How Tech Innovators Can Influence Their Own Regulatory Fate
The Treasury Department on Tuesday capped off a nearly yearlong inquiry into the burgeoning marketplace lending industry with a policy paper that recommends increased transparency and customer protections while also highlighting the sector's potential for expanding credit access.
Following the scandal-tinged departure of CEO Renaud Laplanche, the company is contemplating drastic steps to restore the confidence of loan buyers. Scenarios that would have been far-fetched a short time ago such as diluting shareholders and funding loans off its own balance sheet are now under consideration.
Both banks and fintech firms have reached an innovation crossroads.
Before now, nonbank fintech firms could do no wrong in the public eye. They enjoyed a long run as media darlings. But that period has ended. Alternative online lenders have increasingly felt the sting of challenging headlines in recent weeks for increased losses, internal control weaknesses and the debate over the appropriate level of regulatory protections for both their small business and consumer borrowers. While the risk of regulation for marketplace lenders continues to grow, an opportunity has opened for banks to be proactive in this market by delivering sound products that can serve tech-savvy customers with the important protections banks are known for.
The threat of regulation for the innovation efforts of both banks and fintech companies has risen with the release of the Treasury Department's long-awaited white paper studying online marketplace lending. We must all now accept that increased regulation is inevitable. But that will only intensify competition among companies to show who has the most innovative, and safest, products to offer.
Banks and nonbanks have other distinct challenges to overcome as they compete in the fintech space. As illustrated in the 2015 Small Business Credit Survey — published by seven of the Federal Reserve banks — one of fintech's biggest strengths is providing credit to microbusinesses and small businesses with less than $1 million in revenue. These small companies, including many startup firms, have likely found it difficult to get funding from the mainstream banking industry, as banks probably find their risk profiles to be quite high. But according to the survey, satisfaction ratings among many online small business loan customers are low given the less-than-favorable repayment terms and interest rates charged for higher-risk loans. But business customers were also critical of banks' cumbersome application processes, and how long it took banks to reach a credit decision.
The Treasury white paper raises a number of issues and may be predictive of future regulatory focus. Concerns were raised regarding the reliability of lending algorithms not yet tested by a full credit cycle or for the risk of disparate impact. The paper also pointed to potential benefits, such as leveraging technology to better serve underserved markets. Perhaps most compelling, the paper drew attention to similarities between small business loans under $100,000 and consumer loans, and to the fact that the latter has a borrower protection regime and the former does not.
Signs pointing to regulators becoming interested in new small business lending rules are clear, but how far they go will depend on a number of factors. For example, nothing will more surely bring regulatory overreach than a scandal harming small business borrowers. That would likely impact nonbank fintech firms and banks alike.
U.S. regulators, including the Office of the Comptroller of the Currency, have been criticized by some for not stalwartly supporting financial innovation. There are promising signs of that changing; the OCC's recent paper calling for responsible innovation is right on the mark. But the industry can't view such calls as license to take too much risk. Unfortunately, there is a long history of companies (both banks and nonbanks) that leveraged less rigorous oversight into market advantages that typically disadvantaged consumers. There is also a graveyard of financial products once called innovative — including interest-only and low-documentation mortgages, refund anticipation loans and add-on products — that did not season well.
Small and start-up businesses are instrumental in providing job and economic growth. Banks should innovate toward the goals of increasing access to small business credit and improving the customer experience. But this must be done in a responsible and sustainable manner. The rush to embrace innovation should not ignore basic risk management principles and appropriate common sense protections for small business owners. This will ensure that government's oversight of small business lending will be reasonable, balancing necessary safeguards with the need for credit availability.
Steven L. Antonakes is the senior vice president and chief compliance officer at Eastern Bank in Boston, the largest and oldest mutual bank in the United States. He previously served as the deputy director of the Consumer Financial Protection Bureau and as the commissioner of the Massachusetts Division of Banks.