LendingClub Is Ruining It for the Rest of Fintechby
Scandal complicates conversations with regulators, lawmakers
Executives are quick to explain differences between companies
Washington lobbyists for online lenders have a new challenge: LendingClub Corp.
Scandal, fleeing investors and a subpoena at the high-profile financial-technology firm aren’t the only bumps in the road. A U.S. Treasury report last week recommended stricter scrutiny of fintech firms, which have mostly been regulated until now only on the state level. In recent weeks, a major bank stopped buying debt from Prosper Marketplace Inc. and losses mounted at On Deck Capital Inc.
All that woe made it tougher for executives like Kathryn Petralia of Kabbage Inc. to argue that the industry should be spared from rules that would make it more difficult to lend on the Internet to small businesses.
“LendingClub is kind of a bummer,” said the co-founder and chief operating officer of the Atlanta-based Internet lender, who was in Washington for meetings with government officials. “It’s been quite a week.”
Quite a decade, too. Starting from nearly nothing, tech companies looking to bypass traditional banks by lending money over the Internet have grown to more than $20 billion in U.S. loan volume in the last year. That could climb to $120 billion by the end of the decade, according to Morgan Stanley research.
Online loan companies have slowly built a ground game in Washington to match their growing presence in American finance. Now they’re drawing a line in the sand between the industry’s different business models. Not surprisingly, LendingClub is frequently on the other side of that line.
The lobbyists’ message: Some companies abuse customers, others don’t. Some make loans to small businesses, and they should be subject to different rules than firms that lend to individuals. Some use their balance sheets to finance, while others arrange loans by matching borrowers and investors. Some should be called online lenders, others loan marketplaces.
Companies have banded together to tout their transparency and responsibility -- earlier this month, Kabbage, On Deck and others were the latest to form a trade group. Now they’re all trying to avoid the stain that’s seeping through fintech.
Offense to Defense
“The industry has to shift from playing offense to defense right now in Washington,” said Isaac Boltansky, an analyst at Compass Point Research & Trading. “They’re drawing the wrong kind of attention and it plays into the burgeoning fears in D.C. that this model is untested and therefore warrants additional scrutiny.”
LendingClub has been drawing its own lines in Washington. The company helped start a trade group, whose members include Prosper and Funding Circle Ltd., and has worked with other companies on ways to improve transparency in the industry.
LendingClub continues “to lead the industry in its dialogue with policymakers and regulators on best practices for borrowers,” said Richard Nieman, LendingClub’s head of regulatory and government affairs. It’s critical that its focus on responsible innovation doesn’t get lost in the recent headlines, he said.
Sarah Cain, a Prosper spokeswoman, and Jim Larkin, of On Deck, declined to comment.
Online lending makes up a fraction of outstanding loans in the U.S. But the industry’s fate is part of a broader debate over fintech, a catchall word for new technologies changing everything from consumer payments to trade settlements. Fintech issues have captivated the capital, where policymakers are under pressure to adopt rules that ensure safety without stifling innovation. The future of finance is at stake -- as well as $13.8 billion of investment that poured into fintech companies last year, according to data from CB Insights and KPMG International.
“Fintech is definitely the new hot topic in town,” said Jackson Mueller, a Washington-based financial policy expert at the Milken Institute.
Agencies have taken only baby steps toward oversight. The big question, so far unanswered, is who should be in charge. The contenders: the Office of the Comptroller of the Currency, the Consumer Financial Protection Bureau and the Federal Deposit Insurance Corp. The Federal Trade Commission and the Securities and Exchange Commission are also keeping an eye on the industry.
Clarity on Rules
In Congress, Republicans mostly aim to help tech firms avoid what they fear could be too much regulation and get clarity on what rules they should follow. Democrats are generally more concerned about risks the new systems pose.
In a climate of such uncertainty, cocktails are called for. At 5:30 p.m. on a recent Wednesday before the LendingClub turmoil, happy hour at Mango Tree, a trendy Thai restaurant in downtown Washington, was packed. Dozens of people had gathered at one of the city’s many fintech-themed networking events that have sprung up in recent months.
The gathering exposed yet another divide in the fintech debate -- between the financial and the technology. As if to demonstrate the split, representatives of the two industries gravitated to opposite sides of the room. In the middle of the bar, apparently more accustomed to fraternizing with frenemies, was a bipartisan group of Capitol Hill staffers. But by the second round of drinks, the groups were mingling.
Bridging the divide between banks and nonbanks elsewhere in Washington may take more than a couple gin-and-tonics. Despite escalating calls from both sides to work together, alliances remain fuzzy. Some banks and industry groups like the American Bankers Association have pushed regulators to clamp down on fintech firms. Banks like Wells Fargo & Co. are building their own competing online lending businesses. Others, including Regions Financial Corp., Banco Santander SA and JPMorgan Chase & Co., are working with them. And sometimes, banks that invest also lobby against.
At Mango Tree, one Republican joked that a fintech lobbyist phoned to warn him that his client would be showing up at a congressman’s office dressed not in a suit and tie but in blue jeans and a t-shirt. A lobbyist told the story of a congressman who took a tour of a fintech office, only to ask at its conclusion, “So what is it you build here?”
What they’re building is a new way to lend money using algorithms to determine a borrower’s creditworthiness and then finding someone willing to finance a loan. Early fintech businesses acted strictly as middlemen, matching borrowers with financiers. But as the industry evolved, some companies began funding loans themselves and selling them to money managers, hedge funds and Wall Street banks.
LendingClub dropped 51 percent last week after the surprise departure of Chief Executive Officer Renaud Laplanche following internal-control lapses related to the sale of some loans to an investment bank. The company said Monday it had received a grand jury subpoena as the U.S. Justice Department examines what happened.
Fintech’s explosive growth, along with the relatively high interest rates they charge and the lack of information some of them provide about their business models, has lawmakers concerned. The companies are obligated to follow state laws, but the lack of a federal regulator has raised concerns about bad behavior falling through the cracks.
Regulators are also raising questions about whether new companies have enough of a stake in the outcome of the loans they arrange.
The companies have been bracing for regulatory attention. Over the past year, they’ve hired lobbyists, lawyers and former regulators as advisers and board members.
“Look, there are some bad players in this space,” said Brock Blake, CEO of Lendio Inc., a small-business lending website. He declined to provide names but said there are companies akin to payday lenders that prey on borrowers, charging them high rates on loans they’ll never be able to repay. “Ninety-five percent of our industry are reputable companies, five percent aren’t. And they’re the ones giving us a bad name.”
Lendio’s Blake and Kabbage’s Petralia stressed that their companies make loans to small businesses, which they believe policymakers should treat differently from individuals.
The Treasury Department appears to disagree. In its report, the agency called for legislation that would subject online small-business lenders to consumer-protection laws. Democratic Senators including Sherrod Brown of Ohio, Jeff Merkley of Oregon and Jeanne Shaheen of New Hampshire have also raised persistent questions.
“The entire online lending space is at an inflection point,” said Brian Abrahams, who handles government relations at online loan startup Avant Inc. “The strong players will flourish and the challenges of weaker players will become more apparent.”