The Treasury Department launched an inquiry into the marketplace lending industry on Thursday, seeking information on its business models, customers and ways firms should be regulated.
The move was the first public step by regulators in assessing the rapid growth of marketplace lending in the past several years and how such firms should be overseen.
For now Treasury appears to be in information-seeking mode, asking 14 specific questions about the industry and how it operates in a formal request for information expected to be published in the Federal Register soon.
One question was squarely aimed at securitization of marketplace loans, a nascent asset class: "...what advantages and disadvantages might a larger securitization market, including derivatives and benchmarks, present?"
The questions in general provide a glimpse of how regulators view the industry, signaling in which direction they may be headed.
Another question posed by Treasury is whether marketplace lenders should be required to retain any risk from the loans they originate or underwrite.
"To what extent, if any, should platform or 'peer-to-peer' lenders be required to have 'skin in the game' for the loans they originate or underwrite in order to align interests with investors who have acquired debt of the marketplace lenders through the platforms?" Treasury asks
"How would the concept of risk retention apply in a nonsecuritization context for the different entities in the distribution chain, including those in which there is no pooling of loans?" Treasury further asks. "Should this concept of 'risk retention' be the same for other types of syndicated or participated loans?"
While Treasury didn't ask specifically about risk retention in a securitization, the topic is on the mind of asset-backed players and is bound to be addressed at some point by regulators. Unlike in other asset classes, the originator in a marketplace securitization isn't required to purchase the lowest rated tranche — the first to get hit in the event of losses. This gives marketplace lenders less skin in the game when it comes to the performance of their securitizations.
Risk-retention requirements outside of securitization would also likely prove problematic for large players like Lending Club, which has positioned itself more as a tech company than a financial firm.
"It would certainly have some chilling effect on the model that is there now," said Jo Ann Barefoot, a former top official at the Office of the Comptroller of the Currency and now a consultant to consumer finance companies. "Part of the strength of it now is the ability to run very light and lean and match up borrowers and investors."
Jaret Seiberg, an analyst with Guggenheim Partners, agreed that "some of the ideas that Treasury floats ... could be incompatible with the peer-to-peer business model."
"This includes requiring marketplace lenders to retain a portion of each loan they originate," he wrote in a note to clients Thursday.
Treasury is also seeking information about how marketplace lenders assess customers' ability to repay loans.
"This could be trouble for the marketplace lenders if Treasury becomes convinced that there is not enough focus on whether borrowers can afford their loans," Seiberg said.
Yet overall Treasury does not appear to be taking a negative view of marketplace lending. Indeed, some of its questions appear to recognize the role the business has played in helping small-business owners find funding through other avenues than regular banks. One question also specifically asks whether marketplace lending is "expanding access to credit to historically underserved market segments?"
"It's a model of how the government should be thinking about financial innovation," said Barefoot. "It's very positive and worthwhile. They are asking the right questions. They have a positive thought process underway on how to be nurturing of good innovation and yet alert to potential consumer harm."
Raj Date, managing partner of the consulting firm Fenway Summer and former head of the Consumer Financial Protection Bureau, agreed.
"It seems to me they're trying to catalyze a pragmatic, fact-based approach to articulating what policy levers might help marketplace lending achieve its promise, and avoid consumer-protection and investor-protection pitfalls," he said.
Isaac Boltansky, an analyst with Compass Point Research & Trading, said Treasury's request for information "serves as a clear signal that policymakers are both heartened by the promise of the burgeoning marketplace lending industry while still cautious regarding the existing regulatory framework."
"Policymakers are becoming increasingly interested in both the promise and peril posed by the marketplace industry, which suggests that additional scrutiny of the model's regulatory framework is ahead," Boltansky wrote in a note to clients Thursday.
Treasury also wants to understand marketplace lenders' ties to banks. Lending Club and many of its competitors continue to rely on banks to issue their loans, helping them to avoid getting licensed to lend in every state.
"Describe whether and how marketplace lending relies on services or relationships provided by traditional lending institutions or insured depository institutions," Treasury wrote. "What issues are raised with online marketplace lending across state lines?"
Additionally, Treasury asks what kind of operational risks marketplace lenders may pose.
"Describe how marketplace lenders manage operational practices such as loan servicing, fraud detection, credit reporting and collections. How are these practices handled differently than by traditional lending institutions?" Treasury wrote.
In a separate question, Treasury asks about the "privacy considerations, cybersecurity threats, consumer protection concerns and other related risks that might arise out of online marketplace lending."
"Do existing statutory and regulatory regimes adequately address these issues in the context of online marketplace lending?" Treasury asked.
One question Treasury does not explicitly ask is which regulator should take the lead in supervising marketplace lenders. Treasury's role is not typically that of a regulator, but it is unclear whether the existing bank regulators would have direct oversight. In Treasury's document, it says only that online marketplace lenders may be subject to rules promulgated by the CFPB and the Federal Trade Commission, among others.
"The innovation and technology that is coming at us is not aligned with the regulatory structure," Barefoot said. "There are all kinds of things coming that don't have a natural regulatoror natural home. If there were to be a regulatory step coming out of this, I have no idea which agency would own it, but it's not necessarily Treasury."
Date said that "Treasury is particularly well-positioned to help craft this conversation. They don't have a ton of formal authority per se, but they have the clout and credibility to convene a deliberative conversation among state and federal regulators, platforms, investors, and — critically — advocates for consumers and small businesses themselves."