As alternative lenders multiply online, state and federal regulators are starting to pay closer attention and are hinting that new rules could be on the way.
The Consumer Financial Protection Bureau announced March 7 it’s now accepting complaints about online marketplace lenders, such as Lending Club and Prosper, and closely monitoring consumer experiences. Disgruntled borrowers can now file a grievance directly with the CFPB, which forwards the complaint to the company in question and asks for a response.
The CFPB also indicated in a fall 2015 rule-making agenda that it’s taking a closer look at nonbank financial services providers — which are more lightly regulated than traditional banks — and may begin supervising them more closely.
“All lenders, from online lenders to large banks, must follow consumer financial protection laws,” said CFPB Director Richard Cordray in a statement. “By accepting these consumer complaints, we are giving people a greater voice in these markets and a place to turn to when they encounter problems.”
Meanwhile, state regulators are also monitoring unconventional online lenders and are considering whether or not to craft new state-based regulations. For example, the Department of Business Oversight in California — where many marketplace lenders are headquartered — announced in December that it, too, is keeping a close eye on online lenders and has launched an inquiry into the lenders’ practices.
In order to determine whether new rules are needed to keep the lenders in check, the state office contacted 14 alternative online lenders and asked them to complete a survey, due March 9, about their business and underwriting practices.
“These online lenders are filling a need in today’s economy and we have no desire to squelch the industry or innovation,” said the department’s Jan Lynn Owen in a statement. “We have a duty, however, to protect California consumers and businesses, and they have more and more at stake as this industry grows.”
The U.S. Treasury Department may also soon weigh in on the nascent industry. Last summer, the department announced it also has begun looking into online marketplace lending and asked for comments from the public. It’s currently sifting through those comments as it weighs whether or not to push for tighter restrictions.
More regulations to come?
Regulators are approaching the alternative lending industry gingerly since the industry is still in its infancy and some analysts fear that tighter regulations could stifle innovation.
Regulators have largely praised the alternative lending industry for offering credit to consumers who have been shut out of the traditional credit system and for offering less expensive loans to selected borrowers.
However, regulators have also raised concerns about lenders’ use of alternative underwriting methods and unconventional data to size up potential borrowers. Analysts also worry about the lenders’ ability to withstand negative financial events, such as another economic downturn.
In addition, some regulators and consumer advocates are concerned that alternative underwriting practices may not be fair to all consumers. In an October 2015 speech, the Treasury Department’s Antonio Weiss pointed to a number of unintended consequences that could potentially occur. “Just because a credit decision is made by an algorithm does not mean it’s fair,” said Weiss in prepared remarks. “Consumer advocates noted that, while data has the ability to make fast and blind credit assessments, it also has the potential to create unintended correlations that lead to discriminatory lending or penalize consumers without a large digital footprint.”
Because many online lenders create proprietary credit scores rather than purchase scores from consumer reporting companies (which are regulated by the Fair Credit Reporting Act), consumers don’t have the right to see what information is used to create their alternative scores, said Weiss, nor can they dispute erroneous information.
“Advocates expressed concern that the new credit models are a ‘black box’ and applicants have no recourse if the information being used is incorrect. This is an area of real concern for consumers even when they have more robust protections,” said Weiss. “The existing model is far from perfect, but applicants at least have the right to check — and correct — their personal data that gets used in credit decisions.”
It’s still too soon to tell what kind of regulations will result from regulators’ recent fact-finding missions. But it’s a good bet that something is in the works. Lawmakers have also expressed interest in learning more about marketplace lending. But with today’s slow-moving Congressional environment, it’s unlikely any legislation affecting online lenders will get passed anytime soon.