The biggest threats to U.S. marketplace lending may not come from Washington, but from the 50 state capitals.
So far the fast-growing industry, in which online platforms sit between borrowers and lenders, has largely avoided state regulation. The lending platforms often work with small banks, such as Utah-based WebBank, to originate their loans nationally, relying on the banking industry's authority to preempt state laws.
But those relationships may eventually draw scrutiny at the state level, warned Raj Date, the former deputy director of the Consumer Financial Protection Bureau.
In an interview Date predicted that getting state licenses could prove to be more of a burden for smaller lending platforms, and for the increasing number of firms that target subprime borrowers, than it is for larger companies that lend to more creditworthy consumers.
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"If you're big you know, like Lending Club, say and you're mostly prime, it's kind of a pain in the neck to be licensed in every state, but it's certainly not impossible. It is merely less convenient and a little bit more costly," Date said.
"It becomes a lot more problematic if you're small, and if you are focused on subprime. Because in that case, you start running into both scale problems and state usury caps."
Date, managing partner of Fenway Summer LLC in Washington, has a unique vantage point on marketplace lending, also known as peer-to-peer lending.
His firm has investments in online loan platforms, including Prosper Marketplace and the small-business lending platform StreetShares, and has also advised marketplace lenders. Date sits on Prosper's board. And as the former No. 2 official at the CFPB, he has rare insight into the thinking of regulators.
The CFPB has broad authority to regulate consumer lending, but has said little publicly about the nascent marketplace lending industry. Industry officials are acutely aware of the consumer agency's power.
Date predicted that regulators will evaluate specific loan products on a case-by-case basis. "If the products are the kind that invite bad outcomes for people, then I think it will without question draw scrutiny and criticism over time," he said.
Date, a onetime executive at Capital One Financial, also warned that regulatory scrutiny of marketplace lending is likely to rise when loan defaults increase.
"At some point we'll have a cyclical worsening of credit. And when that worsening happens, then a number of lenders who have heretofore not really had to be that focused on collections and recoveries suddenly will be," Date said.
"And when that happens, my guess is that the regulatory scrutiny is going to intensify. Because in general, across the U.S. consumer finance sector, there tends to have been a lot of messiness with respect to collections."
Date argued that the increased regulatory burden with respect to debt collection is again likely to fall harder on companies that target subprime borrowers. Chicago-based Avant is among the online loan platforms targeting borrowers with less pristine credit histories.
"The nature of the subprime market is that obviously losses are going to be higher, which means that collections intensity is going to be higher," he said. "I think it is kind of a top-tick regulatory concern, and I think appropriately so."
But Date expressed skepticism that either Congress or federal regulators will soon enact stronger protections for small-business borrowers. He said that even during the financial crisis, "There wasn't much hue and cry for small-business protections. I don't think much has changed in that regard."