David Price of the Federal Reserve Bank of Richmond was kind enough to send me a link to the an article by Tim Sablik in the latest edition of the bank's "Econ Focus" magazine called "Tomorrow's Lenders?". It's actually about some of today's lenders: online lenders, part of the "fintech" movement that promises to disrupt the banking world as we old-timers have known it. I recall predictions from pundits in the late 1990s that internet banking would replace bank physical branches by the end of the last decade. Nothing seems to move as quickly as true believers wish, does it? Nevertheless, Mr. Sablik cites a University of Chicago study that states that "online lenders more than tripled their lending volume between 2104 and 2015," most of it to consumers. The article explores both the potential risks and potential benefits of this "new wave" of online lending.
Sablik notes that banks have traditionally acted as middlemen, taking deposits from savers and making loans to borrowers. The source of the money made to make the loan and the borrower never met. While some online lenders (called "balance sheet" lenders by Sablik) follow closely the traditional model of acting as middleman, others, like Prosper, directly connect lender and borrower, often using traditional financial institutions to actually make the loans and then buying the loans from the originator. The alleged advantage of online lenders is cost and speed, which they leverage by operating with minimal physical infrastructure and by using "advanced algorithms" to make quicker (but, allegedly, sound) underwriting decisions.
While online lenders hope, by "analyzing new sources of consumer data," they may be able to lend to a wider array of previously underserved borrowers. Sablik asserts that, thus far, "the typical borrower at an alternative lender looks like the typical borrower at a traditional bank." However, what, thus far, appears to be an advantage for some alternative lenders is that they have been able to identify low-risk borrowers better than your average bank of credit union. Still, many other new wave lenders are going after consumer with less-than-pristine credit histories (or little credit history), and small business borrowers who have traditionally been the meat and potatoes of community banks. As to the latter, Sablik cites another Econ Focus article that we discussed last August, that noted the dearth of de novo banks and the effect that was having on small business borrowers. As notes, banks of all sizes have pulled back on small loans to small businesses, which are the just the types of loans that small businesses need to grow. Also, the loan application process at commercial banks has become cumbersome and slow. Alternative lenders are trying to fill the gap, with availability, speed, and ease.
The article also states that weighing against availability and convenience is the fact that, thus far, the rates on alternative loans appear to be higher than those made by traditional banks. When your options aren't plentiful, or you need the cash and you need it NOW, then paying higher rates may not be an impediment. Nevertheless, Sablik discusses the potential state law usury problems that have arisen, in some cases compounded by the Second U.S. Circuit's Madden v. Midland Funding decision that upset the apple cart regarding the continued "exporting" of interest rates when loans made by a bank are sold to a nonbank. An evenly divided US Supreme Court's decision not to hear the appeal of that decision last June has put a potential fly in the ointment, at least until The Orange Lord appoints the late Justice Scalia's successor to the SCOTUS and the issue can make its way back up the food chain.
Another uncertainty is regulatory oversight. The FDIC plans to give online lenders' bank partners a closer examination. Let's hope that does not result in the laying on of hands, especially in the neck area, although scrutiny of third party relationships has been a hot button with all the federal regulators for some time now. It goes with the territory. The OCC has announced plans to consider a "fintech charter" for nonbanks, but recent discussions with the OCC by people within my sphere of professional blathering indicate that the OCC will be deliberate in approaching this subject and, at any rate, since the current Comptroller's term is up in March, not much movement will take place on the subject until his successor is appointed and has a chance to focus on the issue and give his strong preference for, opposition to, or complete inertia with respect to, a national fintech charter. The Conference of State Bank Supervisors recently came out with a statement that alleged that the establishment of an OCC-granted fintech charter would hasten to arrival of the anti-Christ, so you can expect that sector to remain solid in its opposition to a one-stop-shop for all things "fintech."
Sablik concludes that although "its too early to tell" what form online lending will eventually take, he thinks that banks that don't have their head buried in the sand will be exploring how what fintech does well can be of value to them when married to what the bank does well. He notes that one huge competitive advantage for banks is that most have a whole lot of something that fintech wants: customers. Barring another choke-point-like coma induced by the regulators, partnerships like the JPMorgan Chase-OnDeck alliance may become a common template. The likely evolution of online lending may be much more "baby steps" than "revolution."