US Treasury Publishes Recommendations for Marketplace Lending

The US Treasury has released a white paper on the marketplace lending industry, and the timing couldn’t be more intriguing.

The Treasury issued a Request for Information to industry stakeholders in July last year – with a view to fostering discourse about how the emergent marketplace lending industry could evolve to best serve the financial needs of the American public. The Treasury received about 100 responses from a range of marketplace lending platforms, trade associations, consumer and small business advocates, academics, investors and financial institutions.

We were in fact able to publish Renaud Laplanche’s response to the RFI (written on behalf of Lending Club) on AltFi News in September last year. Mr. Laplanche resigned as CEO and Chairman of Lending Club on Monday this week, capping a period of turbulence within the US’ online lending sector.

The Treasury has identified a number of key themes among the many responses to the RFI. The first is that the use of data and modeling techniques in underwriting represents “one of the sources of innovation that holds the most promise and risk”. This point refers to the trade-off between speeding up decisions and cutting costs, versus the risk of fair lending violations and the like. This from the paper: “Importantly, applicants do not have the opportunity to check and correct data potentially being used in underwriting decisions.”

The potential for expanding access to credit, for both businesses and consumers, was noted. Here the Treasury also touched upon the potential for the formation of distribution partnerships between traditional lenders and online marketplace lenders as a means of further opening up credit in underserved markets.

A key theme in the RFI responses was that the new-age credit models and operations that are run by marketplace lenders remain untested. The paper noted that the platforms have so far been operating in a benign economic environment and are yet to be tested through a complete credit cycle. 

Music to the ears of many, no doubt, particularly in light of the nature of Laplanche’s departure, was the side-heading: “Greater Transparency Can Benefit Borrowers and Investors”. RFI respondents were strongly in favour of greater transparency, with suggested areas of improvement being pricing terms for borrowers and standardised loan-level data for investors. The absence of a developed secondary market was noted, and commenters also argued that the growth of the securitisation market would require increased transparency and repeat issuances.

Opinions were split on the role of government intervention in the market, but a large number of commenters argued that regulators “could provide additional clarity around the roles and requirements for the various participants”. RFI commenters are also concerned about the low level of protection and regulation in small business lending.

In light of the above responses, the Treasury is making the following recommendations to the federal government and private sector participants:

1. Support more robust small business borrower protections and effective oversight;
2. Ensure sound borrower experience and back-end operations;
3. Promote a transparent marketplace for borrowers and investors;
4. Expand access to credit through partnerships that ensure safe and affordable credit;
5. Support the expansion of safe and affordable credit through access to government-held data; and
6. Facilitate interagency coordination through the creation of a standing working group for online marketplace lending.

Given the events of the past few weeks in the marketplace lending sector, it’s the final paragraph in the paper’s executive summary that will likely attract the most attention:

“In addition, this white paper identifies potential trends that will require ongoing monitoring. These include the evolution of credit scoring, the impact of changing interest rates, potential liquidity risk, increasing mortgage and auto loans originated by online marketplace lenders, potential cybersecurity threats, and compliance with anti-money laundering requirements. The business models and data-driven algorithms supporting this industry have largely developed in favorable credit conditions. Treasury believes it is important to consider policies that could minimize borrower risks and increase investor confidence in a less favorable credit environment.”

You can read the full paper here.