Financial Services Law

FDIC Dips Its Toes Into Marketplace Lending

Why it matters

In the Winter 2015 edition of the Federal Deposit Insurance Corporation's (FDIC) Supervisory Insights, the agency provided an overview of the marketplace lending model, "a small but growing component of the financial services industry that some banks are viewing as an opportunity to increase revenue." Defining the industry broadly "to include any practice of pairing borrowers and lenders through the use of an online platform without a traditional bank intermediary," the FDIC set forth some of the risks originating banks face in dealing with marketplace lenders, particularly those involving third-party arrangements.

Evaluating the risk involved in a marketplace lending relationship can be tricky given the early stages and evolving nature of the market and the variations depending on the borrower, the agency noted, cautioning that the need for such individualized risk identification "could lead to an incomplete risk analysis" or "gaps in bank management's planning and oversight." To protect themselves and limit supervisory concerns, the FDIC admonishes banks to "perform a thorough pre-analysis and risk assessment on each marketplace lending company with which it transacts business, whether acting as an institutional investor or a strategic partner." The agency's discussion follows an inquiry into the marketplace lending industry by the California Department of Business Oversight launched in December. To "assess the effectiveness and proper scope of our licensing and regulatory structure as it relates to these lenders," the state regulator sent a survey to 14 marketplace lenders to gather information about their business models and online platforms.

Given that the FDIC's mandate is to regulate licensed financial institutions, the agency's goal with the Supervisory Insights is to remind banks to not shortcut their due diligence responsibilities with respect to originating marketplace loans. There are only about a half dozen banks that originate on behalf of marketplace lenders, so their focus on the sector, especially with little risk posed to the deposit base by these loans because of the banks quick exit, is somewhat puzzling.

Detailed discussion

Banks considering an entry into the marketplace lending industry should consult the Winter 2015 edition of the Federal Deposit Insurance Corporation's (FDIC) Supervisory Insights newsletter. As marketplace lending has grown—from three lending companies in 2009 to 163 as of September 2015—the regulator provided an overview of the industry and offered financial institutions some tips on risk identification.

Broadly defining marketplace lending to include "any practice of pairing borrowers and lenders through the use of an online platform without a traditional bank intermediary," the FDIC explained that the process typically begins with a borrower submitting a loan application online where it is "assessed, graded, and assigned an interest rate" using the marketplace lending company's proprietary credit scoring tool. Factors generally considered include a borrower's credit score, income, and debt-to-income ratio.

Once the application process is complete, the loan request is advertised for retail investors to review and pledge funds. In addition, a large segment of the market is bought by institutional investors as whole loans. Once fully pledged, the marketplace lending company then originates and funds the loan through one of two frameworks: either lending the funds directly or partnering with a traditional bank to facilitate the loan transaction. Direct marketplace consumer lenders are typically required to be registered and licensed by state regulators, the FDIC noted, and facilitate all elements of the transaction. Alternatively, the bank-affiliated marketplace company hands over the reins to the bank once the loan application package is complete; the partner bank approves and funds the loan, holds the loan on its books for a few days and then sells it to the bank-affiliated marketplace company.

What risks do these models pose for banks?

"The marketplace lending business model depends largely on the willingness of investors to take on the credit risk of an unsecured consumer, small business owner, or other borrower," the FDIC said. But given the infancy of the market—and its existence during a period of low and steady interest rates—the current credit loss reports or loss-adjusted rates of return "may not provide an accurate picture of the risks associated with each marketplace lending product."

Adding to the calculation: The risk level varies with each marketplace lending company. "Given the credit model variations that exist, using a nonspecific approach to risk identification could lead to an incomplete risk analysis in the bank's marketplace investments or critical gaps in bank management's planning and oversight of third-party arrangements," the regulator explained. "As such, banks should perform a thorough pre-analysis and risk assessment on each marketplace lending company with which it transacts business, whether acting as an institutional investor or a strategic partner."

The FDIC highlighted several risks for all banks to consider, particularly third-party risk. Banks should review Financial Institution Letter 44-2008 on managing third-party risks, the agency suggested, and consider whether the proposed activities are consistent with the institution's overall business strategy and risk tolerance. This will require a "strong understanding" of the marketplace lending company's business model, regular monitoring, and contractual agreements protecting the bank from risk, among other factors.

Due diligence—with questions about what duties the bank relies on the marketplace lender to perform and who bears the primary responsibility for consumer compliance requirements—is essential, the agency added.

Other areas of risk: compliance risk, transaction risk, servicing risk, and liquidity risk. Banks should remember that they cannot assign the responsibility to comply with various fair lending laws and regulatory requirements—such as the Truth in Lending Act and the Equal Credit Opportunity Act—to the marketplace lending company. "Banks that partner with marketplace lending companies should exercise due diligence to ensure the marketplace loan underwriting and pricing policies and procedures are consistent with fair lending requirements," the FDIC said.

