With Richard Cordray stepping down as head of the Consumer Financial Protection Bureau and the agency poised to undergo significant changes from leadership installed by the Trump administration, consumer protection in America could take a hit — at a time when new, untested financial technology firms are in particular need of someone to look over their shoulder.
Fintech lenders, especially marketplace lenders that match borrowers with investors through online platforms, can provide consumers with quicker access to small-value, short-term loans, often getting back to a borrower in a matter of hours — all done via smartphone or laptop.
These firms are growing at a rapid pace. In the second quarter of 2017, venture capitalists injected 38% more money into the fintech sector than they did the year before, and a number of fintech startups are now valued at over $1 billion.
Fintech lenders use a host of nontraditional factors to inform the lending decision — many of which might shock most American borrowers. Information such as where a borrower lives, what clubs he or she belongs to, and even someone’s text messaging habits and social media activity can all be used to make lending judgment calls. This information is processed by machine learning programs that utilize sophisticated underwriting algorithms to make credit decisions. Better information equals better lending, equals better return on investment, equals better outcomes for everyone.
These big data innovations certainly have the potential to benefit the economy. But could the current setup also be too good to be true? It is hard to know the answer. We can’t be sure because so little is known about these lenders. They aren’t banks, so they don’t have a prudential federal regulator, and their underwriting programs are protected as trade secrets.
So who is watching this fast-growing sector? The folks at the CFPB have been. Just recently the bureau filed a lawsuit against the fintech firm Think Finance. The company is alleged to have engaged in deceptive practices by demanding that consumers pay loans they did not owe and by making electronic debits from the accounts of individuals who were not obligated to pay any money.
Considering the characterization of the CFPB by Trump officials as a “rogue agency” and a “joke” that is unfriendly to American businesses, it is uncertain whether we will see much in the way of robust regulation or consumer enforcement of fintech firms in the future. Could other federal bank regulators step in to fill the gap? They too could start applying a lighter touch to oversight, with leaders appointed by the administration who are focused on deregulation.
But as we start to gain more insight about fintech borrowers, the case for strong consumer protection measures grows stronger. On the one hand, many of these firms reported to the U.S. Treasury in a 2016 survey that they were “serving mostly prime and near-prime borrowers consolidating debt from credit cards or student loans.”
In an article that is forthcoming in the Alabama Law Review, I conduct an empirical study of marketplace lender complaints submitted through the CFPB’s online complaint portal. Although the data set is limited, the complaint narratives reveal many fintech consumers living paycheck to paycheck, often using these loans to cover basic expenses like groceries and utility bills. Moreover, some of the complaints tell stories of consumers being denied credit by a fintech firm after having completed an application, only to then be steered toward a loan by a third-party lender that contained more predatory features.
Some have recently suggested that the next crash will not come from Wall Street, but rather from Silicon Valley. Fintech companies and big banks are partnering with one another to make these loans, and Wall Street firms are purchasing the resulting paper. This should be a major concern because defaults on fintech loans have been growing at a troubling rate. Considering that institutional investors like insurance companies, retirement funds, and even traditional banks are investing in these fintech loans, one wonders if there is a potential for contagion if things go south.
Richard Cordray won’t be around anymore to keep an eye on the fintech sector. The question now is: Who will?