Lax regulation of fintechs leaves consumers vulnerable to abuse

A new regulatory regime in Washington — highlighted by the recent confirmation of a new director of the Consumer Financial Protection Bureau and President Biden’s nomination of Saule Omarova as the next comptroller of the currency — faces a rapidly evolving financial services marketplace and, with it, a new set of challenges.

In recent months, some leading fintechs have been tarnished by allegations of consumer harm.

Just recently, one of these platforms enabled merchants to submit loan applications on consumers’ behalf — without the consumers’ knowledge or consent — and then approved such loans. This type of flagrant abuse is exactly what now-Sen. Elizabeth Warren warned against when she championed the creation of the CFPB, and it’s far from an isolated incident. Here’s why we’re likely to see even more consumer harm without action from policymakers.

Where once consumers overwhelmingly went to banks to meet their financial needs, a growing percentage of consumers are now looking to financial technology companies for banking products and services. In the consumer lending market, fintechs now issue nearly half (49%) of all personal loans, up from just 22% in 2015, according to Experian. Competition is inherently good for consumers, resulting in expanded access, innovation and choice, but fintechs that extend personal loans are not subject to any federal oversight, depriving consumers of the high level of protection they expect and receive from leading retail banks.

Fintech fumbles have also been seen in small-business lending, most notably during the Paycheck Protection Program, the federal COVID-19 relief initiative designed to provide small businesses forgivable loans through the Small Business Administration. A recent study from the University of Texas found fintech PPP lenders were nearly five times more likely than traditional lenders to be involved with suspicious loans. It also concluded that nine out of the top 10 lenders with the highest rates of suspicious PPP loans were fintech firms. Further, the Department of Justice found in October 2020 that 75% of approved PPP loans connected to fraud were from fintech lenders.

If the federal government was susceptible to this level of fraud during the implementation of a high-profile lending program, how can consumers expect they will be protected when nobody is watching?

Missteps among growing companies in new sectors should be expected as internal processes are streamlined over time, but the sheer magnitude of these instances coupled with the growing market share of nonbank fintech lenders raises serious questions of whether adequate safeguards are in place to prevent a repeat of the past.

The 2008 financial crisis was caused, in part, by the actions of nonbank mortgage originators, whose niche products were not subject to the purview of prudential regulators. The same is true of nonbank fintechs in the consumer loan market today. While they compete directly for the same customers, they are not subject to the same regulatory standards as traditional banks — putting consumers at risk.

After the 2008 crisis, Congress established the CFPB specifically to protect consumers and instituted new safety-and-soundness requirements through the passage of the Dodd-Frank Act. Unfortunately, this law was written before the phrase “fintech” ever entered our lexicons.

Recognizing this disparate regulatory landscape, a leading consortium of global central banks recently warned the lack of sufficient regulation and supervision of fintechs poses significant risks to the safety and soundness of the financial system, encouraging global regulators to “invest with urgency.” Similarly, the International Monetary Fund stated: “With […] the emergence of fintech companies […] financial shocks in one jurisdiction can quickly spill across financial sectors and national borders. Therefore, resilient financial systems that are well regulated and well supervised are essential.”

To immediately mitigate the growing risks to consumers in the underregulated fintech lending market, the CFPB should amend its regulations under Dodd-Frank to monitor and examine these companies so they are accountable under the same standard banks have abided by for over a decade. The Consumer Bankers Association recently submitted a letter to the director of the CFPB urging the bureau to do just that — examine whether nonbank fintech lenders are complying with federal consumer financial laws.

Safety-and-soundness regulation and supervision by federal prudential regulators have strengthened banks and provided security for consumers since the 2008 financial crisis. Policymakers of all stripes should be concerned these measures, which have been heralded by many on Capitol Hill, do not apply to a growing segment of the banking activity happening today. Just as Congress passed legislation more than a decade ago, policymakers have the authority and responsibility to modernize the rules of the road today. Doing so will help strengthen protections for American consumers — regardless of whom they choose to borrow from — and ensure the mistakes of the past are not repeated.