The regulatory pitfalls of online small-dollar lending

Ever since the 1800s, respective U.S. governments have attempted to find the perfect balance between regulation and deregulation. As the 2008 financial crisis demonstrated, finding this perfect equilibrium is no easy task.

The fintech movement, with all the convenience, transparency, and innovation it brings to the user, presents a formidable challenge to regulators, banks, and fintech companies themselves. New fintech creations are expanding the financial map, and it’s only recently that regulators have started to gain a foothold in this new landscape.

One sector that has been struggling to find its regulatory footing in the age of 1-click checkout is lending. Part of this has to do with the complicated, conflicting multitude of state laws trying to police the online lending industry. “If the states come together and find a way to harmonize their rules and regulations, it will be easier for compliance and easier for consumers to understand what the rules of the road are,” said Lisa McGreevy, president and CEO of the Online Lenders Alliance.

The 7-person D.C. organization, which represents online companies offering small-dollar loans, is trying to convince states that as far as online lending is concerned, cooperation is the best way forward. “It’s a constant discussion that we’re having with Congress and federal regulators and even with the states,” said McGreevy. “We’re saying to the states: we need a uniform system to operate.”

It’s not simply that the states are taking their time adapting to the new reality of online loans. Online lenders are concerned that federal agencies may not understand the nature of online lending well enough to police it. Most recently, online small-dollar lenders have taken issue with the CFPB’s proposed rule to end payday debt traps.

The rule, which would require small-dollar lenders to ensure their customers have the ability to repay their loans, has serious implications for lenders and for borrowers. McGreevy argues that the sheer complexity of the rule means that consumers will have a difficult time understanding their credit options, while the rules prescriptiveness won’t allow companies the flexibility of using their own algorithms or their own underwriting.

“We support a federal rule,” McGreevy explained, “but we’re all concerned that this is going to result in fewer credit options for people.” McGreevy isn’t alone. The Pew Charitable Trust thinks the rule would leave borrowers vulnerable to payday sharks while locking out lower-cost loans from banks.

Moreover, Kevin Foster-Keddie, president and chief executive officer of Washington State Employees Credit Union and its small-dollar online loan platform, QCash Financial, is worried that “the rules as proposed by the CFPB may also have the unintended effect of driving away consumer-friendly financial institutions that provide better alternatives.”

For McGreevy, voices like Foster-Keddie’s from the credit union camp are a confirmation that the CFPB needs to rethink its small-dollar strategy. “Making small-dollar loans is a highly specialized industry,” she said. “Even the credit unions have a hard time in this market space. And I think the fact that they are saying this rule is going to result in fewer credit options is a harbinger for everybody.”

The O.L.A. is one of the industry’s in-house regulatory bodies trying to keep online lenders in check. Instead of viewing the O.L.A. as a millstone around their necks, online lenders have actually been the drivers for the creation and implementation of best practices.

“The companies that are members of O.L.A. want to set the standards for the entire industry,” McGreevy remarked. “We’re not interested in having bad actors and fraudulent businesses give the industry a bad name.” Neither, it would seem, are some of the big-name online lenders, who launched their own self-regulating association in April 2016.

For the O.L.A., the major challenges are protecting consumers, both from fraudsters and from unethical online lenders. The O.L.A. consumer hotline receives various types of fraud reports, from the nefarious IRS phone scam to standardized prepayment terms as a prerequisite to loan issuance. O.L.A.’s best practices make sure their members steer clear of any underhanded dealings with consumers, but not everyone wants to lend responsibly, and so the hotline phones keep ringing.

The line between unethical lending and aggressive marketing isn’t always clear, and O.L.A. has had to step in over the 11 years since they were established to help online small-dollar lenders understand what’s ok and what’s not. Several years ago, small-dollar online lenders were offering lines up to $5,000 with no credit checks.

“Unfortunately, the average customer couldn’t get what was promised,” McGreevy explained. O.L.A. put a stop to that with their best practices. Companies that join the O.L.A. can’t advertise using those terms. Recently, the “no credit check” marketing ploy has resurfaced, and the O.L.A. is in the process of tracking offending companies down.

O.L.A.’s best practices may not solve all of the regulatory hurdles that small-dollar online lenders want to overcome, but the fact that responsible lenders are interested in having regulation in place is a good sign for the 12 million consumers in the market for small-dollar loans. “I think that across the board, online, brick and mortar, it’s always better when the industry can self-regulate,” said McGreevy, “and we have accepted the challenge and the responsibility to self-regulate.”