The dramatic growth in online lending has far-reaching implications for the retail lending industry, offering numerous advantages for consumers and lenders alike: Lenders benefit from reduced costs, while consumers with online capability have access to more information and choice and lower transaction and loan prices.

From the regulatory perspective, however, the Web revolution raises compliance issues that may fundamentally alter fair-lending enforcement. Regulators and activist groups can be expected to voice increasing concern about how online lending will affect borrowers who lack access to the Internet, and who therefore will not be able to obtain the lower prices and broader choices it offers. The growth in online lending will also stimulate the use of risk-based pricing, which may further accentuate regulatory concerns as higher-risk borrowers are forced to pay higher loan prices.

CREDIT AT THE CLICK OF A MOUSE

Most traditional lenders have established an Internet retail lending operation, though many are still struggling to find the right balance between Web- and relationship-based services. And they are encountering tough competition from Internet-only lenders and from nonbanks that are entering Web lending.

Ultimately, however, online lending will spur dramatic changes in the retail lending environment: Lower overhead costs, increased information exchange, and intensified price competition will make the Internet the source of low-priced consumer credit.

More competition and lower margins will encourage lenders to focus on volume and to adopt risk-based pricing and automated underwriting. This will result in lower prices for most online borrowers. But at the same time, online lenders will face more price competition than traditional ones, since multilender Web sites that facilitate comparison-shopping will increasingly attract prospective borrowers.

Thus, lenders will be inclined to price online loans lower than ones obtained through traditional channels. This differential pricing may disproportionately harm racial, ethnic, and economic groups that lack Web access.

A January 2000 survey of more than 80,000 U.S. households by Forrester Research found that a much bigger percentage of whites than blacks were online, though Web access was rising in African-American homes. The same study found income to be the strongest predictor of online penetration (education and age also were relevant). As concerns about this digital divide spur debate about equal access to lower-priced online credit, lenders will be asked to give credible business reasons for differential pricing between channels.

HE END OF CROSS-SUBSIDIZATION

The transition to risk-based pricing will also bring new regulatory challenges. Historically, all applicants that met acceptable credit criteria thresholds were priced at similar rates - an approach under which borrowers with higher credit quality and lower default risk subsidized those who were less qualified.

Online lending, in contrast, will foster an information-based sensibility in which cross-subsidization within loan portfolios is phased out and prices are adjusted to reflect each applicant's credit quality and default risk. Moreover, the rapid adoption of risk-based pricing in the online market will compel traditional lenders to compete by using risk-based prices.

This increased reliance on risk-based pricing will probably have two major effects across all retail markets. First, borrowers with worse credit risk may have better access to credit, though they will also have to pay a higher, and in some cases unaffordable, price. Second, if consistent differences in credit quality develop between demographic groups, risk-based pricing may create systematic differences in loan pricing among borrower segments, attracting the attention of regulators, consumer groups, and policymakers.

When Freddie Mac, in its 1999 Consumer Credit Survey, asked borrowers to describe their credit histories, it found that minorities had poor histories compared with nonminorities. Regulators may question the fairness of risk-based pricing patterned after online and offline segments' racial characteristics. Moreover, as lenders profile their customers and e-mail them offers tailored to these profiles, regulators may worry about "Weblining," the practice of using such data to limit credit access to groups of Web-enabled people.

ENSURING EQUAL ACCESS

The industry needs clear regulatory guidance on acceptable practices, including clarification of whether a lender can offer differential pricing by channels, and what justification, if any, it needs to support that pricing structure. And regulators must provide guidance on lenders' responsibility for third-party fair-lending practices, particularly for Web sites or portals offering multilender access, or bundling of credit products with other services.

Lenders, for their part, must recognize that Internet use may inadvertently generate fair-lending issues and allegations that could seriously damage their reputation. So, lenders should maintain documentation supporting the business justification for lower online prices and its risk-based pricing framework. This could include competitor pricing analyses, internal cost-accounting data, delinquency analysis, and strategic business growth and marketing plans. Similarly, before entering third-party relationships, it is prudent to ensure that your partner-to-be is committed to consistent treatment of all borrowers and follows fair-lending principles.

Finally, to the extent that a lender is using data to cross-sell and profile borrowers' profitability, lenders must ensure that these initiatives do not include any characteristics that may be deemed discriminatory in nature.

Mr. Sangha is the director of financial services economics for Ernst & Young LLP in Washington.

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