Finance

Lisa Abramowicz is a Bloomberg Gadfly columnist covering the debt markets. She has written about debt markets for Bloomberg News since 2010.

Innovating in banking is easy compared with regulating it.

One of the most promising developments in the buzzy "financial technology" realm, the one that is supposed to usurp traditional banks, was peer-to-peer lenders. These firms electronically match up people with money to lend to people who want to borrow. Internet businesses such as LendingClub and Prosper Marketplace were all the rage, the bright shiny future of banking.

And then the shiny future ran into the stodgy present in the form of regulators. These online lenders are not considered banks and therefore need to comply with the standards of 50 individual state overseers rather those of a single centralized regulator. 

To avoid becoming mired in compliance purgatory, these internet-based marketplaces have teamed up with big banks to underwrite loans for them. But this may not work anymore as a shield from local laws about usury and loan standards, according to a recent court ruling in Madden v. Midland Funding. The biggest online lenders are scrambling to ensure their business models still work.

This is no way to to usher in a new era of banking. The Office of the Comptroller of the Currency agrees and last month released a white paper on the issue. It proposed that these online lenders become special purpose national bank charters, in the mold of some trusts and credit card operators. The goal is to pull them under a federal umbrella, allowing them to adhere to one set of standards rather than a piecemeal, state-by-state approach.

Not so fast, New York regulators said. They wholeheartedly rejected the OCC proposal in a note filed Tuesday, contending the existing setup works just fine. Not only that, but New York State Department of Financial Services Superintendent Maria Vullo rejected the idea that "fintech" was any sort of special innovation that required special consideration.

"Technology is not new to financial services,"  Vullo wrote in a response to the OCC. "Using the term 'fintech' to potentially sweep all nonbank financial services companies not authorized by the National Bank Act into a new regulatory regime is highly problematic." 

Vullo is correct on one narrow point, that it's wrong to treat the current online lending market as if it has already revolutionized banking. The biggest firms, including Lending Club and Prosper Marketplace, dominate the current "fintech" industry, and their originations to date hardly make a dent in U.S. capital markets. Lending Club, for example, has originated $22.7 billion in loans since it started operations in 2007, according to a November regulatory filing. Prosper Marketplace is responsible for about $8 billion of debt since its inception.

Lots of Loans
Lending Club, a dominant online lender, has seen its loan originations increase in recent years
Source: Company filings

That's a drop in the bucket compared with the $8.6 trillion U.S. corporate debt outstanding, or the more than $1 trillion in U.S. student loans outstanding. But it is the beginning of a shift in the way financial firms interact with clients.

The idea of a truly internet-based lender is novel, and it will most likely be a precursor to how big banks operate in the next decade. The largest banks certainly recognize this. They're starting their own internet-based lending sites, with Goldman Sachs recently rolling out its Marcus platform

Government officials recognize the potential. The U.S. Treasury released a report last year, for example, saying that online loan originations could reach $90 billion by 2020. And venture capitalists have been pouring a significant amount of cash into these firms. 

Perhaps the OCC's proposal isn't perfect, but it's a starting point for thinking in fresh ways about the direction of banking. New York regulators are right that doing stuff on the internet isn't new. And these online lenders have run into enough trouble to raise questions about how they should operate. It's not as if the securitization of loans never got anybody in trouble before. 

Internet-Backed Bonds
Online lending companies have rapidly increased the amount of loans they finance through securitization
Source: PeerIQ Research

But financial innovation is good and inevitable. Regulation needs to be innovative as well, if for no other reason than to protect people from threats yet unseen. Fifty separate rule-makers doing business as usual isn't anybody's idea of embracing the future. 

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story:
Lisa Abramowicz in New York at labramowicz@bloomberg.net

To contact the editor responsible for this story:
Daniel Niemi at dniemi1@bloomberg.net