The regulatory system that oversees the financial technology sector is a bunch of different agencies and inconsistent rules. Karen Mills and Brayden McCarthy propose a six-point plan to regulate credit online.
by Karen Mills and Brayden McCarthy
The election of Donald Trump shifted Washington’s political debate on financial services overnight. Recent signs, such as the words of the President-elect and those of the GOP leaders, show that further efforts have been made to lift the Dodd-Frank Act. What is missing in the debate, however, is the only area of financial services where common sense regulation is welcome and necessary: online business credit.
Online loans have exploded in recent years. Dozens of fintech players such as OnDeck, Kabbage and Funding Circle have been formed. Rather than spending hours filling in documents, borrowers can complete requests in minutes, reducing approval times to days or even minutes. And in cases where borrowers want to shop and compare a variety of options in one place, they can use markets like Fundera or QuickBooks Intuit Financing for a unique business experience.
Not to be outdone are established providers such as JPMorgan Chase and Wells Fargo, which also provide online loans and work in part with emerging FinTech players. Overall, Morgan Stanley (pdf) estimates that online lending to small businesses will increase by 50% per year by 2020, with an affordable $ 280 billion market.
It’s music in the ears of small businesses. Our study shows that there is a large credit gap for small businesses, especially for loans of less than $ 100,000, the size that more than 60% of small businesses want, and the size of their size. Loans offered by fintech players.
The problem is that loans for small businesses are not regulated, especially with regard to the protection of borrowers. For example, safeguards such as the Truth in Lending Act allow consumers to disclose the credit, but if the same consumers apply for a commercial loan, they are left behind. The lack of universal corporate credit disclosure is particularly important given the rise in online credit, as online lending can carry high prices with annual rates above 50%.
But that’s not the whole story.
Our regulatory system was also an unnecessary obstacle to the growth of financial technology players and banks trying to work with them. No federal agency has the power to oversee business loans. Instead, there is a spaghetti soup of at least seven agencies with overlapping responsibilities and viewpoints. As a result, small online lenders are governed by a costly and time-consuming patchwork of government supervision, often with inconsistent rules that can restrict online lending to state silos, undermining a national market.
As the Congress and the new president endeavor to streamline financial regulation, they should consider our six-point plan, which was featured in our Harvard Business School working paper published today: Innovation and Technology and Regulatory Implications (pdf). The aim is to create the first principles of a legal framework for the sustainable growth of small business loans.
1. Create a national non-bank charter option for online lenders
The Office of the Comptroller of the Currency (OCC) should allow online lenders to apply for a special non-bank charter that allows the state’s right of first refusal. The Internet is not tied to a state, and the online credit market is no exception – regulation must reflect this new reality. However, supervisors should not simply apply all federal laws associated with a national banking charter to non-banks. Rather, supervisors should carefully consider which aspects of bank credit balancing should apply to online lenders by ensuring the business strength and recognition of the vital innovation that newcomers bring to lending to small businesses. Most existing banking laws were designed at a time when online loans did not even exist, let alone the fastest growing segment of the market.
2. Set universal rules and guidelines to improve borrower protection
An important prerequisite for a national charter should be the creation of new, generally enforced rules that protect small businesses. If the fintech players are offered a national regulatory option as a proverbial carrot root, the respect of the Common Sense Bans could be the key. This is important because the lack of rules requiring universal disclosure allows lenders, including traditional banks, to inconsistently credit terms and costs. Regulators should demand clear and precise disclosures and let borrowers decide what works best for them. Information on models developed in the online small business lending sector, including the Fundera credit market model and the SMART box on long-term lending, is in the right direction and could provide a useful foundation.
3. Development of common guidelines for bank fintech partnerships
Partnerships between banks and new entrants should increase with regulatory approval. This can be beneficial for online lenders, banks and borrowers who both want to service lenders.
For example, when large banks turn down small businesses, they leave them on their own to settle complicated loan options for other banks or online lenders. Another solution could be partnerships where banks finance the small businesses they want and refer those who can not finance them to an external fintech partner.
Although this practice in the UK has become law on this side of the pond, the recent OCC and Federal Deposit Insurance Corporation (FDIC) policies would make these partnerships expensive and complicated to implement. , In order for these partnerships to flourish, clear, coherent and non-overlapping rules must come from the various agencies that already have relationships with third parties. Letters in which nothing is done could be useful tools as they would allow supervisors to assure lenders that new products or partnerships are legal and no enforcement action is needed.
4. To highlight the bad players with better data on the results of the borrowers
We lack market-wide data on the evolution of lending to small businesses. Survey data, small business administration data and anecdotal information exist, but they are dull tools and offer a limited view of supply and demand, often years back. The lack of quality data means that policymakers and regulators are blind in trying to assess the scale of small business credit problems and finding and measuring solutions. With the arrival of another credit crunch, this could prove catastrophic.
The Office of Consumer Protection (CFPB) has the authority to collect basic data on small business loans, including origin, shares and other data deemed useful by Dodd-Frank in section 1071 of Dodd-Frank, the bureau. “We believe that CFPB should use this authority to highlight the bad players of small business loans, whether online or offline, including the requirement of disclosure of product results, such as average rates and rates of failure Allowing observers and the market to evaluate bad actors.
5. Comply with loyalty obligations
Small credit intermediaries are generally not taken into account by the supervisory authorities and, apart from fair credit laws, are not subject to any supervision by the Federal Government. Few states need brokers to obtain licenses. The problem is that brokers can add significant costs to the loan and are not required to disclose their fees or conflicts. And brokers account for three-quarters of all credit granted by some major online lenders, partly because it can be difficult to find creditworthy borrowers.
The subprime crisis has highlighted the dangers of brokers not taking care of themselves. Like mortgage brokers in many states and, more recently, brokers at the federal level, small credit brokers should act in the best interest of the borrowers, in compliance with fiduciary disclosure requirements, loyalty and caution. More importantly, brokers should strive to reduce or eliminate distortions as much as possible, expose conflicts that jeopardize their impartiality, and clearly allocate the fees they add to loans.
6. Creation of a National Advisory Council on responsible financial innovation
We are aware that the creation of a National Advisory Board is all too often a substitute for real action. But in this case, it would be a means for a broader target and a key precursor to a more coordinated regulatory approach to financial services supervision. Industry should be involved and brought to the table to ensure that it has a consistent mechanism to provide suggestions and advice on how new rules hinder or hinder innovation.
Fintech will benefit from targeted regulation
The debate in Washington may have changed, and the word “r” – that is – could become a non-starter, but this stunning view misses important questions. Finally, the financial crisis has made it clear that regulatory vigilance and financial innovation must exist in tandem and in dialogue. This also applies to the increase in online credit. Targeted regulation is needed to better protect small businesses from predation and strengthen the accountability of emerging financial technology players.
Our regulatory action plan sets out the first principles that regulators should follow in order to achieve these goals and ultimately to improve the efficiency of the small corporate bond market. This will help small businesses to focus more on what they do best: grow their business, create jobs and continue to play an important role in the US economy.