A quieter, but still enthusiastic crowd arrived at Day 2 of Marketplace Lending conference. The room was nearly full as LendingClub’s Scott Sanborn provided the keynote. Highlights of the day included Raj Date’s session on ‘Innovation in Highly Regulated Environments,’ ‘How Partnering with Marketplace Lenders Can Help Community Banks Compete’, and ‘How to Navigate a Changing Regulatory Landscape.’
Mr. Sanborn focused on how rather than replacing the banks, Marketplace Lenders are working with them. Working together was the key message of Mr. Sanborn’s speech, and it was well received by the audience.
Next was Raj Date, who spoke on ‘Innovation in Highly Regulated Environments.’ Mr. Date led the Consumer Financial Protection Bureau (CFPB) for its first six months, and helped grow the organization from 12 people working in a sub-basement of the Treasury, to 1,200 people when he left. The CFPB is the regulatory agency people are most interested in; recommendations from the US Treasury (which released an RFI this summer about P2P lending) would likely come from the CFPB, as the Treasury is not a regulatory agency.
After noting the importance of wearing suits, Raj gave an overview of what’s going on. He noted that we’re at a special moment in financial services that won’t exist in 10 years:
- Tech Innovation – Bitcoin, blockchain, etc…
- Heightened Regulatory Requirements – Regulation is getting stronger
- Shifting Consumer Behavior – Plastic, mostly generational and driven by millennials, Mobile
- Capital Market Dislocation – Creating opportunity for firms that wouldn’t have a chance i.e. balance sheet businesses
- Digital Distribution: You can build your own technology and it’s a good idea. This hasn’t been the case previously, in fact it used to be a horrible idea.
- Rewired Financial Infrastructure: Much of the piping is now decades old, and you can circumvent or complement its breakthroughs. He cited the example of Align Commerce, which can move money at 1/4 time and cost. If it scales, it’s amazing.
- Next generation analytics: Modern analytics enable analysis of giant data sets that provide far better insights than they used to. We’ve moved past Log regression models that were state of the art in 2007.
- Capital-efficient Marketplace: AirBNB is the largest hotelier and doesn’t own rooms. Shift is the second largest auto dealer but doesn’t own any cars, etc…
Marketplace Lending takes advantage of the above four trends, and will continue to grow as nothing is more efficient than removing intermediaries.
Innovation is harder in Financial Services, especially with banks that must be ”bullet proof, platinum, and compliant”:
- Have to be compliant first
- The ‘stacks of paper’ banks use to document what they’re doing and how to do it can’t be upgraded every software release.
- Hard to have ongoing conversations with regulators
- Hard to put A grade talent on new things that will probably fail
- Hard to be disciplined when resources are not constrained
Regulatory arbitrage is mostly false: The CFPB was intentionally constructed to remove conduct arbitrage so that Financial Institutions have some of the same rules, even if they’re not a bank. Other regulatory agencies interested in Financial Institutions are the OCC, FDIC, and Fed (interested in compliance obligations when firms have to work with banks), there are still BSA/AML/Money Licensing requirements by state including the BitLicense in New York.
Banks still matter, and they always will:
- They have access to data
- Choice of law (One set of rules which is a huge advantage, and a permanent feature)
- Payments (Access to the payment network)
- Leverage (Can run at 10:1 leverage permanently, and it’s a huge advantage)
It’s difficult to regulate in industry where things change quickly. Regulators must acknowledge that problem is real and:
- Engage – spend time with investors, and customers that are one million times smaller as that’s where change is driven. Otherwise it will be invisible until it’s too late. You can’t well regulate ideas you’ve just heard about.
- Assert principles early: Agencies should put a stake in the ground early, as long as they know they may be wrong and have to revisit.
- Make exceptions – Regulators have discretion with how statutory obligations are made. Use this to ensure things aren’t burned out down the line.
Session: ‘How Partnering with Marketplace Lenders Can Help Community Banks Compete.’
Summary: This session focused on two banks who decided to partner with LendingClub to provide consumer loans. Neither BankNewport or Coastal States Bank previously offered online applications for loans.
BankNewport left consumer loans 20 years ago, because they were doing it the old fashioned way with manual underwriting, and decline rates of 80-90%. This led to an unhappy customer base and a money losing area for the bank.
Coastal States Bank had not previously done consumer loans, but knew they wanted to be in the space. However, they didn’t have the resources or time to build their own. They wanted to find a partner, and did.
Andrew Deringer explained how LendingClub provides banks with a cost advantage by utilizing technology. It’s hard to offer small dollar loans the old fashioned way, but it’s possible in the new way.
Brian Graham mentioned that Community banks don’t get involved with lending out of fear of regulation, but due to scale. Bank alliance is a co-op network of community banks designed to solve problems for each bank; it provides the scale to take advantage of things like a partnership with LendingClub.
Finally, Messrs. Merrill Jr. and Langs mentioned both had successfully gone through audits. Regulators asked questions, but were happy there was a new product for the community that they didn’t have access to before- regulators were happy banks were serving their communities. In addition, regulators wanted to ensure banks had done their due-diligence, including:
- Vetting it internally
- Updating processes
- Executive and board buy-in
Session: How to Navigate a Changing Regulatory Landscape
Connor French mentioned that Small Business lending is down 18% since 2008. The cost of underwriting $250k-$500k loans makes it hard for banks to make money.
Mr. French also discussed the most pertinent existing regulation:
- Madden vs. Midland
- True Lender Cases
Joe DePaulo spoke about how just because an algorithm is deciding whether or not to lend, doesn’t mean it doesn’t discriminate. Rather than looking at unique metrics that may not pass muster with a regulator, it’s better to use the information on the credit file- a majority of which isn’t used, as no investor would want you to look at non-financial information vs. financial.
Connor French disagreed with the statement that Marketplace Lending is regulatory arbitrage, and spoke forcefully on why they’re subject to large amounts of regulations for both lenders and investors.
- As a direct lender, they’re subject to state licensing and usury laws
- Difficult to calculate state laws on usury based on rate cap
- AML on both lender and borrower
- Were heavily regulated by the SEC, which shut down Prosper for a time. Since then, the SEC has taken less aggressive stance and regulation has focused on the borrower side and is led by the CFPB
Small Business Borrower Bill of Rights: Put forth by Funding Circle and others. It stemmed from a fear of potential of bad actors. By working together and encouraging others, created a standard to prevent bad actors and the ability to point to those who fail to meet it. It calls for:
1) The ability to make apples to apples comparison when offering credit
2) Articulate annualized interest rate
3) Prepayment penalties must be disclosed.
Andrew: Regulators are big fans of self-regulation. However, they don’t want window dressing, they want back-end policing. Regulators publicly say they love it, but privately they say it’s only as good as it’s teeth.
Finally, the session closed with a joke and truthful comment by Connor that any player claiming they make loans based on yelp reviews is lying, they’re doing it on FICO stores, but saying otherwise for publicity.