United States: Rapid Growth In Online Lending Prompts Information Request From U.S. Treasury

The U.S. Treasury Department (the "Treasury") has issued a Request for Information ("RFI") on online marketplace lending, including peer-to-peer lending ("Online Lending") in the U.S. 80 F.R. 42866-68 (July 20, 2015). The RFI seeks a broad range of information regarding:

  • The business models and products offered by online lenders ("Online Lenders") to small businesses and consumers;
  • The potential for Online Lenders to expand access to credit to historically underserved market segments; and
  • How the financial regulatory framework should evolve to support the safe growth of this industry.

Responses to the RFI are due by August 31, 2015.

Background

Online Lending is growing rapidly, with an estimated $12 billion in new loan originations by all Online Lenders in 2014. In "From the people, for the people," The Economist (May 9, 2015) ("The Economist") stated that the five largest Online Lenders have made more than one million loans and are generating new loans at a rate exceeding $10 billion annually. These lenders grew rapidly from a small amount of loans in 2009. A May 2015 Morgan Stanley report estimates that unsecured consumer Online Lending totalled $7.4 billion in 2014, and it may grow at a 47 percent compound annual rate through 2020. Bloomberg (July 23, 2015).

The RFI states that Online Lenders provide convenient online applications, most have no retail branches and rely more on electronic data sources and automated underwriting models and processes.  As a result, Online Lenders may provide credit more quickly and more cheaply than traditional lenders.

Online Lending primarily has been used by prime or near-prime consumers to refinance existing debt. The RFI notes that Online Lenders are developing product structures and underwriting models for non-prime customers that also reduce costs and allow loans to be made to such borrowers at lower rates than those provided by traditional banks, which are subject to regulatory restrictions on such loans. The RFI further states, "it can cost the same amount to underwrite a $300 consumer loan as a $3,000 loan." Bank loans to such customers, if made, may bear higher rates than rates charged by Online Lenders, according to the RFI.

The RFI also illustrates the small business and start-up lending markets that Online Lenders serve. The Treasury acknowledges that small business lending can be unattractive to banks because of their high origination and underwriting costs relative to potential revenue. For example, the Treasury cited a recent Goldman Sachs Report, "The Future of Finance" (March 3, 2015), which estimated that it costs a bank approximately the same amount to underwrite a $5 million loan as a $200,000 loan. Federal Reserve data indicates that more than half of small businesses that applied for credit in 2014 sought only $100,000 or less. Moreover, in a recent survey, a majority of small businesses and startups reported they were unable to secure any credit in the prior year. Still, small businesses may receive up to 90 percent of their financing from banks. Larger businesses are estimated to rely on banks for 30 percent of their financing. In contrast, most Online Lenders provide loans with lower principal amounts to small businesses with potentially better terms.

The Federal Reserve Board's 2104 Annual Report discusses two research studies it commissioned from outside organizations. The first survey of 60 bankers noted that small business customers are savvier today in assessing their banking needs and options, but that banks were becoming more conservative in underwriting small business loans. A separate study of 22 small business borrowers indicated that small businesses find it difficult to compare and evaluate the costs and benefits of various online small-dollar products. Potential borrowers also expressed concerns about safeguards to protect their personal and business information, if they borrowed funds from online sources.

Information Sought by the Treasury

The Treasury seeks to better understand the benefits and risks of Online Lending and how the regulatory framework should evolve to support the industry's "safe" growth. In particular, the RFI seeks the following information:

Market Segmentation and Access to Credit. Information is sought as to how regulators and policymakers should consider market segments among Online Lenders, including:

  • Business model type (e.g., "peer-to-peer," balance sheet, and bank-affiliated);
  • Type of borrower (e.g., small business, subprime borrower, borrowers who are "unscoreable"); and
  • Borrower need (e.g., new small business, mature small business, debt consolidation, new credit).

The Treasury is interested in the competitive advantages and disadvantages, if any, that exist for banks and non-banks to participate in this market. Additionally, the Treasury seems keenly interested in whether Online Lending expands access to credit to historically underserved market segments.

