Online Lenders, Already in Turmoil, Face U.S. Call For New Rules
Marketplace lenders need to be more transparent about their business practices and should be subject to additional oversight from federal regulators, according to a U.S. Treasury study released just as the industry grapples with market turmoil and a scandal facing one of the biggest lenders. Online lenders need to develop a public database for tracking data on their loans, and companies that lend to small businesses in particular should be subject to federal consumer protection laws, the Treasury said in the report released Tuesday. “There is a clear need for greater transparency in the market for borrowers and investors,” U.S. Treasury Counselor Antonio Weiss said Tuesday in a call with reporters. He said Treasury recommends U.S. financial regulators form a group to examine oversight needs for the industry and figure out “where further regulatory clarity could benefit the market.” Marketplace lenders that match borrowers with investors willing to finance loans over the Internet are drawing attention from U.S. regulators amid an explosive growth of platforms that threaten to upend traditional business models. The scrutiny from agencies including Treasury, the Consumer Financial Protection Bureau and the Securities and Exchange Commission comes as firms such as OnDeck Capital ( ONDK ) and Prosper Marketplace Inc. grapple with sluggish returns, and as LendingClub ( LC ) is buffeted by the disclosure of improprieties that led to the resignation of its founder and chief executive officer on Monday. 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 discussed earlier. 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 more than 100 responses, including from some of the biggest marketplace lenders, bank lobbying groups and technology firms. Companies like LendingClub and Prosper 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 rebrand 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 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 OnDeck and Prosper have had to slow down expansion plans as investors scaled back purchases of loans. OnDeck 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% this year. 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% on the news. As policymakers 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 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 ( JPM ) has partnered with OnDeck to use their technology to offer small-businesses loans to the bank’s customers. 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 5% 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 it’s not clear whether this rule should apply to companies like LendingClub, which generates most of its revenue by matching borrowers to investors over the Internet, not by collecting interest on or selling loans. 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.”