Fintech is no longer a wunderkind. The potent combination of the internet, computing power and big data that once promised to transform banking is now well over a decade old and has evolved significantly from its self-declared disruptive origins.

Fintech has produced hundreds of new nonbank online lenders that compete with incumbent banks in consumer finance markets. The online lenders have pioneered accessible online interfaces, novel uses of data for credit scoring and lower costs. But the branding, funding and scale advantages of incumbent banks have proven to be formidable — and many online insurgents, like any startups, have struggled with competitive, growth and legal and regulatory challenges. Moreover, many of online lending’s most fundamental innovations — like algorithmic tests for consumer credit — have never been tested in a recession. They will be.

For their part, banks have absorbed some fintech innovations, while quietly providing the increasingly large and vibrant online-lending startup scene with financing, partnerships and acquisitions.

Business challenges
States all have their own laws aimed at unfair lending practices. However, for many online lenders that target a national market, the inconsistencies and contradictions across the states significantly hamper their efforts. Adobe Stock

Fintech is, and will continue to be, an increasing influence on banking in the decades ahead. Our major caveat, however, is that key regulatory changes need to be made to encourage fintech viability and continued innovation.

Those regulatory reforms, we believe, will prove beneficial not just for consumers and online lenders, but for incumbent banks as well.

It’s easy to forget how young the online lending industry is and how rapidly it is evolving. In fact, U.S. regulators have only belatedly begun the information-gathering process to determine what kind of oversight is necessary for online lending. The New York State Department of Financial Services requested information from only 28 online lenders last June, and the previous administration only released a white paper on fintech in the final weeks of the Obama presidency.

Online platforms, as nonbanks, are more lightly regulated than banks. The banks provide services that online lenders have mostly avoided: maturity transformation and risk diversification, with the accompanying risk of runs. Regulators must balance the benefits of innovation and increased efficiency with monitoring risk and fairness issues. And they must recognize that online lending often provides banking services to an underserved population.

We urge policy recommendations that fall into five buckets. We are aware that the Trump administration has promised sweeping financial deregulation, though it has said little specifically about fintech and key details about the planned deregulatory effort are still unknown. To start, policymakers can focus on the following steps to clarify a confusing tangle of consumer protection and consumer access laws.

Allow compliance flexibility

Consumer protection laws involve an alphabet soup of regulatory bodies. Compliance is often contradictory, confusing and expensive, particularly when it has to do with disclosure requirements. We believe regulators should focus on the impact of compliance requirements on consumers and provide pilot programs for companies to empirically test new products without fear of enforcement. One example currently is the Consumer Financial Protection Bureau’s Project Catalyst, a data-driven initiative that gives entrepreneurs a chance to engage in informal discussions with the CFPB early in the development process. Yet the CFPB initiative should have a clearer mandate to give innovators the room and flexibility to try new product ideas.

Harmonize state lending laws

The states all have laws aimed at unfair lending practices. However, for many online lenders that target a national market, the inconsistencies and contradictions across the states significantly hamper their efforts. The result is that the system ends up passing along costs to borrowers and restricting new entrants. One solution: Online lenders and their advocacy organizations need to engage with organizations like the Conference of State Bank Supervisors to harmonize lending laws. To a certain extent, harmonization efforts are already underway. The Nationwide Multistate Licensing System provides firms with a single route for licensing in multiple states, while the Uniform Law Commission seeks to coordinate multiple state laws. But these efforts need to be strengthened.

Raise usury caps

Some states also have individual limits on what they consider unfairly high interest rates. But those caps are often too low to compensate lenders to provide funds for customers that aren’t considered prime. This disadvantages state-licensed companies subject to the usury limits since consumers might find more flexible credit options at national, federally-chartered lenders, which are not bound by state usury caps, or shadowy credit providers that ignore or bypass state usury laws. This toothless system needs to be fixed.

Clarify disparate impact guidance

Federal laws that protect consumers from discrimination need to be defined more rigorously. While the goals are laudable, the lack of clarity of legislation like the Equal Credit Opportunity Act poses significant legal risks for technically savvy institutions that, for example, use machine-learning algorithms to improve underwriting. The CFPB and the Federal Trade Commission should jointly develop and issue guidelines with clear tests that lenders can use to prove that their underwriting methods do not have disparate impacts.

Increase funding transparency

While these recommendations would help fintech firms in any economic environment, the long-term health of the sector depends on its ability to thrive through multiple cycles. Challenges last year suggest that funding sources for marketplace lenders were not as robust as they had claimed, even under stable market conditions. Considering the pervasive though necessary use of leverage, often provided by banks, in funding marketplace loans, we believe that the industry would benefit from increased transparency, standardization and reporting of loan origination and funding data. To avoid adding to regulatory burdens, data collection could be managed through an industry association, as is done in the United Kingdom, that would allow the production of better, more representative statistics on the industry. Such measures could allow regulators and industry participants to better prepare for the eventual effects of a downturn or a sudden squeeze of funding.

Marshall Lux

Marshall Lux

Marshall Lux is a senior fellow at the Mossavar-Rahmani Center for Business and Government at Harvard University’s John F. Kennedy School of Government.

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Martin Chorzempa

Martin Chorzempa

Martin Chorzempa is a visiting fellow at the Peterson Institute for International Economics and a research assistant at the Mossavar-Rahmani Center for Business and Government at Harvard University’s John F. Kennedy School of Government.

BankThink submission guidelines

BankThink is American Banker's platform for informed opinion about the ideas, trends and events reshaping financial services. View our detailed submission criteria and instructions.