Alternative lenders have enjoyed light – if any – regulatory pressure over the last few years, but regulatory interest in the industry suggests marketplace lending’s time outside of the authorities’ spotlight is running out.
That interest really revved up last year – and carried on into 2016 – with the U.S. Treasury. The department’s anticipated report on the marketplace lending sector landed in May, and the basic gist of it all is that alt lending could probably use some more regulatory oversight.
In response, marketplace lenders had stated openly that they would welcome regulatory oversight. Recently, however, the anxieties about what that regulation would actually mean for their business models have begun to surface.
Some analysts are concerned that the Treasury Department’s assessment is calling for some small business loans via online platforms to be reclassified as consumer loans. That, experts say, would create a whirlwind of a mess for alternative lenders.
Reality, it seems, is beginning to set in.
The Treasury’s Analysis
“Opportunities and Challenges in Online Marketplace Lending” spelled out a number of concerns the Treasury has for the industry. For one, the algorithms and analysis of Big Data that aids these online lenders in underwriting loans to small business borrowers is not transparent. Plus, those underwriting models have yet to be tested through full credit cycles, the report noted, and the inevitable increase in federal interest rates may spark a round of defaults.
On top of heightened data, and the development of a registry for regulators to keep tabs on transactions and company disclosures, one of the plans the Treasury and other authorities have may be to classify the loans provided by these marketplace lenders.
Alternative lenders have said they would welcome greater regulatory oversight.
PayPal, which only recently became an alternative lender by launching its working capital unit, is one.
“I suspect more regulation will come to the space, and I think that will suit us well,” said PayPal VP and General Manager of Small Business Lending Darrell Esch in an interview with Forbes last year.
When asked by PYMNTS whether he was concerned about incoming regulation on the space, OnDeck Vice President of External Affairs and Associate General Counsel Daniel Gorfine simply stated, “No, not concerned.”
“We are confident in what we do and look forward to engaging with policymakers in a productive and proactive way,” he continued.
OnDeck, Kabbage and CAN Capital recently collaborated to launch the Innovative Lending Platform Association, an advocacy group and a sort of self-policing unit to improve transparency in the alternative and marketplace SME lending spaces.
“Our view is that this is an industry self-regulatory solution that really does help solve any challenge around disclosure,” Gorfine added, referencing the creation of the ILPA. “We think that’s something policymakers will certainly welcome.”
Changing Their Tune
Reports from Bloomberg BNA this week, however, could signal a shift in how alternative lending players are reacting to the incoming threat of regulation.
According to reports, the Treasury has recommended that marketplace lenders to SMEs should be reclassified as consumer loans.
“Strong evidence indicates that small business loans under $100,000 share common characteristics with consumer loans yet do not enjoy the same consumer protections,” the Treasury stated in its May report. “Treasury is willing to work with members of Congress to consider legislation that addresses both oversight and borrower protections.”
Bloomberg BNA reported that some analysts are taking this statement as a suggestion that smaller alternative small business loans be classified as consumer loans. Should that happen, experts say, alt lenders are in for a headache.
“I would have to do everything differently,” said CAN Capital Chief Legal Officer Parris Sanz in an interview with the publication. “I can’t give you a rundown of all the various moving parts that would be affected, but I can tell you for sure that it would be significant.”
In a separate interview with Bloomberg BNA, Richard Eckman, a partner at Delaware-based Pepper Hamilton LLP, said alternative lenders are probably wise to pay attention to this possibility.
“They’re very smart in being concerned about that,” he said. “There are a whole host of consumer laws that apply to loans that are for personal, family and household purposes, that’s sort of the definition of a consumer loan.”
Eckman highlighted the Truth In Lending Act, a federal consumer protection law that could come crashing down on alternative and marketplace lenders should they be forced to operate as consumer lenders, even when lending to SMEs, reports said.
The TILA regulation includes disclosure, dispute-resolution and other requirements; according to Eckman, it would be time-consuming and expensive for marketplace lenders to adhere to these demands.
“You would have to build a compliance function in your company,” he told the publication. “It would cost them more money and it would limit their ability to be creative because they would have to do things a certain way.”
Doing things “a certain way,” in a broad sense, is exactly the point of regulation. The responses of Sanz and Eckman suggest that, while alternative lenders have enjoyed the light touch of regulation in recent years, and assure they remain confident that regulators will collaborate with industry players to ensure the market operates safely for borrowers and investors, the realities of regulation may wake up some marketplace lending firms from their pipe dream.
In fact, Eckman said, reclassifying small business loans for these companies as consumer loans would be a “nightmare.”
“It’s really like peeling back an onion, when you think of all the things that a consumer lender has to go through,” he told reporters. “To foist that on a small business lender that has never had to go through it, that’s a tall order.”
CAN Capital’s Sanz seemed to agree. “It would fundamentally change the nature of the business,” the CLO said. “We would have to work those costs through the business and for us, that would almost certainly change our decision-making in order to remain a viable business — and that would mean restricting access to capital for small businesses.”