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For Online Lenders, Greater Regulatory Scrutiny Is a Matter of Time

I recently returned from New York City where I attended LendIt, a conference bringing together nearly 2,500 current and prospective participants in the rapidly growing online lending space. A number of my FICO colleagues also attended, leading several engaging sessions – on credit scoring basics, our new alternative data credit score, origination strategies with online lending client Kabbage, as well as industry best practices that featured FICO’s new alternative lending platform in China.

I was at the event to moderate a panel focused on regulatory trends impacting the online lending community. Regulatory compliance is a prominent theme at nearly every industry gathering in the financial services industry. However, of the 48 hours of session content at the LendIt conference, less than two directly addressed regulatory issues.

During our panel discussion, I raised this topic with my colleague and FICO’s regulatory counsel, Vance Gudmundsen, along with the head of PepperHamilton’s Financial Services Practice, Rick Eckman. Vance noted that the industry is still in its infancy and, at this stage, it is simply “too new,” “too small” and “too compelling” to become a high priority for regulators.

Both legal experts agreed that as the industry matures, increased regulatory scrutiny will certainly follow.

Our panelists detailed a broad number of state and federal laws that online lenders should keep on their radars. Their applicability ranged from underwriting activities, anti-money laundering efforts, marketing, collections and privacy, to state rules governing interest rates and licensing.

Rick pointed out that regulators are increasingly holding financial institutions responsible for the compliance failures of their vendors. He recommended that contracts with service providers detail the expected compliance responsibilities, and be followed-up with management, oversight and audits in order to demonstrate to regulators compliance with applicable laws.

Rick also noted that vendors with customer-facing employees (e.g., online platform providers) are especially vulnerable to compliance missteps. These vendors should provide appropriate staff training and closely monitor employee activities to ensure that all applicable regulatory responsibilities are met.

Perhaps the most interesting topic we discussed was the industry trend towards leveraging new or alternative data in scoring models. There has been a lot of media buzz about the promise of new algorithms used in underwriting by some online lenders. These algorithms utilize non-traditional data for credit decisions, such as social media data (e.g, from LinkedIn and Yelp) or an applicant’s job history or education.

Vance cautioned that scoring models, whether for business or consumer loans, must comply with fair lending laws, most notably the Equal Credit Opportunity Act. Vance outlined key guidelines that should be followed with any data used to make credit decisions. The data should be “abundant and renewable,” “reliable and accurate,” “not easily manipulated,” “not double-counted,” “correlated to risk,” “predictive,” and “not illegal or unfair.”

Based on the number of attendees at this year’s LendIt conference, there is clearly great excitement around the industry’s rapid growth and continued innovation. While regulation may not be a front-burner issue today, I suspect it will draw much more attention at next year’s conference. As our panelists concluded, it is just a matter of time.

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