Online lenders have not been feeling a lot of love lately, at least not from regulators and other consumer watchdog groups who are wary of the industry.
Though the industry has grown explosively in the past few years, making an estimated 1 million loans worth about $12 billion to consumers and small business owners, so too have questions and complaints.
This summer the U.S. Department of Treasury announced it was seeking comments on how to update regulations for alternative online lenders, to keep up with the growing sector. A policy paper released last year by former U.S. Small Business Administration head Karen Mills raised questions about how best to regulate the market, which provides critical financing for a gap that banks aren't filling, and who the appropriate regulator should be. On Monday, the New York Times published a blistering report about the lending practices of some of the leading alternative finance companies, including Inc. 5000 companies Lending Club and OnDeck, and cited a Moody’s report that compared the industry to the mortgage industry and its risky lending practices in the lead up to the 2008 financial crisis.
But online lenders say they’ve been unfairly painted as reckless villains, and they want to set the record straight. They also say they have their own skin in the game when it comes to making loans. They also affirm that they care about their customers and that they are regulated almost as much as banks. And in areas where they are not required to protect their customers, they said they are making efforts to put protections in place.
“The story was inaccurate in the sense that we are just as regulated on the borrower side as any bank,” says Renaud Laplanche, founder and chief executive of Lending Club, who referred to the recent story in the New York Times.
The Heart of the Debate
Just where online lenders fit in the regulatory scheme of things is a matter of ongoing debate. And to sort things out, I turned to Brian Riley, principal executive advisor and an expert on emerging payment technology at CEB TowerGroup. He said the regulatory world around online lending is indeed unclear, especially when it comes to making small business loans.
On the consumer side, the lenders must adhere to numerous federal regulations. The two most prominent are Regulations E and Z. The former protects consumers in electronic transactions, and the latter involves the so-called truth in lending laws, which govern terms and cost of loan products.
Online lenders, however, don’t hold deposits, so they aren’t covered by Federal Deposit Insurance Corporation (FDIC) coverage, nor are they governed by the capital requirements that banks must adhere to in order to cover for loan losses. And that could potentially push some alternative lenders to be overly aggressive, Riley says.
And protections for small businesses are particularly weak.
“It gets sticky when you go down the food chain in alternative lending,” Riley says. “Many of the regulations that protect consumers don’t apply to small businesses, because businesses are supposed to be more sophisticated with dealing with lenders.”
Lenders Sound Off
In effect, consumer-only lenders like Avant, an Inc. 30 Under 30 company, may have an easier time of things, because it has more clarity on what it can and can't do.
Still, Al Goldstein, chief executive and founder of Avant, which has made 300,000 loans to consumers in the past three-and-a-half years, with an average value of $8,000, says the portrayal of the industry as recklessly making too many loans is flawed. For his part, he says the company has a vested interest in making good loans, as it holds 50 percent of its loans on the books. (The other 50 percent are bought by investors in a marketplace.)
“Our future profitability is tied up in the loans we make,” Goldstein says. “And we hold the same loans that the investors do.”
Additionally, Goldstein says the company attempts to be as transparent as possible about terms with customers: It doesn’t charge origination fees, and it gives consumer choices about how they want to pay--which includes direct debit, paper check, or online payment. That last point is important because some critics have accused online lenders of forcing their customers to accept automatic payment withdrawals from their bank accounts, which can cause cash flow issues for struggling businesses.
By contrast, alternative lenders who cater to small business owners may encounter difficulties because of lack of regulatory clarity. Such lenders may, for example, not be as transparent as they could be regarding interest rates, fees, and repayment terms. And they could push borrowers to take out loans that are larger than they need. OnDeck, which has been embroiled in lawsuits involving its daily direct debit payments from the bank account of businesses that had declared bankruptcy, is one example.
In August, a North Carolina judge reportedly rebuked OnDeck, calling the company "particularly willful and malicious", for continuing to debit payments from a new bank account set up by Wayco Ham, of Goldsboro, after it had filed for bankruptcy. The judge had not given OnDeck permission to do so, as the ham company reorganized.
OnDeck says it has rectified the conditions that led to that lawsuit and others, and adds it makes every attempt to be clear with its borrowers about terms and conditions, including publishing its lending principles on its website to establish best practices and transparency, including about interest rates, fees and other loan terms.
“When it comes to transparency, we believe the key consideration is whether a small business owner can clearly understand the credit product and assess if it is a proper fit for their business need or use case,” OnDeck said in an emailed statement.
Finding Common Ground
And enough lenders were concerned about this regulatory murkiness around small business lending to come together in August to offer entrepreneurs something called the Small Business Borrowers' Bill of Rights. Spearheaded by more than two dozen lenders and small business advocacy organizations, including Lending Club, Funding Circle, the Aspen Institute, and the Small Business Majority, the bill requires transparency about pricing and fees, fair treatment of borrowers and responsible underwriting, as well as clear language and easy-to-understand terms.
(OnDeck, however, is not among the signatories. In a statement, the lender said it has published its own set of core principles for lending, and said it was “continuing to review and consider the best way to advance comprehensive industry-standards that take into account the full range of responsible credit products that serve small businesses.”)
Just the same, it’s seen a stop-gap measure, while regulating bodies attempt to catch up.
"Small business owners are seeing the number of alternative sources for financing their companies grow at an unprecedented rate, and while this is a good thing in terms of increasing access to capital, borrower protections have not caught up,” Mills said last month while introducing the borrowers rights bill in Washington. “Seeing industry and other stakeholders take responsible steps like this toward ensuring the basic rights and safeguards is noteworthy and will help shape the dialogue going forward in a way that protects America's small businesses, without stifling innovation and access."