The potential for customer service problems or technology failures poses transaction risk while servicing risk exists given the pass-through nature of the marketplace notes, the agency wrote, especially if a marketplace lending company becomes insolvent. "At a minimum, banks that invest in marketplace loans should determine whether back-up servicing agreements are in place with an unaffiliated company before investment," the FDIC suggested, which could mitigate some risk of loss.

Liquidity risk is posed by the limited secondary market opportunities for marketplace loans, the agency noted, and a full risk analysis should also include considerations such as compliance with other state and federal requirements, including anti-money laundering laws. "The partner bank should evaluate the bank-affiliated marketplace company as it would any other customer or activity, and financial institutions investing in marketplace loans should exercise due diligence in evaluating appropriate compliance for any loan purchase," the FDIC emphasized.

FDIC examiners will assess how financial institutions manage third-party relationships and other investments with marketplace lenders by reviewing bank management's "record of and process for assessing, measuring, monitoring, and controlling the associated relationship and credit risks," the agency cautioned. "The depth of the examination review depends on the scope of the activity and the degree of risk associated with the activity and the relationship."

Marketplace lending offers an attractive source of revenue to banks, the agency recognized, but bank management must "look beyond the revenue stream" to determine whether the related risks align with the institution's business strategy. "[F]inancial institutions can manage the risks through proper risk identification, appropriate risk-management practices, and effective oversight," the FDIC concluded. "With the rapidly evolving landscape in marketplace lending, institutions should ascertain the degree of risk involved, remembering they cannot abrogate responsibility for complying with applicable rules and regulations."

To read the FDIC's Winter 2015 Supervisory Insights, click here.

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Doors to Financial Relationship With Cuba Continue to Squeak Open

Why it matters

Continuing to ease the restrictions on financial relationships with Cuba, the Department of the Treasury's Office of Foreign Assets Control (OFAC) announced additional policy changes to "remove existing restrictions on payment and financing terms for authorized exports and reexports to Cuba of items other than agriculture items and commodities," as well as establishing "a case-by-case licensing policy for exports and reexports of items to meet the needs of the Cuban people, including those made to Cuban state-owned enterprises." Depository institutions in the United States are now permitted to provide financing for authorized exports and reexports (including issuing a letter of credit) with the elimination of the restriction to only cash in advance or third-country financing. However, the amendments—which also lift limits on travel and telecommunications—may be the end of the actions permissible by President Barack Obama's administration without Congress formally lifting the embargo against Cuba. The expansion of commercial relationships with Cuba will continue to be a focus for many businesses which eye residents of Cuba, and individuals and businesses with ties to Cuba, as potential areas of growth.

Detailed discussion

In furtherance of President Barack Obama's efforts to improve relations between Cuba and the United States, the Department of the Treasury's Office of Foreign Assets Control (OFAC) and the Department of Commerce's Bureau of Industry and Security (BIS) announced new amendments to the Cuban Assets Control Regulations and Export Administration Regulations.

In 2014, the President advocated for a changed position with regard to Cuba and began the process of reconnecting the two countries. Last year, a Florida bank became the first in 50 years to engage in direct transactions with a Cuban bank. Although the U.S. trade embargo remains in place (and requires congressional approval to be lifted), both the BIS and OFAC have issued regulations to allow U.S. banks to open correspondent accounts in Cuban banks and permitted American travelers to use credit and debit cards on the island.

Now the agencies have opened the door even further. With new amendments that took immediate effect in late January, the BIS and OFAC removed financing restrictions for most types of authorized exports, allowing payment of cash in advance, sales on an open account, and financing by third-country financial institutions or U.S. financial institutions.

Pursuant to the changes, Section 515.533(a) of the Cuban Assets Control Regulations (CACR) was amended to remove the previous limitations on payment and financing terms for exports and reexports of items other than agriculture items or commodities to Cuba. Where only third-country financing or cash in advance was permitted, sales on an open account are now allowed by the regulations.

"Depository institutions … are authorized to provide financing for exports or reexports of items, other than agricultural items or commodities, authorized pursuant to Section 515.533, including issuing, advising, negotiating, paying, or confirming letters of credit (including letters of credit issued by a financial institution that is a national of Cuba), accepting collateral for issuing or confirming letters of credit, and processing documentary collections," according to the amendments.

Previously, financing provided for exporters was limited to cash-in-advance payments or through third countries.

To read the amended CACR, click here.

To read OFAC's FAQ document, click here.

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CFPB Tackles Checking Accounts With Compliance Bulletin, Letter to Banks

Why it matters

Taking a deep dive into the area of checking accounts, the Consumer Financial Protection Bureau (CFPB) sent a letter to 25 of the largest retail banks "encouraging them to make available and widely market lower-risk deposit accounts that help consumers avoid overdrafting" and issued a Compliance Bulletin warning banks and credit unions that the failure to meet accuracy obligations when they report negative account histories to credit reporting agencies could result in Bureau action. "Consumers should not be sidelined out of the basic banking services they need because of the flaws and limitations in a murky system," CFPB Director Richard Cordray said in a statement. "People deserve to have more options for access to lower-risk deposit accounts that can better fit their needs." The letter urged banks to offer lower-risk products (such as "no-overdraft" accounts) and advertise them during sales consultations and on their websites. As for the Bulletin, the CFPB cautioned financial institutions that they must have systems in place to ensure the accuracy of information passed on to consumer reporting companies such as negative account histories of overdrafts, fraud, or bounced checks—or face enforcement action.

