The Federal Deposit Insurance Corporation's (FDIC) publication of an article highlighting the risks for banks that partner with marketplace lenders further underscores the focus of federal regulators on marketplace lending. Featured in the FDIC's Winter 2015 Supervisory Insights, the article reflects the FDIC's recognition that "[m]arketplace lending is a small but growing component of the financial services industry that some banks are viewing as an opportunity to increase revenue."
In the article, the FDIC emphasizes that it expects banks partnering with marketplace lenders to conduct thorough due diligence and ongoing monitoring to ensure that lenders are complying with applicable legal requirements, such as consumer protection and anti-money laundering laws. Although the most well-established banks in this space already are doing this, we anticipate that the FDIC article will result in bank partners increasing their scrutiny of marketplace lenders with which they do business. All marketplace lenders therefore would be well-advised to revisit their programs so they can demonstrate federal and state compliance to their bank partners.
For purposes of the article, "marketplace lending is broadly defined to include any practice of pairing borrowers and lenders through the use of an online platform without a traditional bank intermediary." The article anticipates the use of two structures by marketplace lenders to originate and fund loans—a "direct marketplace lender" framework in which a non-bank company lends funds directly to the borrower and issues notes to investors who provide such funds, and a "bank-affiliated marketplace lender" framework in which a non-bank company partners with a bank that makes the loan and, after buying the loan from the bank, sells notes to investors who agreed to fund the loan.
The article highlights the following risks associated with marketplace lending:
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Third-party risk. A bank should consider whether the proposed activities are consistent with its overall business strategy and risk tolerances. To that end, the FDIC encourages bank management to develop a strong understanding of its partner's business model, establish contractual agreements that protect the bank from risk, regularly monitor the non-bank partner, and require the partner to take corrective action to address gaps or deficiencies. The FDIC states that such due diligence may result in banks "requiring policies and procedures from the marketplace lending company with respect to legal and regulatory compliance prior to the bank's investment or before any services are offered." Banks are also advised to conduct ongoing monitoring and "expect marketplace lenders to undergo independent audits and take corrective action on audit exceptions as warranted."
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Compliance risk. Banks are advised to conduct appropriate due diligence and monitoring to validate that its partner is complying with applicable federal and state laws, such as consumer protection, fair lending, and anti-money laundering laws.
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Transactional risk. The FDIC observes that high levels of transaction risk can arise from large loan volume, document handling, and movement of funds between institutions or third-party originators. Banks are advised to anticipate risks that could arise from problems with customer service, product delivery, technology failures, inadequate business continuity, and data security breaches.
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Servicing risk. Noting the potential risks to investors created by the insolvency of a marketplace company that services the loans, the FDIC advises banks that, before investing in marketplace loans, they should assess the company's creditworthiness and solvency and determine whether back-up servicing agreements are in place with unaffiliated companies.
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Liquidity. The FDIC observes that there is a limited market for resale of marketplace loans.
While some have expressed alarm at the FDIC article, we note that most banks participating in marketplace lending are supervised by the FDIC, which we take to reflect a level of acceptance by the FDIC, and currently take the FDIC guidance at face value, as advice concerning the right way to engage in a program of this type.
Marketplace and bank-model lending already have attracted the attention of the U.S. Department of the Treasury, which issued a request for information regarding online marketplace lending in July 2015, and the Consumer Financial Protection Bureau, which sent multiple representatives to a recent industry-sponsored conference, and has been sharpening its focus on small business lending, and state authorities in California, Maryland, and Pennsylvania.
