Courtesy of Vincent Di Lorenzo
Fintech lending, sometimes referred to as online marketplace lending, is lending through digital platforms that often collect and base lending decisions on nontraditional data sources. Underwriting is typically automated and may employ nontraditional credit algorithms.
In the consumer and small business credit market, fintech loan originations have experienced an annual compound growth rate of 163 percent between 2011 and 2015. It is estimated that fintech loan originations (excluding mortgages) could reach $90 billion by 2020, up from approximately $25 billion in 2015. In the U.S. personal loan market, fintech lenders’ market share increased from less than one percent in 2010 to 36 percent in 2017. In the mortgage market, fintech lenders’ market share increased from two percent in 2010 to eight percent in 2016, with the total dollar volume of originations growing thirty percent annually.
In my recent paper, “Fintech Lending: A Study of Expectations Versus Market Outcomes”, I examine the benefits and risks of fintech lending. The paper documents expectations through large-scale surveys and interviews of various stakeholders in the fintech lending market. It also reviews market outcomes through studies of substantial data sets of various types of loans, in addition to policy making implications of the evidence presented. Large scale surveys of stakeholders indicate the following benefits are expected from fintech lending: (a) expanded access to credit, (b) faster and more convenient access to credit, (c) lower costs to borrowers, (d) less systemic risk, (e) less privacy and data security risk, (f) less bias in lending decisions, and (g) better loan portfolio performance. Such surveys also indicate the following risks are expected: (a) predatory lending and targeting of vulnerable borrowers, (b) fair lending violations, (c) lack of transparency, (d) threats to customer privacy, (e) delinquency and default risks for both borrowers and lenders, (f) challenges to the ability of government to effectively regulate, and (g) exclusion of unbanked or low-income consumers. Expectations are, of course, not consistent across stakeholders.
The overriding issue when considering regulatory or legislative intervention is whether market choices can be relied upon to deliver the potential benefits of fintech lending and to address its risks. This consideration is especially important in the fintech industry because it has introduced many innovations in a lightly regulated environment.
Increased access to credit was one of the most frequently cited expected benefits of fintech lending. Overall, market outcomes largely confirm delivery of this benefit in the consumer loan market and small business market. Increased access was provided through the removal of geographic barriers to credit and through availability of smaller loans. It was also available through increased access for younger firms, smaller firms, and minority-owned firms. However, the evidence is divided as to whether consumers with credit challenges under traditional criteria for creditworthiness experienced increased access to credit in either the consumer loan market or mortgage market. Moreover, it is unlikely fintech lending has increased access to credit among the unbanked.
Market outcomes also confirm the expected benefits of faster and more convenient access to credit. However, the evidence is divided on the expected benefit of lower costs to borrowers. Fintech lenders charge slightly higher interest rates to similar borrowers than traditional banks in the mortgage market. In addition, market outcomes for small business borrowers evidence high interest rates in some markets, and usurious or predatory terms in some cases.
Market outcomes also confirmed the expected risks around a lack of transparency in terms and pricing in the small business loan market. Two expected risks, however, have not surfaced. One is a heightened risk of default due to nontraditional methods of credit assessment. Indeed, the risk of default in mortgage loans originated by fintech lenders was significantly lower than comparable loans originated by non-fintech lenders. The other risk that has not surfaced is the risk of fair lending violations. Indeed, the evidence suggests that automated credit underwriting performed by fintech firms has decreased the risk of biased outcomes.
These outcomes signal a need to embrace regulatory or legislative initiatives that control excessive interest rates and fees, and that require transparency, especially in the small business loan market. The outcomes to date generally do not signal a need to embrace regulatory or legislative initiatives to require greater financial inclusion on the part of fintech lenders, except, perhaps, in the mortgage loan market and technological literacy initiatives for the unbanked. The outcomes to date also do not signal a need to address the risk of loan defaults through substantial capital requirements. The caveat is that fintech lenders’ underwriting procedures have not been tested in an economic downturn.
