Press Center

 Remarks by Counselor to The Secretary Antonio Weiss at The Second Annual Investors Conference on Marketplace Lending


12/1/2016
 
Introduction
Good morning.  Thank you for that kind introduction, and thank you to the Information Management Network for hosting this conference and, once again, inviting Treasury to participate.  
 
When I spoke at this forum last year, Treasury had recently released a Request for Information (RFI) to study online marketplace lending.  We believed the industry had reached a point of maturation that warranted further dialogue among borrowers, lenders, investors, and policymakers.
 
Since then, the industry has undergone transformative change.  The economic environment in 2016 challenged companies to reevaluate lending standards, reexamine uses of data, and reassess business models.  Loan originations slowed compared to 2015 levels and credit models were tested.  Delinquency and default rates began to rise.  The securitization market and venture investment dropped.  Yet despite the turbulence, one fact remains clear:  the customer experience pioneered by marketplace lenders has changed expectations for “ease of use”– the efficiency and speed of delivering credit.
 
In recognition of the changing industry dynamics and in response to the feedback we received to the RFI, in May of this year, Treasury published a White Paper entitled Opportunities and Challenges in Online Marketplace Lending.  The White Paper was developed in consultation with seven federal agencies, namely the CFPB, the FDIC, the Federal Reserve Board, the FTC, the OCC, the SBA, and the SEC, all of which have authorities in this area. 
 
We proposed six recommendations to public and private sector participants.  First, we support exploring more robust small business borrower protections and effective oversight.  Second, we encourage companies to align interests of borrowers and investors by ensuring sound borrower experience and back-end operations.  Third, to promote a transparent marketplace, we recommend the creation of a private sector registry for tracking data on transactions, issuances, securitizations, and loan-level performance for the public.  Fourth, we suggest the expansion of access to credit through partnerships that ensure safe and affordable credit.  Fifth, we support the use of smart disclosures and data verification sources to improve the borrower experience and make loans and investments safer and more accurate.  And last, we proposed the creation of a standing, interagency working group on online marketplace lending to facilitate regulatory coordination.
 
Today, I would like to take stock of what Treasury and the interagency working group have accomplished since the release of the White Paper, and outline central considerations for the safe growth of this industry going forward. 
 
Progress on Interagency Working Group
The online marketplace lending industry is fast growing and continuously evolving.  As such, the activities of online marketplace lenders have implications across policy governing capital markets, registered depositories, and consumer protections.  This range of activities requires coordination across federal agencies. 
Accordingly, Treasury created an interagency working group on online marketplace lending to share information, engage industry participants and public interest groups, and evaluate where additional regulatory clarity could protect borrowers and investors.  The working group allows policymakers to holistically evaluate and coordinate the use of tools that may promote safe innovation.  Since the group’s founding, Treasury has convened quarterly roundtable meetings with senior officials from each of the agencies.  I am pleased to report that all agencies come to the table with the recognition that regulatory clarity and consistency is critical to supporting safe and positive innovation in financial products and services. 
 
Progress on Small Business Borrower Protections
An early area of focus has been to address the clear regulatory gap in small business borrower protections.  Of the recommendations in the White Paper, this suggestion has generated the most debate around effective implementation.  
 
Approximately 23 million small businesses, or 80 percent of all businesses in the United States, are non-employer firms, meaning the owner is the only employee and works for him or herself.  Among these businesses, the demographic groups with the fastest growing self-employment rates are women, minorities and immigrants.   
 
Banks, particularly community banks, have traditionally provided the majority of credit to small businesses in the United States.  Community banks are often closest to their borrowers and in a unique position to assess and address the credit needs of their customer base.  This can lead to more effective risk assessments and better outcomes for lenders and borrowers. 
 
However, small businesses are increasingly turning to online marketplace lenders as potential financing sources.  According to the 2015 Federal Reserve’s Small Business Credit Survey, one in five small businesses sought out online marketplace lenders in 2015 as potential financing sources.  
 
Unfortunately, those same survey results found small businesses approved for financing were often dissatisfied with their experience using marketplace lenders.  The top three survey complaints were high interest rates, unfavorable repayment terms, and most critically, a lack of transparency.  These results echoed the comments Treasury received in the RFI.  Commenters across the spectrum, including some industry participants, argued that small business borrowers need enhanced safeguards to ensure terms are well understood. 
 
Federal consumer financial laws generally apply to consumer loans, which are typically defined as a loan obtained by a natural person for personal, family or household purposes.  When a loan of similar size is obtained for business purposes, the lender is under no obligation to disclose standardized information about the product despite what are often comparable levels of borrower financial sophistication.  Put simply, if a borrower takes out a loan as a consumer, he or she is protected.  The same borrower seeking to expand his or her small business is not.  This represents a regulatory gap where there is often no recourse against irresponsible or incomplete financial disclosures.  
 
There have been encouraging signs of industry initiatives to address these discrepancies.  Many industry participants collaborate on small business borrower protection policies and commit to a consistent level of responsible practices in the absence of statutory requirements.  In the past, I specifically acknowledged the signatories to the Small Business Borrowers Bill of Rights.  These industry participants pledge to provide small business borrowers with transparent pricing and terms, non-abusive products, responsible underwriting, fair treatment from brokers, inclusive credit access, and fair collection practices.  This year, we were also encouraged to see new industry efforts to promote clear and fair small business lending disclosures.  
 
Treasury is generally supportive of the direction of these initiatives.  However, because they are voluntary and not universally adopted, they remain insufficient.  They stop short of providing small business borrowers with full access to standardized, relevant, and accurate information when making credit decisions.  
 
