Marketplace Lending's Woes Might Spur More Regulation

By Gregory Roberts

May 11 — Federal regulators and legislators already casting their eyes on online marketplace lending may intensify their scrutiny in reaction to the drumbeat of negative developments coming from the industry, Capitol Hill and agency veterans say.

“Historically, bad news has moved policy makers closer to additional oversight,” longtime financial-services industry lobbyist Scott Talbott told Bloomberg BNA.

“It's not crystal clear what the response will be,” Jo Ann Barefoot, former deputy comptroller of the currency, told Bloomberg BNA. “There inevitably will be a response.”

The Treasury Department issued a report on marketplace lending May 10, the day after Renaud Laplanche quit as chief executive officer of LendingClub in light of revelations that his company had sold loans to an investor that did not meet the investor's criteria for the product and of a conflict of interest involving Laplanche and the company's participation in an investment fund. Laplanche was a pioneer in the industry and a high-profile spokesman for it, as he built LendingClub into the biggest marketplace lender.

LendingClub's stock fell 35 percent after the announcement. Although not tied to scandal, other leading marketplace lenders also have suffered financial setbacks recently: OnDeck Capital experienced a similar fall-off in its stock price this month, and Prosper Marketplace has said it would cut more than one-fourth of its workforce as loan growth slows.

“We would argue that markets fluctuate,” said Talbott, who works for the Electronics Transactions Association (ETA). “Market fluctuation is normal and should not lead to overreaction by policy makers.”

Months in the Making

The Treasury report was in the works well before the Laplanche news broke: The agency issued a request for information about the rapidly growing marketplace lending sector in July, and the report built on the feedback from that.

Treasury would not be a direct regulator of marketplace lending, but the report called for creation of a “working group” that would include the Office of the Comptroller of the Currency (OCC) and its fellow prudential bank regulators, the Federal Reserve and the Federal Deposit Insurance Corp. (FDIC); the two federal agencies most active in consumer protection, the Consumer Financial Protection Bureau (CFPB) and the Federal Trade Commission (FTC); the Securities and Exchange Commission (SEC), the Small Business Administration (SBA) and a state bank supervisor.

There have been rumblings on the regulatory front about marketplace lending for months.

In March, the CFPB highlighted its acceptance of consumer complaints about marketplace lending and issued a tip sheet for consumers. The CFPB's regulatory agenda includes installment loans and, under that rubric, it is expected to propose marketplace lending rules, although it has yet to define their scope. The FTC has scheduled a forum on marketplace lending June 9 in Washington.

Marketplace lenders accept loan applications online and apply computerized formulas to evaluate them and render a decision within hours or days on whether to grant a loan. The technology reduces underwriting costs, and the overhead for the companies is low relative to banks because of the absence of brick-and-mortar branches. That has allowed the lenders to make money from smaller-dollar loans to small businesses and consumers, a market that had been largely abandoned by conventional banks.

In the earliest days of the industry, the money to make the “peer-to-peer” loans came from investors matched to borrowers through the online platform. As the online loan business has grown, more banks have formed partnerships with marketplace lenders. In some cases, a bank simply refers its own customers seeking smaller loans to the website of its marketplace partner. In other cases, the bank may purchase loans that are originated by the marketplace lender.

Consumer Protection Ranks High

Increased risk to investors in marketplace lending may not move the needle much among bank regulators, the consumer protection agencies or Congress. More likely to do so would be any harm inflicted on consumers.

The ETA counts several marketplace lenders among its 500 members, and Talbott is working with a task force of lenders who focus on small-business loans, including OnDeck. The task force seeks to draw a distinction, among policy makers and regulators, between small businesses and consumers as customers, Talbott said.

“Small businesses are more sophisticated and use the loan process for business reasons, which distinguishes them from consumers,” he said.

It's an issue addressed in the Treasury report.

“Strong evidence indicates that small-business loans under $100,000 share common characteristics with consumer loans yet do not enjoy the same consumer protections,” the report said.

“In terms of the CFPB, it's widely accepted that there is a gray area in terms of their jurisdiction over small businesses,” Talbott said. “Hopefully, the industry and the CFPB can come to a resolution.”

Marketplace lending also could draw increasing attention of the OCC, the Federal Reserve and the FDIC as lenders form more partnerships with banks, Barefoot said.

“If the regulators take a dim view of those kinds of partnerships, formally or informally, those are going to be chilled,” she said. “That would harm not only the marketplace lenders, but it would harm the banks, too, by making it harder for them to come into the digital age.”

FDIC Raises Red Flag

The FDIC, in late 2015 and earlier this year, has signaled its concern about the arrangements, warning banks not to abrogate their lending standards to their marketplace partners.

Marketplace lenders are not subject to the same kind of “safety and soundness” supervision exercised over banks by the prudential regulators. Some banking trade groups, including the American Bankers Association (ABA) and Consumer Bankers Association, have called for regulators to “level the playing field.”

Robert Morgan, vice president of emerging technologies at the ABA, told Bloomberg BNA that although banks and marketplace lenders are subject to similar regulatory laws, banks face more intensive oversight of their compliance than do marketplace lenders. No federal bank examiner would allow a bank to get away with the kind of ambiguity about annual percentage rates on loans that's common to some marketplace lenders, he said.

“They're trying to avoid the oversight that clearly is coming,” Morgan said.

Richard Eckman, a partner with Pepper Hamilton LLC in Wilmington, Del., and expert in marketplace lending, told Bloomberg BNA the tide was running toward increased regulation of the industry well before the latest revelations of misdeeds and difficulties. He anticipates some bills addressing marketplace lending will be introduced in Congress, such as a proposal to bring small-business loans under the Truth in Lending Act (TILA), although he said it's unclear how far they will get.

“I'm not sure that the things that have happened change the discussion all that much,” he said. “It's certainly going to continue the discussion.”

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To contact the editor responsible for this story: Mike Ferullo at