In light of these market outcomes, how have federal agencies proposed to address fintech lending benefits and risks? On July 31, 2018 the Office of the Comptroller of the Currency announced it will begin to accept applications for Special Purpose National Bank Charters for Fintech Companies. This followed the Department of the Treasury’s endorsement of such a charter. What regulatory requirements does such a charter impose to address the risks and benefits of fintech lending identified in this paper? What additional changes in the regulatory environment has the Treasury Department endorsed?
The Licensing Manual for charter applications from fintech companies, issued July 31, 2018, makes no mention of transparency requirements, and neither does the OCC Policy Statement on Financial Technology Companies. This is understandable given that the risk of lack of transparency for borrowers is a risk identified in the small business loan market. The Truth-in-Lending Act requires transparency in consumer loans, but its reach does not extend to small business loans. This is a matter, therefore, that the Comptroller cannot address by regulation, but requires legislative action.
The benefit of increased access to credit and the risk of excessive or predatory rates and fees are briefly mentioned in the Comptroller’s newly issued Policy Statement and Licensing Manual Supplement. Access is addressed in the Policy Statement’s discussion of financial inclusion. It states: “[t]he OCC …expects a fintech company that receives a national bank charter to demonstrate a commitment to financial inclusion. The nature of that commitment will depend on the company’s business model and the types of products, services, and activities it plans to provide. By providing a high standard similar to the Community Reinvestment Act’s expectations for national banks that take insured deposits, the financial inclusion commitment will help ensure that all national banks provide fair access to financial services and treat customers fairly.”
Studies of market outcomes confirm that the current market is already generating many forms of increased access to credit in the consumer personal loan market and the small business loan market. The mortgage market, however, has not clearly realized this benefit. Moreover, the evidence is divided as to whether credit challenged borrowers under traditional underwriting criteria experience greater access in the fintech loan market. Some of the commentators responding to the OCC’s Request for Public Comments on a Special Purpose National Bank Charter raised questions concerning the OCC’s power to impose a financial inclusion requirement as part of its licensing requirements. That issue is beyond the scope of this essay. However, financial inclusion obligations in the mortgage market arise from the Community Reinvestment Act. That statute applies to “regulated financial institutions”, defined as “an insured depository institution . . ..”  The Act does not apply to financial institutions that do not hold insured deposits, and therefore does not apply to current fintech lenders absent legislative action.
Finally, with regard to the risk of excessive rates and fees, and other predatory lending issues, the OCC’s Policy Statement merely mentions that in providing a charter the OCC will consider . . . “whether a proposed [fintech] bank . . . will provide fair access to financial services, will treat customers fairly, and will comply with the applicable laws and regulations.” However, it also warns that “proposals that include financial products and services that have predatory, unfair, or deceptive features or that pose undue risk to consumer protection, would be inconsistent with law and policy and would not be approved.”
Some of the commentators responding to the OCC’s Request for Public Comments pointed out that a national charter might exacerbate the risk of excessive interest rates and predatory lending by preempting state laws. In light of the evidence of excessive rates and predatory terms evidenced by some studies of market outcomes, the possible heightened risk of predatory lending is an issue that requires close scrutiny.
The Treasury Department’s recommendations for fintech lending regulation may exacerbate the risks of excessive interest rates and potentially predatory terms in situations involving partnerships between traditional banks and fintech lenders. The Treasury Department endorsed the “valid when made” doctrine, urging rejection by Congress of the Second Circuit’s decision in Madden v. Midland Funding. That case held that the National Bank Act did not preempt state usury claims against a third party that had purchased the loan from a federally chartered bank. The Treasury Department also urged that Congress and the federal regulators endorse the concept that a service or economic relationship between a bank and a fintech lender does not affect the role of the bank as the “true lender” of the loan provided the bank originates the loan. Such a conclusion would allow preemption of state interest rate limits and may preclude state licensing requirements. Finally, the Treasury Department urged the Consumer Financial Protection Bureau to rescind its payday lending rule issued in November 2017. That rule required lenders that make “covered loans” to determine the borrower’s ability to repay the loan.
The issue of risk management and capital requirements is addressed in the OCC Licensing Manual Supplement for fintech companies. After stating fintech banks with a national charter will be subject to the minimum leverage and risk based capital requirements that apply to all national banks, the Licensing Manual Supplement highlights risks posed by nontraditional strategies. The OCC then states a minimum level of capital that the bank will meet or exceed at all times due to risks associated with the applicant’s business plan, including volatility specific to a business line, will be required. The market outcomes to date on default and delinquency suggest a low level of risk from fintech lending, and therefore no need for significantly greater capital requirements. However, there are two words of caution in embracing this conclusion. First, fintech lenders’ nontraditional underwriting practices have created loans that have not been tested in an economic downturn. Second, the Opportunity Fund’s study highlights that some fintech lenders are making loans with terms that are not sustainable.
Seeking a Special Purpose National Bank Charter is merely one option for a fintech lender that seeks to operate on a nationwide basis. If fintech lenders chose not to obtain such a charter, the risks identified in studies of market outcomes must be addressed under other, existing, federal or state laws, and regulatory requirements. Whether such laws and requirements are up to the task of minimizing the risks of predatory lending and potential default risks, and maximizing the benefit of increased access to credit, are issues to be explored as fintech lending continues to evolve.
 Congressional Research Service, Marketplace Lending: Fintech in Consumer and Small Business Lending 5 (Sept. 6, 2016) (based on a report by analysts at Deloitte).
 American Bankers Association, The State of Digital Lending at 5 (2018), http://www.aba.com/Products/Endorsed/Documents/ABADigitalLending-Report.pdf (results of a 2016 report by Autonomous Research).
 U.S. DEPARTMENT OF THE TREASURY, A FINANCIAL SYSTEM THAT CREATES ECONOMIC OPPORTUNITIES: NONBANK FINANCIALS, FINTECH, AND INNOVATION 13 (July 2018) (analyzing data from TransUnion), https://home.treasury.gov/news/press-releases/sm447.
 Andreas Fuster, Matthew Plosser, Philipp Schnabe, and James Vickery, The Role of Technology in Mortgage Lending, Federal Reserve Bank of New York, Staff Report No. 836 at 1 (Feb. 2018), http://www.newyorkfed.org/medialibrary/media/research/staff–reports/sr836.pdf.
 DiLorenzo, Vincent, Fintech Lending: A Study of Expectations Versus Market Outcomes (September 10, 2018), https://ssrn.com/abstract=3247112.
 Office of the Comptroller of the Currency, NR 2018-74, OCC Begins Accepting National Bank Charter Applications From Financial Technology Companies (July 31, 2018), https://www/occ.treas.gov/news-issuances/news-releases/2018/nr-occ-2018-74.html.
 U.S. DEPT. OF THE TREAS., A FINANCIAL SYSTEM THAT CREATES ECONOMIC OPPORTUNITIES, supra note 3 at 73.
 Comptroller’s Licensing Manual Supplement: Considering Charter Applications from Financial Technology Companies, https://www.occ.gov.
 Office of the Comptroller of the Currency, Policy Statement on Financial Technology Companies’ Eligibility to Apply for National Bank Charters, https://www.occ.gov.
 15 U.S.C. §1603(1) (not applicable to extensions of credit primarily for business, commercial or agricultural purposes).
 Supra note 9 at 3. See also Comptroller’s Licensing Manual Supplement, supra note 8 at 17 – 18 (Appendix B: Financial Inclusion Commitment Guidance).
 12 U.S.C. §§ 2901-2908.
 12 U.S.C §§ 2901(a) (1) and 2902 (2).
 Supra note 9 at 3.
 Id. at 3-4
 U.S. DEPT. OF THE TREAS., A FINANCIAL SYSTEM THAT CREATES ECONOMIC OPPORTUNITIES, supra note 3 at 92-93.
 Id. at 93-94.
 Id. at 128-129.
 A covered loan consists of credit with terms of 45 days or less and longer-term credit with balloon payments. Id. at 128. A loan secured by real property is exempt from the rule.
 Comptroller’s Licensing Manual Supplement, supra note 8 at 8-9.
 Opportunity Fund, Unaffordable and Unsustainable: The New Business Lending at 4 (May, 2016), https://www.opportunityfund.org/media/blog/unaffordable-and-unsustainable-new-opportunity-fund-report/. Opportunity Fund is the nation’s largest nonprofit micro lender.