The U.S. Treasury Department has released a white paper addressing the online marketplace lending industry. Based in part on the responses to Treasury's July 2015 Request for Information (RFI), the white paper offers a broad overview of marketplace lending, summarizes the responses to the RFI, and makes a series of policy recommendations. Although the report acknowledges that marketplace lending is innovative and beneficial in many respects, it expresses concerns about potentially negative impacts on consumers and small businesses, and calls for greater regulation and further study.

Treasury begins its report by defining 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."Based on the input received, Treasury makes seven principal findings:

  • Data-driven underwriting, while perhaps faster and less costly, poses fair lending risks and may unfairly base decisions on inaccurate data without affording borrowers the opportunity to correct inaccurate information;

  • Marketplace lending is expanding access to credit "in some segments," but there are opportunities to do so in underserved markets;

  • New credit models and operations have not been tested through a complete credit cycle;

  • Additional safeguards are needed for small business borrowers;

  • Greater transparency is needed for both borrowers and investors;

  • The secondary market is undeveloped; and

  • Regulators can aid the market by providing more "clarity around the roles and requirements for the various participants."

Notably, the report mentions that many of the RFI responses cited the issue of "true lender" designation—whether a marketplace lender or an issuing depository institution is the true lender—as an area requiring greater regulatory clarity. Likewise, the report notes that uncertainty surrounding the Second Circuit’s decision in Madden v. Midland Funding LLC, (holding that the National Bank Act does not preempt state-law usury claims against third-party debt collectors who seek collection of loans assigned to them by a national bank) as one of the "primary hurdles" in the development of a secondary market for online marketplace lending loans.

Based on these findings, Treasury makes several recommendations to "facilitate the safe growth of online marketplace lending while fostering safe and affordable access to credit for consumers and businesses." The recommendations, many of which are not favorable for the industry, are as follows:

  • Increase Regulation of Small Business Loans. Relying on the Fed's 2015 Small Business Credit Survey and a selective reading of RFI responses, the report concludes that small business loans are in need of greater regulation and oversight. However, it notes that ongoing self-regulation efforts such as the Small Business Borrowers' Bill of Rights suggest that small businesses can be protected "without adding undue burden or cost to this emerging industry."

  • Improve Servicing Operations. The report expresses concerns about servicing challenges that could result from a "less favorable credit climate," and urges market participants to "adopt standards designed to provide a sound borrower experience from customer acquisition straight through to collections in the event of delinquency or default." The report also considers it "vital" that marketplace lender servicer platforms adopt back-up servicing plans to protect borrowers in the event the company fails.

  • Promote Transparency. In the capital markets, Treasury encourages adoption of standardized representations, warranties, and enforcement mechanisms; consistent reporting standards for loan origination data and ongoing portfolio performance; loan securitization performance transparency; and consistent market-driven pricing methodology standards.

  • Partner with CDFIs to Expand Access to Credit. Noting the current focus of many marketplace lenders on prime borrowers, Treasury urges marketplace lenders to partner with Community Development Financial Institutions (CDFIs) to expand access to credit in underserved markets.

  • Improve Access to Government-Held Data. The report encourages making more government-held data available to online marketplace lenders, including the release of information in standard machine readable formats that can be easily processed by third-party software and data that may be used to verify ability to repay.

  • Form Regulatory Working Group. Treasury recommends the formation of an interagency working group that would include Treasury, CFPB, FDIC, FRB, FTC, OCC, SBA, SEC, and a representative of a state bank supervisor. A non-exhaustive list of focus areas includes identifying and promoting awareness of existing regulations that apply to online marketplace lending; supporting responsible innovation; examining the impact of nontraditional data on credit scoring models, and monitoring risk through the credit cycle.

The report also identifies a number of "potential trends that will require ongoing monitoring," including:

  • The evolution of credit scoring through the use of new variables and complex algorithms, and the attendant opportunities and risks;

  • The impact of changing interest rates, given that the growth of the industry has coincided with a period of historically low interest rates;

  • Potential liquidity risk and funding challenges as "[l]arge investors and financial institutions are showing signs of reluctance to invest in whole loans, member payment dependent notes, and securitization transactions;"

  • Cybersecurity;

  • Applicability of Bank Secrecy Act requirements to online marketplace lenders; and

  • Growth of marketplace lending in the mortgage and auto loan markets.

Although the report acknowledges some of the benefits provided by marketplace lending, it confirms that increased federal regulation and oversight of the industry is coming in the immediate future. It further confirms that fair lending issues are front-and-center on the federal regulatory agenda. It therefore is essential for marketplace lenders to mitigate regulatory risk through comprehensive compliance assessments, including evaluation of loan origination structures, licensing, and practices for underwriting, marketing, servicing, and debt collection.

This white paper also comes on the heels of the CFPB's March 2016 announcement that it would begin accepting consumer complaints about marketplace lenders. Likewise, in February 2016 the FDIC published an article highlighting the risks for banks that partner with marketplace lenders. Moreover, next month the FTC will host a half-day forum on marketplace lending. While it is notable that Treasury did not recommend new statutes or regulations as responses to the concerns identified in the report, these developments reveal strong and continued interest by federal regulators in marketplace lending, and could present significant challenges for the industry.

On June 9, 2016, Ballard Spahr attorneys will hold a webinar discussing fair lending issues for marketplace lenders titled "Is FinTech FairTech? (The Government Wants to Know.) Fair Lending Issues for Marketplace Lenders," from 12:00 PM to 1:00 PM ET. The webinar registration form is available here.

Ballard Spahr's Marketplace Lending Task Force is nationally recognized for counseling marketplace lending businesses in both the consumer and small business spaces. We offer soup-to-nuts guidance, working with startup alternative lenders, long-established market leaders, bank participants in marketplace lending programs, institutional investors, and others. We document and advise on the structure and strategy of bank, platform, and investor relationships, assist in concluding account servicing arrangements, draft and review website disclosures, consumer-facing documents and policies and procedures and provide extensive consumer regulatory advice and state licensing guidance.

Ballard Spahr's Consumer Financial Services Group is nationally recognized for its guidance in structuring and documenting new consumer financial services products, its experience with the full range of federal and state consumer credit laws, and its skill in litigation defense and avoidance (including pioneering work in pre-dispute arbitration programs).

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