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On May 10, the U.S. Department of the Treasury (hereafter, Department or Treasury) released a report on “Opportunities and Challenges in Online Marketplace Lending.” The result of Treasury’s July 20, 2015 Request for Information (RFI) on Expanding Access to Credit through Online Marketplace Lending, the report summarizes the Department’s understanding of the online marketplace lending industry, including the potential benefits and risks of the growing industry in relation to consumers’ financial needs. Treasury’s key observations and findings are discussed in sections three through six of the report – Background and Definitions; Treasury Research Efforts and Themes from (RFI) Responses; Recommendations; Looking Forward.
Background and Definitions
The report provides a high-level overview of the two primary business models in online marketplace lending: (i) direct lenders originating loans to hold in their own portfolios (or balance sheet lenders); and (ii) platform lenders that partner with an issuing depository institution to originate loans, subsequently purchasing the loans and reselling them to whole-loan investors or issuing securities tied to the performance of the loans. Commenting on the various types of consumer loans offered through marketplace lending, the report identifies the unsecured consumer credit market (debt consolidation, credit card repayment, and home improvement), small business credit market, and student loan market as constituting the majority of the industry’s business. The report also notes that the industry is moving into the mortgage lending and auto loan markets. According to the report, while both direct lenders and platform lenders have altered their frameworks to allow for “flexibility in varying economic environments,” neither has demonstrated an ability to perform well in a less than favorable economic environment: “[o]nline marketplace lenders have demonstrated their ability to improve operational efficiencies, but neither the durability of technology-driven operations and credit underwriting, nor the sustainability of investor demand for loans, have yet been tested during a downturn in the credit cycle.”
Treasury Research Efforts and Themes from RFI Responses
The report summarizes approximately 100 industry responses to the RFI. According to Treasury, the overarching topics that emerged from the comments included:
- Data and Modeling Techniques for Underwriting: While the industry’s use of data as an underwriting tool to provide loans in targeted market areas expedites credit assessment and reduces cost, the report suggests that it also poses disparate impact risk in credit outcomes and could lead to fair lending violations. Many commenters highlighted the efficiency benefits of automated data sources, while others expressed concern for the lack of transparency when using “big data.”
- Access to Credit: Industry stakeholders maintain that online marketplace lending is expanding access to credit by lending to borrowers who otherwise might not qualify for loans from traditional financial institutions.
- Operational Challenges: According to commenters, a gap in lenders’ servicing and collection capabilities exist. In addition to concern that new underwriting models have not been tested through a full credit cycle, consumer advocates expressed concern for the industry’s reliance on servicing and collections firms: “[w]here depository institutions have tended [to] perform most functions internally, many online marketplace lenders are choosing to specialize in certain core functions while outsourcing other services.” Since new underwriting models and underlying operations of the industry have not been tested in deteriorated credit conditions, commenters’ main concern in relation to the “heavy” reliance on outsourcing services to collections and servicing firms lies in the possibility of a rise in delinquencies and defaults.
- Consumer Protection: RFI commenters addressed a need for “uniform consumer protections across financial institutions and online marketplace lenders,” with many consumer advocates arguing for enhanced safeguards for small business borrowers: “[s]mall business loans do not currently operate under all of the same consumer protection laws and regulations as personal loans, but may receive protection only under contract law or the enforcement of fair lending laws under ECOA. Consumer advocates argued that many small business borrowers should be treated as consumers.”
- Transparency: Most commenters agreed that greater transparency in disclosure forms would benefit industry participants, borrowers and investors alike.
- Secondary Market Activity: Commenters acknowledged that the secondary market for whole loans is underdeveloped, noting that although trading platforms for online marketplace securities have emerged, they’re not widely used. Generally, commenters agreed that the industry would benefit from a transparent and “well-functioning securitization market with active repeat issuance.”
- Regulation: Commenters’ views regarding the regulatory regime surrounding the industry varied. Some argued for a uniform regulatory regime, others recommended an ongoing interagency working group, and several argued that existing regulations sufficiently address industry risk. A need for greater regulatory clarity was expressed in many comments, with commenters drawing attention to the following areas: (i) consumer protection; (ii) small business protection; (iii) cybersecurity and fraud; (iv) true lender designation in the platform business model; (v) BSA/AML requirements; and (vi) risk retention.
Based on its understanding of the marketplace lending industry and review of responses to the RFI, Treasury makes the following policy recommendations in the report: (i) support greater small business borrower protections and effective oversight; (ii) adopt industry servicing standards that ensure sound borrower experience from customer acquisition through collections in the event a loan becomes delinquent; (iii) promote a transparent marketplace by, among other things, creating a “private sector driven registry for tracking data on transactions, including the issuance of notes and securitizations, and loan-level performance”; (iv) expand access to credit through sound partnerships with traditional financial institutions and Community Development Financial Institutions; (v) support the expansion of safe and affordable credit through government held data by promoting the use of smart disclosures (the release of information in standard machine readable formats that third-party software can easily process) and data verification sources; and (vi) facilitate interagency coordination by creating a standing working group to include the Treasury, CFPB, FDIC, Federal Reserve, FTC, OCC, Small Business Administration, and SEC that would, among other things, identify areas where additional regulatory clarity could benefit consumers.
