Fintech charter should be paired with beefed-up borrower protections

By Karen Mills and Brayden McCarthy
Jan. 29, 2017
American Banker BankThink

Something transformational is taking place in the world of online lending. Over the last several years, new fintech competitors have challenged traditional banks with innovative, customer-friendly online applications and quick loan decisions. At first bankers saw these disruptors primarily as threats, grabbing share from community banks overburdened by regulatory compliance costs. The online players were said to have an advantage, with no federal regulator to oversee them.

This view has changed somewhat over time and will even more with the Office of the Comptroller of the Currency planning to provide oversight of fintech companies through a special-purpose charter. Some in the banking sector — who originally opposed the OCC idea as permission for “banking light” — now support the proposal. This is most likely due to banks’ new strategy of partnering with the online entrants to take advantage of their technology. And to do so, they need their third-party partners to be compliant.

But besides the OCC charter, there is another regulatory need that should receive top priority — small-business borrower protections. If offering a national regulation option to fintech players is the proverbial carrot, compliance with commonsense borrower protections could be the stick.

These protections are important because credit extended for a commercial purpose is not covered by the disclosure requirements of the federal Truth in Lending Act. That means lenders, including traditional banks, can display loan terms and costs, such as annual percentage rates, inconsistently, which makes it difficult for borrowers to compare offers. Some bury prepayment penalties deep inside 3-inch-thick loan documents. Few disclose an APR at all.

The line of thinking that small-business owners are financially sophisticated or have knowledgeable advisers has not proved to be the case, particularly for the large majority of those who take on small-dollar loans. A recent study conducted by the Federal Reserve Bank of Cleveland was telling. The research found that mom-and-pop businesses struggle to compare credit products when using information provided by alternative lenders on their websites.

Regulators should require disclosures that are clear and concise. If lenders had to compose standardized contracts in plain English — and provide APRs — it would go a long way toward reducing complexity, helping borrowers decide what is best for them, and eliminating bad actors.

Absent universal standards, it is considerably more challenging for lenders and brokers to take the high road when competing with irresponsible players. With that in mind, regulations could help those who are responsible lenders, so they aren’t forced to choose between a race to the bottom on borrower protection and surrendering market share.

With regard to the OCC charter, some concerns also have been raised about financial inclusion. The argument that fintech entrants should help foster small businesses in underserved communities has strong merit, and it’s one with which we agree. As detailed in our working paper, we advocate that a program with goals similar to the Community Reinvestment Act be among the requirements for obtaining and maintaining the OCC charter.

The OCC charter is a step in the right direction and holds the promise of promoting responsible financial innovation and improving small-business access to capital. Borrower protections and greater financial inclusion for small businesses would go even further toward accomplishing this goal. The charter, and the accompanying federal oversight, could become an opportunity to require additional transparency from new entrants and go after predatory behaviors.

Small businesses need a government that supports them — not just through lower taxes and less regulation, but also through smart and streamlined financial oversight that looks out for their interests. These types of actions will help the small businesses that drive our economy and form the backbone of our communities. And that should be a goal we can all agree on.

Karen Mills is a Senior Fellow with the Harvard Business School. She served in President Barack Obama’s Cabinet as Administrator of the US Small Business Administration from 2009 to 2013.

Brayden McCarthy is Vice President of Strategy for Fundera. He served as a Senior Policy Advisor at the White House National Economic Council and the US Small Business Administration.