On December 19, 2018, the United States Government Accountability Office (“GAO”) issued a report to Congress focused on three segments of fintech lending industry that cover personal loans, small business lending and student loans (“Report”). For these segments, the Report (i) identifies trends in fintech lending and business models used by fintech lenders; (ii) identifies key regulatory and consumer protection issues in the fintech lending industry; and (iii) examines fintech lenders’ use of alternative data and the extent to which federal agencies monitor lenders’ use of the data. The following is a summary of the Reports’ finding and recommendations.
Trends. The Report identified two recent trends in the three segments of the fintech industry studied (i) growth in loan volume, and (ii) increasing partnerships between nonbank fintech lenders and banks as a model for fintech lending. The Report estimates continued growth in the fintech lending industry in the near future. The Report suggests that factors to such growth include the fintech industry’s:
- greater use of technological innovations than traditional banks that could result in borrowers experiencing faster response times, loan approvals and funding;
- use of lending models that cater to customers and small businesses underserved by traditional banks, through the use of alternative data;
- increase in institutional investors willing to invest in fintech loans; and
- regulatory advantage over traditional banks, such as, lower capital requirements and examination requirement that reduce lending costs.
Regulatory Issues. The Report cites fintech lending industry’s concern with complying with varying state regulations as the industry’s most significant regulatory challenge. Other concerns raised by fintech lenders in the Report include uncertainty resulting from litigation involving the “valid when made” doctrine and “true lender” related litigation. The Report suggests that pursuing Industrial Loan Company Charter or the OCC’s special-purpose national bank charter as a possible solution for fintech lenders’ multistate operations under homogenous rules. However, the Report acknowledges that such charters would subject fintech lenders to more direct prudential regulators supervision.
Small Business and Consumer Protection Concerns. The Report identifies several small business and consumer protection concerns related to fintech lending. These include, the extent of transparency about loan terms and conditions, data accuracy and privacy concerns, fair lending concerns and the potential for high interest rates.
Use of Alternative Data. The Report finds that fintech lenders use alternative data in varying degrees in the underwriting process and for fraud prevention. The Report defines “alternative data” as “any information not traditionally used by the three national consumer reporting agencies when calculating a credit score.” Such alternative data may be comprised from a combination of financial and non-financial alternative data. Examples of financial alternative data include, rent payments, utility payments and examination of cash flow. Nonfinancial alterative data examples include educational background, social media activity and internet browser history.
The Report identifies several potential benefits from the use of alternative data in loan origination process, including:
- expansion of credit availability for consumers without traditional credit;
- enhancement of the assessment of applicants creditworthiness that may lead to lower cost of credit;
- facilitation of faster credit decisions that improve borrowers convenience; and
- assistance in verifying borrower’s identity and fraud prevision.
However, the Report also identifies potential risks that can arise through the use of alternative data. Such risks include:
- Disparate impact and other fair lending issues due to criteria selected as alternative data;
- Lack of transparency as to what alterative data is used, raises concern as to whether applicants have the ability to maintain and dispute the accuracy of the alternative data;
- The reliability of alternative data;
- Untested performance during credit cycle, and particularly economic downturn; and
- Cybersecurity and privacy risks that could result from the aggregation of vast private consumer data in electronic form.
Importantly, the report concludes that federal financial agencies have not specifically and clearly provided written guidance on the appropriateness of using of alternative data in lending process. For example, the Report states that federal financial agencies did not provide to date written guidance on how to use alternative data without raising fair lending concerns, or prudential regulators have not specifically instructed bank management on how it should monitor third party use of alternative data and assess any associated risks.
The Report recommends that federal financial regulators provide written guidance to fintech lenders and to banks partnering with fintech lenders on the appropriateness of use alternative data in the loan underwriting process.
Fintech lenders and banks partnering with fintech lenders should anticipate that federal financial regulators will begin focusing on the issues and concerns raised in the Report in the near future and likely reach out to stakeholders for information. Fintech lenders and partnering banks should consider the Report’s finding and attempt to come up with a framework to address the concerns raised in the Report, be prepared to provide meaningful feedback to regulators request for information and help direct and shape future policy in a way that best preserves the fintech lending industry’s ability to continue deliver innovative lending products and services.
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