Manny Alvarez, Affirm's General Counsel

Money 20/20 analysis: Future of alt-fi depends on consumer protection rules

Manny Alvarez, Affirm's General Counsel
Manny Alvarez, Affirm’s General Counsel

While alternative lending’s future is generally bright, consumer protection-driven regulation will influence how successful the industry becomes.

That is the impression I was left with following a session on alternative lending regulation at Money20/20, currently underway in Las Vegas.

Alternative lending provides many consumer benefits, Manny Alvarez, Affirm’s General Counsel and Chief Compliance Officer said.

“It is efficient for consumers and transparent, while also being easier for providers as a platform is easier to build than a bank.”

Ori Lev
Ori Lev

Ori Lev, a partner at K&L Gates, called himself a net optimist.

“There is a real opportunity to rethink credit making decisions,” Mr. Lev said. “We can expand the pool of customers with access.”

Lending Club Head of Regulatory and Government Affairs Richard Neiman admitted no one should be surprised he is bullish on the space. Both consumers and investors benefit from technology which reduces costs while still providing attractive returns for borrowers.

“There is a benefit to providing responsible credit options to consumers,” Mr. Neiman said.

He added the benefits extend to small business who realize expanded capital access. Smaller community banks can leverage funds to partner with larger companies like Lending Club.

The biggest problem on the horizon is regulation. Mr. Alvarez said his biggest concern is a narrow minded knee-jerk reaction from the regulatory community.

“A regulatory response without a deep understanding (of the industry) would be a problem,” Mr. Lev said.

Regulators not used to rapid change are struggling to keep up with technology that is doing just that. What could be at risk are unique underwriting methods that most benefit those most at risk of exclusion. High FICO risks accurately predict reliability at the high end, but that is not where the problem is.

Sophie Raseman
Sophie Raseman

Online lending has already had a dramatic affect on the consumer, one which may not be reversible, a U.S. Treasury Department official said.

“Many tend to underemphasize the role online lending as a tailwind in reshaping the consumer shopping experience,” Sophie Raseman, the Director of Smart Disclosure at the Office of Consumer Policy said.

“With the internet new opportunities have been created to use third party aggregators to reduce shopping times.”

What is clear is lenders must optimize their ability to interact with smart phones and other devices used by consumers. Some online lenders disclose borrowing and rate information in machine readable formats, for example.

One that that is clear is consumers in the lower income ranges are greatly benefiting from technology, Center for Responsible Lending President Michael Calhoun said.

“They use other data sources to help people build a credit file.”

Given the growth of the sharing economy, many people lack proof of income. This is also a problem in the Hispanic community, Mr. Calhoun added.

“They provide indirect evidence of direct income when direct documentation does not exist.”

Another problem for people with lower incomes is the high percentage of pay devoted to housing, Mr. Calhoun added. One in four households in the low and moderate income levels pay more than half their income on housing.

Another real roadblock to alto progress is opposition from establishment sources who prey on those with lower incomes. The most profitable customers for payday lenders, for example, are those who continually take out such loans. Those who take out ten such loans without a break generate half the industry profit even though they make up a much smaller percentage of customers.

payday-loanWhen Washington State limited people to no more than eight payday loans every year, industry revenue plummeted by 75 percent.

“Such companies do not consider borrower success in their business model,” Mr. Nieman said.

Many panel members acknowledged that new big data sources were very predictive at the macro level but they are less successful at when assessing the individual. That leaves the industry and its customers susceptible to fraud.

One issue the alt-fi industry must address is their insistence that regulators should trust their compliance efforts without knowing what their models are based on, several panel members suggested. Regulators struggle with the secrecy of the black box.

The response may be alto companies to show they have skin in the game, Mr. Lev suggested.

Another tactic is to show how their technology reduces consumer pain points, Mr. Nieman said.

“Technology enables the comparison of multiple lending options (simultaneously).”

And it is not as if disclosure requirements for establishment companies are transparent, several members suggested, citing opaque APR calculations and lengthy disclosure documents on loan and credit applications.

There are also gaps in existing regulations. On the eve of the recession, Countrywide Financial simply reclassified themselves, which allowed them to be supervised by a softer government body, Mr. Calhoun said.

“Many companies complained of enforcement but not of the practices which led to them.”

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