Garnet Capital Advisors Blog

Online lenders to small businesses are concerned that their future holds more regulation if suggestions in the recent U.S. Treasury report Opportunities and Challenges in Online Marketplace Lending come to fruition.


A recent Treasury report might lead to a much stricter regulatory environment for online lenders.

First, online commercial lenders have not been under significant regulatory oversight to date. That may change given recent Treasury statements. Second, and perhaps more significantly, the report suggests that small business loans of under $100,000 be classified as consumer loans. Such reclassification would trigger the much heavier consumer loan regulations. Online lenders fear that the resultant expense and necessity for compliance could change their business model.

Regulation Could Increase on Transparency and Credit Cycle Concerns
Treasury has two concerns about the practices of online lenders. The first is that its metrics are not viewed as transparent. Any regulation would likely be focused on making their data analysis more open to customers.

The second issue is that online lenders' products have not been through a full credit cycle. Interest rates in the U.S. have been low for an extended period of time. The report notes that the credit cycle includes periods of rising rates, which the portfolios of online lenders have not been through. When rates begin to climb again, Treasury is concerned that the default rates associated with online lender loans might climb as well.

Small Business Loans May Be Reclassified as Consumer Loans
Another implication of the Treasury stance suggests that business loans of under $100,000 should be reclassified as consumer loans. The report observes: "Strong evidence indicates that small business loans under $100,000 share common characteristics with consumer loans yet do not enjoy the same consumer protections. Treasury is willing to work with members of Congress to consider legislation that addresses both oversight and borrower protections."

Any regulation that results from this statement would, many online regulators feel, lead to significant changes in their business model.

Why? Lenders are governed by many regulations, some of which apply to both the business and consumer loan sectors. Only consumer loans, however, are governed by the Truth in Lending Act (TILA), which has a multitude of regulations concerning disclosure and stipulations on how any disputes must be resolved.

Lawyers also observe that TILA is a strict liability law, which opens the door to online lenders bearing the brunt of potential repeated penalties for violations that are technical in nature. Richard Eckman, a lawyer at Pepper Hamilton LLP, observed to Bloomberg BNA that TILA could be a "nightmare" given the amount of regulation required. It could cause online lenders to need a compliance department, among other requirements.


Heavy regulation may result in online lenders having to cut back on capital available to small businesses.

Online lenders have relatively low costs and employ broader metrics than larger, traditional banks. Parris Sanz, chief executive officer of CAN Capital, stated that the reclassification would have major effects on the company's business model - and on the ability of online lenders to fund the growth of small businesses, according to Bloomberg BNA. "It would fundamentally change the nature of the business," Sanz noted. "We would have to work those costs through the business and for us, that would almost certainly change our decision-making in order to remain a viable business - and that would mean restricting access to capital for small businesses."

Seasoned Loan Advisers Can Help Banks Adjust Portfolios
Loan sale advisors can assist lenders in working with portfolios to meet regulations. New or heightened regulation can be time-consuming and expensive for lenders. Seasoned loan sale advisors can analyze possible solutions and suggest solutions to a bank's balance sheet needs.

Loan sale advisors such as Garnet Capital can assist with placing banks and other financial institutions in touch with partners in the buying and selling of loans. Keep up with the latest in the regulatory scene. Sign up for our newsletter.