Marketplace lenders need to be more transparent about their business practices and some should be subject to additional oversight from U.S. regulators, according to a Treasury Department study released as the industry grapples with market turmoil and a scandal involving one of its leading firms.
Companies in the burgeoning industry need to develop a public database for tracking data on their loans, and firms that lend to small businesses in particular should be subject to more federal consumer protection laws, Treasury said in the report released Tuesday.
U.S. regulators are focusing attention on online marketplaces amid explosive growth in an industry that is threatening to upend traditional lending models by matching borrowers with investors willing to finance loans. The Treasury study comes as firms such as OnDeck Capital Inc. and Prosper Marketplace Inc. grapple with sluggish returns and a day after LendingClub Corp. was buffeted by the disclosure of improprieties that led to the resignation of its founder and chief executive officer.
“There is a clear need for greater transparency in the market for borrowers and investors,” Treasury Counselor Antonio Weiss said Tuesday in a call with reporters. He said Treasury recommends that regulators form a group to examine oversight needs for the industry and figure out “where further regulatory clarity could benefit the market.”
In its report, Treasury outlined six recommendations, including calling for online lenders to improve how transparent their products are to borrowers as well as investors and the need for them to employ consistent standards and disclosures. Prudential regulators, which would include agencies such as the Federal Deposit Insurance Corp., should evaluate partnerships that banks have with marketplace lenders to help identify risks, the report said. Online lenders should have better access to government-held data to help make credit decisions.
As for small business lending, Treasury is willing to “work with members of Congress to consider legislation that addresses both oversight and borrower protections.” The agency said that evidence indicates that small business loans under $100,000 share common characteristics with consumer loans yet do not enjoy the same consumer protections.
The recommendations come 10 months after Treasury sought public comment on the marketplace lending industry to help government officials better understand the different business models and products being offered. A further goal of the process was to examine how the regulatory system should evolve to support “safe growth,” Weiss said in a speech last year. Treasury received about 100 responses, including from some of the biggest marketplace lenders, bank lobbying groups and technology firms.
The Treasury also called for the creation of an interagency working group, which would include the FDIC, Consumer Financial Protection Bureau and Securities and Exchange Commission as well as the Federal Trade Commission, to collaborate on areas where additional regulatory clarity is needed. Having a group would allow agencies to share information, including about potential enforcement actions, and study emerging credit models.
“That’s a step in the right direction to get everyone to the same table,” said Jackson Mueller, a financial policy analyst at the Milken Institute. “You don’t want firms hearing different things from different regulators.”
Companies like LendingClub and Prosper Marketplace Inc. began about a decade ago, often calling themselves “peer to peer” lenders because they sought to bypass banks by matching borrowers with wealthy individuals who wanted to fund them.
As the industry has evolved, money managers, hedge funds and Wall Street firms have begun buying the debt, leading the upstarts to re-brand as “marketplace” lenders. The industry helped arrange more than $20 billion of loans in the U.S. last year, according to Morgan Stanley research. That figure could climb to more than $120 billion by the end of the decade, the bank said.
As the industry has grown, so has the variety of platforms. There are sites that provide financing to small businesses, help people help people pay for medical procedures, consolidate credit-card and student-loan debt; and get money to open a franchise restaurant.
The budding industry has also seen its share of growing pains. Companies including On Deck Capital Inc. and Prosper have had to slow down expansion plans as investors scaled back purchases of loans. On Deck reduced its full-year revenue forecast earlier this month after reporting first-quarter losses more than doubled as loan sales fell. Shares of the company have declined 52 percent this year through yesterday.
On Monday, LendingClub said Renaud Laplanche would step down as CEO after an internal review found a failure to disclose a personal interest in an investment fund the company was considering investing in. The review also found that he was among managers who had knowledge of abuses that were tied to the sale of some loans. The company’s stock plummeted 35 percent on the news.
As policy makers seek more information on the vast promise and potential risks of marketplace lending, the industry has been scrambling to organize itself in Washington. There are a growing number of groups and alliances taking shape, reflecting the industry’s diverse business models. In addition to joining together with peers, individual firms have also been tapping former regulators as board members and advisers.
Marketplace lenders are obligated to follow state laws, but they don’t always have a federal regulator supervising them like banks do. Some banking trade groups including the American Bankers Association and Consumer Bankers Association have said that’s not fair and called for regulators to “level the playing field.” Still, the relationship between traditional banks and startups is complicated. While many online lending firms set out to compete with banks, the two industries are increasingly becoming partners. For example, JPMorgan Chase & Co. has partnered with On Deck to use their technology to offer small businesses loans to the bank’s customers.
The Treasury said partnerships between online market lenders and traditional banks may present an opportunity to expand access to credit to under-served borrowers.
One of the themes that emerged from Treasury’s study is whether some rules prompted by the financial crisis should apply to marketplace lenders. As part of the Dodd-Frank Act, sponsors of asset-backed securities have to hold only 5 percent of the credit risk on their own balance sheet. The rule — which goes into effect later this year — is designed to prevent a repeat of the 2008 mortgage crisis by requiring firms to have “skin in the game.” But there’s been confusion over whether or not this rule should apply to marketplace lenders.
In its report, Treasury said that risk retention requirements apply “only to the securitizer in the securitization of marketplace lending notes, not to the originator selling the notes.”