The Romance and Reality of the New Financial Technology (Fintech) Companies

Technology is enticing. It’s fun. It can make life easier. With a click of a button, consumers can purchase items instantaneously and have them delivered within hours to their doorstep. […]

Technology is enticing. It’s fun. It can make life easier. With a click of a button, consumers can purchase items instantaneously and have them delivered within hours to their doorstep. But in the lending industry, can technology and online platforms thoroughly and quickly serve borrowers, or is it an inherently complicated business that requires care, deliberation, and a high-touch process?

Borrowing significant sums of money is a complex financial transaction. For many consumers, particularly low- and moderate-income consumers, it is the most complicated transaction they will ever undertake. Executed responsibly, lending can empower consumers and enable them to build significant equity. Executed irresponsibly, lending can result in financial ruination. And given its complexity, lending often requires significant amounts of counseling and underwriting to ensure that borrowers can afford the loan and make payments. A click of a mouse and fancy algorithms are often no substitute for patient counseling and careful underwriting, particularly for those unfamiliar with lending and not possessing an established credit history.

Recently, the federal bank regulatory agencies have been asking the public for comments on the role of technology in banking and whether the agencies should facilitate the development of so-called fintech companies that feature on-line applications for loans and other products. But before the agencies support fintech companies, careful research and assessment is necessary.

A recent Treasury Department paper examining online lending indicates that a key feature is loan approval within 48 to 72 hours. The allure of this feature has helped fuel a boom in the so-called “fintech” industry. In its white paper, the OCC estimates that fintech companies in the United States and the United Kingdom increased to number more than 4,000 and that investment in fintech companies has surpassed $24 billion worldwide. Fintech companies tout up-and coming-technology that appears particularly well suited to the Internet and digital proclivities of the Millennial generation now starting to enter their prime earning years and pursuit of homeownership.

Ominous signs, however, counsel caution regarding a regulatory embrace of fintech. 

A recent survey of small businesses by several Federal Reserve Banks reveals that 20 percent of small businesses obtaining credit used online lenders and that microbusinesses used online lenders to a greater extent. However, online lenders received low satisfaction scores. Only 15 percent of small businesses using online lenders were satisfied. Small businesses complained about lack of transparency and unfavorable repayment terms. Seventy percent of those unsatisfied complained about high interest rates.

Investments are slowing down in fintech. In the wake of the Lending Club scandal, investors are increasingly concerned about the online and fintech model and how well it can withstand recessions as well as healthier economic times.

One basic problem is that most of the new fintech firms are not regulated by federal or state agencies. Without adequate regulation, many of the new firms have been tempted to profit by deceitful and abusive lending practices. Most of them are not banks and do not fall under the purview of the Federal Reserve Board, the Federal Deposit Insurance Corporation, or the Office of the Comptroller of the Currency (OCC). Also, most of them are not mortgage companies and are not regulated by the Consumer Financial Protection Bureau (CFPB) or state agencies.

Prompted by this regulatory vacuum, some agencies such as the OCC are considering their role vis-à-vis fintech companies. The OCC has gone so far as to contemplate offering them a limited purpose charter should a fintech decided to become a bank and seek a federal charter. However, the difficulty with a limited purpose charter is that banks with those charters tend to be lightly regulated. For example, the Community Reinvestment Act (CRA) examinations of banks with limited purpose charters do not examine the retail lending of these banks, although some fintech companies make billions of dollars of loans!

If the federal agencies wish to regulate the fintech companies, they must commit to vigorous CRA exams, compliance exams (testing adherence to consumer protection law), and fair lending reviews. Moreover, the playing field must be made level so that all lenders adhere to uniform anti-predatory lending law and regulation like the Qualified Mortgage (QM) rule promulgated by the CFPB. If all types of lenders complied with uniform rules, they would compete based on affordability, suitability, and sustainability of products instead of some lightly regulated lenders taking advantage of their status by fooling consumers with seemingly convenient products that are in reality predatory.

Finally, the agencies should conduct data analysis to compare the CRA and fair lending performance of traditional lenders to the fintech companies. Who is really reaching the largest percentage of minority and low- and moderate-income borrowers with safe and sound loans? NCRC has argued that the presence of physical branches continues to be a critical component of access to credit as documented by previous research. New research comparing fintech companies to traditional banks with branches would likely find that the traditional approach is the most effective in reaching underserved borrowers with the best performing loans exhibiting the lowest default rates. Before the romance of technology blinds us, we need to do careful analysis of what type of lending we should be promoting.

And a click of the mouse is not substitute for careful and comprehensive regulation of the financial industry.

(Photo credit: Michael Mol, via flickr, CC BY 2.0)

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