Role of Electronic Data and Innovative Lending Practices. The role of electronic data sources in enabling Online Lending is explored, including how these automated decision-making processes compare to manual processes, and their risks and opportunities compared to traditional loan underwriting. The RFI specifically asks about Online Lending's privacy, cybersecurity, and consumer protection risks. Additionally, the RFI asks how the federal government can facilitate positive innovation in lending, such as by making it easier for borrowers to share their own government-held data with lenders.

Operations of Online Lenders. The RFI seeks details regarding Online Lenders' operations, including:

  • How customers are acquired (e.g., marketing channels, partnerships with traditional financial institutions, etc.);
  • How borrowers' creditworthiness and repayment ability are assessed;
  • The accuracy of Online Lenders' models at predicting credit risk;
  • Whether a borrower's stated use of proceeds affects loan underwriting;
  • Online Lenders' reliance on traditional lending institutions;
  • How the credit environment affects Online Lenders;
  • How Online Lenders manage loan servicing, fraud detection, credit reporting, and collections, and whether they do so differently from traditional lenders;
  • Steps Online Lenders take to comply with regulations, including when lending across state lines; and,
  • Whether Online Lenders should be subject to "risk retention" or "skin in the game" requirements, as mandated by the Dodd-Frank Act for bank securitizations.

The Role of Investors. The roles of investors in Online Lending are explored as follows:

  • How investors evaluate different Online Lending platforms and different assets on these platforms;
  • What are the operational arrangements between investors and the Online Lending platforms;
  • How investors may finance Online Lending platform assets;
  • Who are the ultimate investors;
  • The types and amounts of financial leverage used by such investors;
  • The availability of secondary liquidity for assets generated by Online Lending; and
  • The advantages and disadvantages of an active secondary market, including securitizations, derivatives, and benchmarks.

Key Takeaways

The RFI should produce information that is useful generally in understanding, and potentially facilitating, the growth of Online Lending. The Treasury seems particularly intrigued by the potential for Online Lenders to provide loans to small businesses and subprime borrowers, whose access to credit may be limited. While the benefits of Online Lending are noted, the RFI also seeks more about the credit and other risks of Online Lending, including legal risks, borrower privacy, cybersecurity, consumer protection, potential conflicts of interest, lender "risk retention" requirements, investors' use of financial leverage, and the secondary market for loans originated by Online Lenders.

The RFI raises of number of interesting issues, but the short comment period of five weeks may be insufficient to obtain the wide range of data sought by the Treasury. Many sources may be reluctant to provide sensitive data. The data collected, however, should be provided to the public and may be useful information regarding the Online Lending industry's opportunities and issues.

Online Lending offers some significant benefits, although a number of existing laws pose hurdles that require careful evaluation and planning, including:

  • Compliance with the Securities Act of 1933 and state securities laws. Online Lenders  privately and publicly offer equity and debt interests in loans selected by investors ("peer to peer" lending), corporate borrower dependent notes whose payments depend on borrower performance or conventional debt. As loan volumes increase, it becomes increasingly difficult to finance Online Lenders through private placements of debt, including under SEC Regulation D and the Uniform Limited Offering Exemption under state law.
  • Compliance with broker-dealer requirements under the Securities Act of 1934 is important to consider as loans or interests in loans, or other securities, are regularly offered by Online Investors to investors. Online Lenders may find it advantageous to have their own broker-dealer subsidiary to reduce the costs of a third-party broker-dealer.
  • Utilizing exemptions under the Investment Company Act of 1940 (the "1940 Act"). Exemptions again are difficult where the Online Lender seeks to raise funds from numerous small investors as opposed to a group of "qualified purchasers" under Section 3(c)(7) of the 1940 Act, or other exemptions that may be available for loan pools. Loan pools relying on the 1940 Act, Section 3(c)(1) or Section 3(c)(7) exemption, like collateralized loan obligations ("CLOs"), can be "covered funds" under the Volcker Rule unless properly structured. Banking institutions cannot invest in covered funds under the Volcker Rule.
  • Online Lenders are subject to state laws where they make loans. State laws regulate, among other things, licenses, interest rates, loan brokering, money transmission, debt collection, and consumer protections. Additionally, if the Online Lender is selling loans, its return may be limited by loan broker laws. See, e.g., New York General Obligations Law, Section 5-531.
  • Cybersecurity, data protection, customer privacy, and model validation are high-profile issues, especially for business models like Online Lending, which rely on the internet and automated business models.
  • Loan sales and securitizations are important sources of funding and liquidity. Generally, robust secondary markets and securitizations permit a greater amount of loans to be made at reduced funding costs. Derivatives allow market participants to take views on both sides of the market and facilitate hedging of positions, along with enabling more robust price discovery. However, securitizations and derivatives also subject Online Lenders and their investors and counterparties to a panoply of Dodd-Frank Act regulation, such as reporting requirements, mandatory derivatives clearing, risk retention requirements, and Volcker Rule limits. Even though loans that are sold for investment rather than commercial purposes are generally "securities," derivatives referencing these assets could be subject to CFTC jurisdiction.
  • Moody's Investors Service ("Moody's") has noted continued uncertainty for Online Lenders, who originate loans through arrangements with banks.  Moody's "Legal Uncertainty Over 'True Lender' Status Continues for Marketplace Lenders" (June 1, 2015).