Disclosures
We believe Congress should consider taking legislative action to enhance transparency for small business loans.  Such a step would serve as a decisive move forward in addressing many of the harmful and irresponsible practices cited by small business borrowers when seeking or obtaining credit.  It would begin to close the regulatory gap that exists between small businesses and consumer borrowers. 
 
The need for greater transparency and standardized terms across the full spectrum of small business credit products is necessary to promote competition and ensure customers have relevant and accurate information to make informed financial decisions.  
 
Truth in Lending Act (TILA) compliant disclosures are structured to address both term lending and revolving credit.  This structure could cover many of the standardized credit offerings available to small businesses.  Disclosures could include, but not be limited to, a standardized APR, an interest rate, a comprehensive list of all finance charges, the amount financed, payment schedules, and third party agreement disclosures.  
                                   
We believe adopting a structure of mandatory financial disclosures for small business loans under $100,000 could provide the necessary level of standardized information for small business borrowers without becoming burdensome for lenders.  Indeed, many marketplace lenders already provide similar disclosures.  
 
In addition, legislation could address certain types of credit products that are unique to the business and commercial lending markets, such as merchant cash advances (MCA) and other potential working capital financing agreements.  These agreements do not easily fit into the current disclosure framework.  The MCA market amounts to approximately $3 billion of funding annually.  Unfortunately, MCA providers are some of the most often cited abusers of small businesses seeking credit. Given the unique nature of these financing agreements, and the fact that they are often not considered a loan, legislation would need to ensure that working capital financing products are covered by the disclosure requirements.
 
 
New Uses of Data
Treasury’s White Paper showed that the use of data for credit underwriting is a core element of online marketplace lending.  It holds both the most promise and the most risk for borrowers.  Data-driven algorithms may expedite credit assessments and reduce operational friction.  In particular, data allows marketplace lenders to reduce the cost of customer acquisition, automate the origination of loans and the collection of loan documentation, and potentially reduce fraud. 
 
However, these algorithms also carry the risk of disparate impact in credit outcomes and the potential for fair lending violations.  There is limited public research on these topics, and therefore, a lack of consensus on the potential benefits and risks.  This is partly because credit scoring models and operations are proprietary, and data sources are expensive to construct or unavailable to outside researchers.
 
These algorithms continue to evolve, and their ability to generate superior credit outcomes was tested in 2016.  Unsecured consumer loans across a composite of marketplace lending platforms saw delinquency rates rise 30 to 50 basis points from the same time a year ago.  To ensure continued investor confidence in the validity of these new underwriting models, marketplace lenders adjusted to demands by investors for greater transparency, independent due diligence reviews, and heightened data integrity and validation standards. 
 
But the issue of data is not just an investor concern.  It is also a critical concern for borrowers. The simple application of traditional FICO scores has obvious limitations.  Yet it also provides borrowers a central point of access and an efficient process to validate data used for credit decisions, backed up by laws providing for consumer redress of inaccuracies.  While this issue is complex, it will remain a priority of federal regulators to ensure that borrowers have the ability to check and correct data used in credit decisions. 
 
Expanding Access to Credit
We also see the potential for marketplace lending to expand credit in underserved markets.  According to the CFPB, at least 45 million consumers have no access to credit because they have either no credit report or insufficient credit histories.  It is estimated that 26 million Americans are credit invisible and do not have credit records maintained by any of the three credit reporting agencies.  An additional 19 million lack a credit score.  Use of alternative data may mitigate this problem.  Importantly, alternative data can also be used to satisfy customer identification requirements and combat fraud. 
 
Treasury supports partnerships that provide safe and affordable access to credit.  Currently, a majority of consumer loan origination is for debt consolidation by borrowers with higher credit scores.  Small business loans are originated for general working capital and expansion needs.  The development of distribution partnerships between online marketplace and traditional lenders could leverage technology to provide loans to borrowers who might not otherwise have received capital. 
 
However, with the proliferation of partnerships, it will be critical to ensure that financial institutions maintain oversight and compliance obligations under the distribution partnership model.  The proposed third party guidance by FDIC is critical in this regard, and extends beyond marketplace lending.  It ensures safety and soundness, as well as appropriate governance at regulated institutions and third parties.  It does so through increased supervisory attention, including a potentially accelerated 12-month examination cycle, concurrent risk management and consumer protection examinations, and the possible review of third parties on an ongoing basis. 
 
Broader Market
We want to encourage positive and safe innovation to broaden access to affordable credit for underserved borrowers and businesses.  Efforts by other federal agencies, such as the CFPB’s Project Catalyst, the OCC’s new Office of Responsible Innovation, and the recently held forum by the SEC on Fintech Innovation are constructive steps that Treasury supports. 
 
We are committed to fostering a collaborative environment in which promising and safe financial technologies can flourish.  But this of course must be balanced with our critical responsibility to promote the protection of consumers and small businesses. 
 
Conclusion
 
So where does this leave us?  Given the rate of change and innovation occurring in fintech and online marketplace lending, this will continue to remain an area of focus for federal regulatory agencies.  There is real merit to continued engagement among the relevant public and private sector participants to ensure that consumers and businesses have access to safe and affordable financial products and services.  
 
We believe the time is right to advance and expand the financial disclosure regime to small business loans under $100,000.
 
Federal regulators will continue to encourage positive innovation in order to broaden access to affordable credit for underserved consumers and businesses.
 
As online marketplace lending develops, it will be critical to monitor how companies test and adapt models if and when credit conditions deteriorate.
 
As the industry evolves, the principles of transparency, fairness, and sound operations should remain the guiding framework governing market growth.  
 
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