Marketplace Lending: Fintech in Consumer and Small-Business Lending

Summary

Marketplace lending—also called peer-to-peer lending or online platform lending—is a nonbank lending industry that uses innovative financial technology (Fintech) to make loans to consumers and small businesses. Although marketplace lending is small compared with traditional lending, it has grown quickly in recent years. In general, marketplace lenders accept applications for small, unsecured loans online and determine applicants’ creditworthiness using an automated algorithm. Often, the loans are then sold—whole or in pieces—to investors. More traditional lenders are more apt to use employees to make credit assessments and have a greater need for office and retail space. Traditional lenders may hold loans themselves or package many loans together into large securities (a process called securitization). Due to these differences and to marketplace lending’s lack of industry track record, marketplace lending is facing uncertainty about its advantages, its risks, and how it should be treated by regulators.

Some observers assert that marketplace lending may pose an opportunity to expand the availability of credit to individuals and small businesses in a fair, safe, and efficient way. Marketplace lenders may have lower costs than traditional lenders, potentially allowing them to make more small loans than would be profitable for traditional lenders. In addition, some observers believe the accuracy of credit assessments will improve by using more data and advanced statistical modeling, as marketplace lenders do through their automated algorithms, leading to fewer delinquencies and write-offs. They argue that using more comprehensive data could also allow marketplace lenders to make credit assessments on potential borrowers with little or no traditional credit history.

Other observers warn about the uncertainty surrounding the industry and the potential risks marketplace lending poses to borrowers, loan investors, and the financial system. The industry only began to become prevalent during the current economic expansion and low-interest-rate environment, so little is known about how it will perform in other economic environments. Many marketplace lenders do not hold the loans they make themselves and earn much of their revenue through origination and servicing fees, which potentially creates incentives for weak underwriting standards. Finally, some observers argue that lack of oversight may allow marketplace lenders to engage in unsafe or unfair lending practices.

Marketplace lenders are subject to existing federal and state regulations related to lending and security issuance, and some observers assert that the existing system is appropriate for regulating this lending. However, because existing regulations were developed and implemented largely prior to the emergence of marketplace lending, some argue that regulatory gaps and weaknesses exist and should be addressed.

The evolution of the regulatory environment facing marketplace lenders is just one development that will likely occur in coming years. Traditional lenders will continue to adapt to the new technology, market entrants, and market conditions. Marketplace lending has not been through an entire economic cycle, and rising interest rates or the onset of a recession will reveal strengths and weaknesses of marketplace lending.

Congress may have to consider the issues surrounding marketplace lending, because as the industry grows and develops, it will likely require attention from policymakers, regulators, and financial institutions.