There is some evidence that the largest investors in Online Lenders and their loans are institutional investors, including banks. According to The Economist, Citibank announced earlier this year that it would lend $150 million through an Online Lender. Funding from such persons is efficient, as well as most easily structured to comply with applicable securities laws and may facilitate securitization by these loan purchasers. Several of the Online Lenders have gone public, and this is probably needed to support growth consistent with federal and state securities laws, and the capital required by lenders and counterparties.

Online Lending is relatively new, and its models and activities, including servicing and loan sales/securitizations have not been tested in a credit and economic downturn, or in a high interest rate environment where funding may be more difficult and costly than in recent years. Additional consideration ought to be given to the quality of underwriting, the underwriting models' predictability and accuracy, and the capital needed to support loan origination and servicing in the event of an economic downturn. Stress testing could provide useful estimates about potential losses but, given the relatively short history of Online Lending, should not be overly relied upon. Investors, loan purchasers, and derivatives counterparties should have a strong interest in Online Lenders' capital, liquidity, and credit quality, as well as their legal compliance.

In addition, the RFI specifically excludes many Consumer Financial Protection Bureau ("CFPB") initiatives that affect consumer credit. Similarly, the RFI does not consider the Department of Defense's latest regulations under the Military Landing Act regarding lending to military personnel. 80 F.R. 43559-43612 (July 22, 2015). The CFPB's broad mandate to define and regulate consumer financial products exists regardless of the means of delivering these products, and it could inhibit consumer Online Lending.

Indirect lending through Online Lenders to smaller businesses and to less creditworthy borrowers would be an ideal vehicle for banks to provide such credit where it may be impractical to provide such credit directly. Participation could also benefit banks' Community Reinvestment Act performance and support the convenience and needs test for bank acquisitions. The quality of an investment or loan to Online Lenders and their origination and servicing platforms must be established in order to facilitate bank participation in this market. Potential regulation of "shadow banking" and regulatory views of subprime consumer lending may cloud banks' participation in segments of Online Lending, however.

The growth and size of the Online Lending market has attracted interest from investors and borrowers. The Treasury's RFI should result in information useful to the markets. The RFI appears to seek economic growth, especially for small businesses that are the engines of employment growth and for underserved consumers. At the same time, the RFI raises the possibility of new government scrutiny for the Online Lending industry, which, until now, has operated with little government oversight and enforcement. The financial services regulators should respond to the RFI and take as balanced an approach as the RFI. Hopefully, information collected from the RFI will encourage U.S. lawmakers and regulators to evaluate the costs and unintended or impractical regulation of lenders. Similarly, the SEC and state securities regulators should reconsider the application of Depression-era securities laws on Online Lenders and their structure and costs, and consider new approaches, including possible legislation that, with appropriate disclosures and oversight, could facilitate Online Lenders' ability to improve the availability and cost of credit.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Lisa M. Ledbetter
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions