Department of Treasury’s Plea to Understand Online lending

dept treasury

The Treasury Department is deciding how to classify and categorize the new marketplace lending industry. People use the word “marketplace or p2p lending” just as broadly as supply chain finance.

According to the Department of the Treasury's Request for Information on how to regulate this space, they define this space in the following manner: Online marketplace lending refers to the segment of the financial services industry that uses investment capital and data-driven online platforms to lend to small businesses and consumers.

This need for regulation is driven by growth. According to Morgan Stanley’s research, Global Marketplace Lending: Disruptive Innovation in Financials, in less than a decade, online marketplace lending has grown to an estimated $12 billion in new loan originations in 2014, the majority of which is consumer lending.

In undertaking this RFI, the Treasury has three objectives:

  1. understand these business models
  2. assess their potential to expand access to credit to underserved markets
  3. understand how the regulatory framework needs to evolve to support growth.

I can tell you from experience that each vendor that plays in the B2B working capital space have different business models, processes, structures, etc. that could end up having large regulatory differences. Regulators are looking for clearer segment definitions and regulations may be different depending upon how each business is structured.

According to the Treasuries current understanding, they see three general categories of lenders:

(1) balance sheet lenders that retain credit risk in their own portfolios and are typically funded by venture capital, hedge fund, or family office investments;

(2) online platforms (formerly known as “peer-to-peer”) that, through the sale of securities such as member-dependent notes, obtain the financing to enable third parties to fund borrowers and, due to the contingent nature of the payment obligation on such securities, do not retain credit risk that the borrowers will not pay; and

(3) bank-affiliated online lenders that are funded by a commercial bank, often a regional or community bank, originate loans and directly assume the credit risk.

Additionally, some of these companies have adopted a business model in which they partner and have agreements with banks. In these arrangements, the bank acts as the lender to borrowers that apply on the platform.

The Treasury knows that with respect to small businesses, a number of studies have shown that these borrowers are more dependent on community banks for financing than larger firms, and this is a worry, as the number of banks continue to shrink in the U.S. According to Federal Reserve survey data released in February 2015, “a majority of small firms (under $1 million in annual revenues) and startups (under 5 years in business) were unable to secure any credit in the prior year.” More than half of small businesses that applied for credit in 2014 sought loans of $100,000 or less.

So ultimately the Treasury wants to understand not only how to define, segment and regulate, but also understand how reliable these credit risk models really are.

If you are interested in responding to the Treasury’s RFI, visit here.

P.S. If you would like to receive TFM’s weekly digest, sign up here.

Related Articles

Discuss this:

Your email address will not be published. Required fields are marked *