In its final section, the report addresses trends and developments that Treasury believes “should be closely watched.” Regarding evolving credit scoring models, the report expressed concern on behalf of consumer advocates that increased automation and accuracy of credit scoring may “create a vicious cycle where those already disadvantaged will pay more for credit, and therefore be more likely to become financially fragile and default, and the cycle will repeat itself.” Referencing an increase in delinquency rates from January to December 2015, as well as an increase in charge off rates from October 2015 to December 2015, Treasury further stresses the need to monitor how the industry tests and adapts models in an unfavorable credit environment. Additional areas to monitor highlighted in the final section include: (i) the investment community, noting that as securitization activity increases, “[p]rudent loan underwriting, securitization transaction pricing, and robust governance and disclosures are necessary to ensure market soundness”; (ii) cybersecurity, encouraging financial sector firms to develop sufficient baseline protections and best practices to mitigate the risk of cyber incidents and to protect consumers; (iii) Bank Secrecy Act requirements, emphasizing that FinCEN will continue to monitor the industry for money laundering and terrorist financing risks; and (iv) mortgage and auto loan markets, with Treasury continuing to monitor the origination volumes and loan performance as these sectors within the industry develop.
On March 15, OFAC issued a final rule updating the Cuban Assets Control Regulations (CACR), 31 C.F.R. Part 515. The amendments advance policy changes announced by the Obama administration in 2014 by further facilitating travel to Cuba for authorized purposes, expanding the range of authorized financial transactions, and authorizing business and physical presence in Cuba. Regarding financial transactions, the final rule (i) amends section 515.584(d) to authorize certain U-turn payments through the U.S. financial system; (ii) adds new section 515.584(g) to allow U.S. banking institutions to process U.S. dollar monetary instruments presented indirectly by Cuban financial institutions; and (iii) adds new section 515.584(h) to “authorize banking institutions to open and maintain accounts solely in the name of a Cuban national located in Cuba for the purposes only of receiving payments in the United States in connection with transactions authorized pursuant to or exempt from the prohibitions of this part and remitting such payments to Cuba.”
OFAC’s amendments to the CACR were published in the Federal Register on March 16, 2016 and are effective immediately. OFAC simultaneously released a revised set of FAQs and a fact sheet regarding the changes set forth in the CACR.
This week, the Obama Administration released the Fiscal Year 2017 Budget Proposal. President Obama’s proposed budget for the Department of the Treasury would, through the Community Development Financial Institutions (CDFI) Fund, reserve at least $10 million until September 30, 2018 to provide grants for loan loss reserve funds and to provide technical assistance for small dollar loan programs under section 1206 of the Dodd-Frank Act. The Small Dollar Loan Program, according to the budget proposal, “will support broader access to safe and affordable financial products and provide an alternative to predatory lending by encouraging CDFIs to establish and maintain small dollar loan programs.” Earlier this year, Senator Sherrod Brown (D-OH), in a letter to the President, requested that the FY 2017 budget proposal prioritize funding for small dollar loan programs, as outlined in Title XII – Improving Access to Mainstream Financial Institutions – of the Dodd-Frank Act.
On a similar note, the House Financial Services Committee held a hearing titled, “Short-term, Small Dollar Lending: The CFPB’s Assault on Access to Credit and Trampling of State and Tribal Sovereignty,” on February 11, which examined the short-term, small dollar credit marketplace. During the hearing, House members expressed concern that the CFPB and other government agencies are “overextending their efforts” in regulating the industry, thus limiting consumers’ access to credit. Per the CFPB’s 2015 Regulatory Agenda, the agency is “in the process of developing a Notice of Proposed Rulemaking to address concerns in markets for payday, auto title, and similar lending products.” This stimulated conversations on how the potential rule would affect consumers and existing state and tribal law. CFPB Acting Deputy Director David Silberman was present at the hearing; Silberman maintained that the CFPB’s regulatory efforts are to ensure that small dollar loans are affordable and that consumers are not “spiraling into continual debt.”
On January 16, the Department of the Treasury issued a statement regarding Implementation Day under the Joint Comprehensive Plan of Action (JCPOA), the plan reached between the P5+1 (the United States, China, France, Russia, the United Kingdom, and Germany), the European Union, and Iran concerning Iran’s nuclear program. In response to Iran taking the appropriate nuclear-related measures, the United States followed through on lifting nuclear-related “secondary sanctions” on Iran, which included certain financial and banking-related sanctions. To summarize the effect of Implementation Day, OFAC issued guidance and FAQs. As outlined in the FAQs and in addition to lifting the nuclear-related “secondary sanctions,” the United States removed more than 400 individuals and entities from OFAC’s List of Specially Designated Nationals and Blocked Persons (SDN List). Still, as Treasury Secretary Lew noted, “other than certain limited exceptions provided for in the JCPOA, the U.S. embargo broadly remains in place, meaning that U.S. persons, including U.S. banks, will still be prohibited from virtually all dealings with Iranian entities.”
