory focus in the future:
- Potential risks of new sources of credit data. The white paper notes that one of the key features of online marketplace lending is the use of new algorithms and sources of data to make credit decisions faster than was previously possible. The white paper notes that, while these innovations lower costs and increase efficiencies, there are concerns that the data may be unreliable and that they could capture unintended correlations that may lead to disparate impact and fair lending violations against consumers. With fair lending being a topic of perennial concern for regulators, this is an area especially likely to be the subject of regulatory attention in the future, particularly if these fair lending concerns prove to have any merit.
- Need for greater transparency. Concerns about the soundness and fairness of online marketplace lenders’ credit decisions are compounded by a perceived lack of transparency into those decisions. The white paper reports that many RFI commenters saw a need for clearer and more consistent communication of APRs and lending terms to borrowers. Others reported that investors are not being provided with sufficient information about the loans and transactions in which they are investing. The white paper notes that all marketplace lending securitization transactions to date have been conducted as private offerings, which are not covered by the disclosure rules for securitization transactions under the Securities Act of 1933. To address some of the transparency concerns, the white paper recommends that a publicly-available registry be created to track data on transactions, including the issuance of notes and loan-level performance.
- Additional protection for small business borrowers. The white paper also notes that not all online marketplace lenders are financial institutions, so they may not be subject to federal regulation and supervision the way traditional lenders are. The fact that borrowers might be entitled to varying levels of consumer protection depending on who their lender is creates the potential for confusion and abuse. Additionally, the white paper notes that small business loans are not currently protected by all of the same consumer protection laws as personal loans. In a marketplace aimed at micro- and small-business loans, the functional difference in borrower sophistication between a small business owner and an individual may be so negligible as to counsel for added protections for small business owners. The white paper recommends that greater oversight and protections for small business loans under $100,000 would help address this issue.
- Need for industry standards to ensure positive customer experience. Additionally, the white paper recommends that the industry adopt a set of standards to ensure that borrowers have a positive experience with their lenders throughout the life of the loan. The white paper notes that the online marketplace has not been tested in adverse market conditions, so it has yet to be determined how sound these loans are or whether online marketplace lenders’ servicing infrastructure can handle heightened delinquency rates. The white paper recommends that the industry adopt standards for strong customer service from origination to repayment, including in particular that lenders establish clear processes for dealing with customers in financial distress, and that they ensure that borrowers have access to information to help them mitigate default, like dispute resolution options and credit counseling. The white paper also recommends that lenders develop back-up servicing plans to ensure that loans continue to be managed in case the servicer ceases operations.
The white paper also calls for the online marketplace to expand to provide access to credit to “no-file” or “thin-file” consumers who are creditworthy but not scoreable under traditional credit scoring methods, and it suggests that lenders continue to develop ways of verifying borrower data before extending credit. Finally, the white paper recommends that a working group consisting of the Treasury Department, CFPB, FDIC, FRB, FTC, OCC, SBA, and SEC be created to explore further the potential benefits and risks of online marketplace lending.
Considering the relative novelty of online marketplace lending and the lack, to date, of targeted regulation of this growing industry, online marketplace lenders should carefully consider the recommendations made in the white paper, as they may signal future regulatory developments. Thinking about these recommendations now will help lenders develop their online marketplace lending programs in a manner consistent with regulators’ expectations down the road.