Detailed discussion

Hosting a field hearing in Louisville, Kentucky, to address the topic of checking accounts, the Consumer Financial Protection Bureau (CFPB) took a multifaceted approach to the issue. In addition to issuing the first Compliance Bulletin of the year emphasizing the obligation of banks and credit unions to comply with the requirements of the Fair Credit Reporting Act (FCRA), the Bureau sent a letter to some of the country's top retail banks with "a suggestion" to consider while servicing customers.

Compliance Bulletin 2016-01 provides a warning to banks and credit unions about their obligations under the statute and its regulations.

Regulation V of the FCRA mandates that furnishers establish and implement reasonable written policies and procedures regarding the accuracy and integrity of information relating to consumers that they furnish to consumer reporting agencies (CRAs). This requirement applies to the furnishing of all CRAs, including specialty CRAs, and encompasses the furnishing of deposit account information, the CFPB said.

But according to the Bulletin, the Bureau's supervisory experience suggests that some financial institutions are not compliant with these obligations.

"Furnishers' establishment and implementation of reasonable policies and procedures regarding the accuracy and integrity of information are essential components of a fair and accurate credit reporting system," the CFPB wrote. "Such policies and procedures protect against the furnishing of inaccurate information that could potentially cause adverse consequences for consumers when included in a credit report, such as being denied a loan at a more favorable interest rate or being unable to open a transaction account."

The policies and procedures must be appropriate to the nature, size, complexity, and scope of each furnisher's activities, the Bureau explained, and furnishers should consider the factors found in the Interagency Guidelines Concerning the Accuracy and Integrity of Information Furnished to Consumer Reporting Agencies, such as the types of business activities in which the furnisher engages, the nature and frequency of the information the furnisher provides to CRAs, and the technology used by the furnisher to provide information to CRAs.

The policies and procedures must encompass the financial institution's furnishing to all types of CRAs, the Bureau said, from nationwide CRAs to specialty CRAs. Recognizing that the type, frequency, and nature of the information furnished to CRAs can "vary significantly," the Bulletin reminded financial institutions that the burden falls to them to have "reasonable written policies and procedures" for each of the CRAs to which it furnishes.

"The CFPB will continue to monitor furnishers' compliance with the Regulation V requirement to establish and implement reasonable written policies and procedures regarding the accuracy and integrity of all furnished information," the Bureau warned. "Furnishers must ensure that they have such policies and procedures in place with respect to all information furnished. If the CFPB determines that a furnisher has engaged in any acts or practices that violate Regulation V or other federal consumer financial laws and regulations, it will take appropriate supervisory and enforcement actions to address violations and seek all appropriate remedial measures, including redress to consumers."

But the CFPB wasn't done. The Bureau also sent a letter to 25 of the top retail banks in the country, suggesting that they consider a third possibility to the current binary system of either opening a checking account for consumers that pass a screening process to identify credit risks or denying an account to those deemed too risky.

Offer all applicants a lower-risk account, the CFPB proposed, whether a checking account or a prepaid account, where the applicant cannot pose the same level of risk to the institution. An estimated 10 million American households are currently "unbanked," the letter from Director Cordray said, and "we have come to think that banks and credit unions can do more to provide consumers with opportunities to access appropriate products that will give them a better chance to handle their inflows and outflows more effectively."

Such lower-risk products that are specifically designed to prevent overdrafts and overdraft fees can help consumers manage their spending and maintain accounts in good standing, limit risk to financial institutions, and enable banks and credit unions to accept more applicants, the Bureau wrote.

A review of the websites of the letter recipients revealed that only eight of them marketed a "no-overdraft" product on the same page as the traditional checking account option, while seven other institutions offered a product with no authorized overdrafts but did not feature it on the main menu of checking account offerings. Ten of the banks and credit unions did not appear to offer any options for a lower-risk account designed to prevent overdrafts, the CFPB said.

"We therefore are urging all financial institutions to make these lower-risk offerings broadly available to consumers," according to the letter. "We urge banks and credit unions that do not currently offer transaction accounts designed to help consumers avoid overdrafts to do so. We further urge institutions that already offer such accounts to feature them among their standard account offerings both in their branches and online. The lack of marketing for these products, in particular, has lessened their visibility and undermined their rate of uptake among consumers who might otherwise benefit from their availability."

The CFPB also released resources for consumers, including a guide to selecting a checking account and a consumer advisory about handling checking account denials.

To read Compliance Bulletin 2016-1, click here.

To read the letter from the CFPB to financial institutions, click here.

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