On November 16, FinCEN Director Jennifer Calvery and Treasury’s Acting Under Secretary Adam Szubin delivered remarks at the American Bankers Association and American Bar Association Money Laundering Enforcement Conference on continued AML enforcement efforts. Szubin focused on the topic of “de-risking,” which he described as “instances in which a financial institution seeks to avoid perceived regulatory risk by indiscriminately terminating, restricting, or denying services to broad classes of clients, without case-by-case analysis or consideration of mitigating options,” and addressed Treasury’s efforts to curtail the negative effects attributed to de-risking, such as preventing access to the dollar and pushing people out of the regulated financial system. Szubin emphasized, however, that the Treasury would not “dilute or roll back [its] AML/CFT standards,” but expects financial institutions to be vigilant when identifying potential risks and to implement AML/CFT programs that effectively address risks associated with illicit financing on a client-by-client basis. In a separate speech, Director Calvery addressed FinCEN’s reliance on Bank Secrecy Act (BSA) data to “uncover risks, vulnerabilities, and gaps in each financial sector,” noting that BSA data supports FinCEN’s ongoing AML enforcement efforts.
On October 29, OFAC granted a General License authorizing nine Belarusian entities to make transactions otherwise prohibited by Executive Order 13405, effective October 30. The General License also authorizes transactions with any entities that are owned 50 percent or more by the nine named entities. U.S. persons must report authorized transactions or series of transactions exceeding $10,000 to the U.S. Department of State no later than 15 days after execution. The General License expires on October 31, 2016, unless extended or revoked.
On October 18, the Department of the Treasury released a statement on reaching the formal “Adoption Day” of the Joint Comprehensive Plan of Action (JCPOA), the plan reached between the P5+1, the European Union, and Iran regarding Iran’s nuclear program. Adoption Day is the day JCPOA participants will begin taking steps necessary to implement their JCPOA commitments. According to Treasury Secretary Lew, October 18 marks an “important milestone” as “Iran begins taking its nuclear-related measures and the United States and [its] partners prepare to lift nuclear-related sanctions in response.” Although this action means that the JCPOA’s effective date is October 18, 2015, no sanctions will be lifted until Implementation Day, which will occur after international inspectors confirm that Iran has met its commitments under the JCPOA. As decided in July and outlined in an OFAC press release, licenses with certain credentials will remain in effect in accordance with their terms until Implementation Day. OFAC also issued FAQs concerning Adoption Day. Commenting on the implications of Adoption Day, the White House likewise issued a Statement that it had directed the heads of all relevant executive departments and agencies of the United States to begin preparations to implement U.S. commitments under the JCPOA.
On October 14, the CFPB released its annual report of the CFPB Student Loan Ombudsman, which analyzes consumer complaints submitted from October 1, 2014 through September 30, 2015 and provides an examination of issues raised in its September student loan servicing report. The CFPB is predominantly concerned about the group of borrowers facing repayment issues with older federal student loans made by banks and private lenders under the Federal Family Education Loan Program (FFELP). According to the CFPB’s report, at least 30 percent of borrowers who participated in FFELP are either behind in their loan repayments or already in default. The report includes the following additional noteworthy data: (i) more than one in five of borrowers with federal loans made by private lenders are past-due, with more than 10 percent in forbearance; and (ii) 95 percent of borrowers with federal loans made by private lenders are not enrolled in income-driven repayment plans. The content of the report emphasizes the importance of the Department of the Treasury, Department of Education, and the CFPB’s joint statement to improve student loan servicing practices, promote borrower success, and minimize defaults.
On September 29, the CFPB issued a report examining public comments and providing policy recommendations to address issues in the student loan servicing market. The report follows a May 2015 Request for Information notice where the CFPB, together with the Department of Treasury and the Department of Education (collectively, the Agencies), sought feedback on ways to improve student loan servicing practices.
In a parallel announcement, the Agencies released an interagency Joint Statement of Principles on Student Loan Servicing, which is expected to serve as a regulatory framework in the reformation of current student loan servicing practices, and establish minimum federal compliance requirements.
On September 10, Deputy Secretary of the Treasury Sarah Bloom Raskin delivered remarks at the Center for Strategic and International Studies Strategic Technologies Program in Washington, D.C. After summarizing threats posed to U.S. companies and strategic interests, citing to notable recent cyberattacks, Raskin laid out the roles governments, the insurance industry, and state insurance regulators can take in responding to cyberattacks.
Raskin noted that governments can facilitate information-sharing related to cyber threats and deter incidents through law enforcement and diplomatic engagement as well as by imposing financial sanctions on wrongdoers overseas. The insurance sector can gauge the risks and costs posed by cyber incidents and provide an important risk mitigation tool by allowing policyholders to transfer some financial exposure associated with cyber events. The insurance qualification and underwriting process also encourages businesses to engage in increased cybersecurity and risk-mitigation activities. Finally, state insurance regulators can assist response by setting standards for cybersecurity and the protection of the sensitive information of policyholders at the entities that they regulate.
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- Kari K. Hall and Christopher M. Walczyszyn to speak on the "Understanding updates to Regulation CC to ensure effective check processing" at a National Association of Federal Credit Unions webinar
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