Online marketplace lending is an industry rooted in the innovative culture of Silicon Valley that may soon have to find its way in the bureaucratic culture of Washington, D.C. As one federal agency after another launches a study of the technology and business practices of non-bank companies that make online consumer and small business loans, the odds increase that these firms will face more regulatory scrutiny and oversight.
“There could be and likely will be regulations focused on online marketplace lenders in the future,” says Michael Nonaka, partner at Covington & Burling LLP, Washington, D.C. Adds Anthony Nolan, practice leader for global finance at K&L Gates LLP, Washington, D.C., “The whole construct of online lending platforms is being overtaken by the real world.”
While it is too early to know how extensive a regulatory regime might ultimately be established, some observers are worried that regulators might overdo it and, in the process, impede the industry’s growth and further development. Others are worried that the failure to establish an appropriate regulatory regime could fail to check abuses and risks that could harm borrowers and ultimately damage the industry.
Regulation is a powerful force that has both created the online marketplace phenomenon and could just as easily potentially chill it, according to Linda McGreevey, president and CEO of the Online Lenders Alliance, based in Alexandria, Virginia. “The reason you see this incredible growth in marketplace lenders and other forms of non-bank technology companies coming into this space is because banks have been unable to expand into it because of the regulatory challenge,” she says, explaining that the prohibitive cost of compliance prices banks out of the consumer and small business markets served by online lenders.
Marketplace lending, or peer-to-peer lending as it was originally known, traces its origins in the U.S. to the 2006 launch of Prosper Marketplace, Inc. in San Francisco, which boasts it has lent $6 billion in mostly small personal loans to 250,000 borrowers. Another San Francisco company, LendingClub Corporation, was launched shortly afterward and reports its platform had enabled $15.98 billion in loans as of the end of 2015. A 2007 start-up, New York-based OnDeck Capital Inc., which arranged $1.7 billion in loans to small businesses in 2015, has agreed to enter into a partnership with JPMorgan Chase.
There are no official statistics for online lending and many of the companies are privately held and do not provide public data on their lending volumes. Autonomous Research LLP, a London-based equity and credit research firm estimates $22 billion in online lending in the U.S. in 2015 and forecasts volume will expand to $37 billion this year.
Consumers, especially Millennials, are flocking to the online lenders because they find the loan application process easier and approval times faster, shrinking decisions on applications from weeks to a matter of hours, in some cases. Investors, in turn, have shown a growing appetite to buy or invest in the loans to earn higher yields at a time of widespread low yields in the bond market.
In the wake of this growth, marketplace lenders are casting an increasingly worried eye at what might be forthcoming from the Consumer Financial Protection Bureau (CFPB). On March 7, the agency, which would like to see transparency around fees and interest rates, issued a bulletin that asked consumers to submit complaints about online lenders. “From the CFPB’s perspective, it is the first stake in the ground as to what the agency might do from a supervisory or enforcement perspective,” Nonaka says. For example, in the case of payday lenders, the CFPB first collected complaints and then later used those complaints to design regulation, yet to be released, to rein in such lenders.
Some marketplace lenders are already embracing compliance with federal banking rules to enable them to enter into arrangements with banks, which are required to make sure their non-bank partners are compliant with relevant banking rules. On November 6, 2015, the FDIC issued an advisory letter to banks on effective risk management practices for purchased loans, aimed at least in part at the online lending market. “Such moves by regulators suggest they may be interested in broadly regulating marketplace lenders indirectly through their interactions with banks,” Nonaka says.
The Department of the Treasury has also signaled potential regulation down the road with its July 2015 request for information. In the request, Treasury expressed hope that the right financial regulatory framework could “evolve to support the safe growth of the industry” and extend credit to underserved populations. “The fact that the request for input was issued by Treasury suggests a broader interest in online marketplace lenders and how they should be regulated,” Nonaka says.
So far, industry growth has come without the kind of widespread problems that could lead to a heavy regulatory response. “There’s really a lot of momentum behind the industry without much in the way of complaints and horror stories,” says Peter Renton, founder and chief executive officer of Lend Academy and also co-founder of LendIt, the industry’s annual conference. “I think what regulation will come will be relatively light,” Renton says, while allowing that there are no guarantees of that. “Something may happen in the meantime, perhaps fraud on a platform, and, as a result, regulators could come down hard.”
Some suggest there are also risks for the industry should the government fail to move in a timely manner to create an appropriate regulatory regime. “A little bit of regulatory scrutiny may actually help the development of marketplace lenders,” says Robert Morgan, vice president of emerging technologies at the American Bankers Association in Washington, D.C. “Right now, as a consumer, you don’t have clarity on what the protections you have” with marketplace lenders, Morgan says.
Regulators may want to look for hidden risks that companies promoting the online lending business “are not ready to acknowledge,” says Todd Baker, managing director at Broadmoor Consulting LLC, based in San Francisco. He points out that the performance of the loans underwritten by the new technology employed by marketplace platforms has not been tested by a downturn. The challenge for regulators will be to develop a regime that supports legitimate lending through online marketplaces while preventing or scaling back some of the potential abuses and keeping an eye on the safety and soundness of some of the business models of the marketplace lenders, he says.
With share price valuations of marketplace lenders currently well below of their initial public offering levels, Nolan sees a potential shakeout in the overcrowded online lending market. A potential consolidation will likely favor the largest marketplace platforms. The differentiating factor will be the ability to offer a robust compliance capability. “It’s not about big data any more. It’s about being an accredited institution,” Nolan says.
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