The Treasury Department has released a report entitled “Assessing the Impact of New Entrant Non-bank Firms on Competition in Consumer Finance Markets.”  The report was issued in response to President Biden’s July 2021 Executive Order on promoting competition.  That Order directed the Secretary of the Treasury to issue a report assessing how the entry of large technology firms and other non-banks into consumer finance markets has affected competition. The report focuses on fintech and other new entrant “non-incumbent” non-banks that are directly involved in providing digital financial products and services in the core consumer finance markets of deposits, payments, and credit.  The report looks at the role of these new entrant non-banks, how they interact with insured depository institutions (IDIs), and their impact on these core markets.

Unlike the CFPB which has often given more emphasis to the potential consumer risks of financial technology-related advancements than the potential consumer benefits, the Treasury report takes a more even-handed approach.  For example, while the report raises the potential risks of new underwriting approaches that use new technologies, it observes that “[w]hile policymakers must address the potential risks posed by these new technologies, a broad rejection of prospective new forms of consumer credit underwriting is not costless to consumers who are inadequately served by the status quo.”  It also notes that “[a] lack of sufficient clarity regarding the application of existing law or supervisory standards to available credit underwriting approaches can impact the willingness of responsible lenders to use those approaches.”  In particular, the report’s recommendations deserve attention because they are likely to influence future actions by the federal banking regulators and the CFPB.  (The report is also worthwhile reading for its discussion of the role of fintechs and other non-banks in providing consumer financial services and how that role has evolved.)

While the report does not address “true lender” challenges in bank/fintech lending relationships, it does discuss the risk of “so-called ‘rent-a-charter’ schemes that market themselves as innovative fintech lending platforms, but operate with essentially the same harmful business model as a traditional payday lender.”  The report attributes the risk that such schemes will arise to bank/fintech relationships that “lack proper regulatory oversight or principles for responsible lending.”  The report observes that “[i]n addition to exorbitantly priced credit, ‘rent-a-charter’ lenders deploy products using other practices that are both unsafe and unsound for the lender and unfair to consumers.  Likewise, high-cost, high-default loan programs that do not sufficiently consider a borrower’s financial capabilities may warrant review for unsafe or unsound practices and violations of law, including consumer protection statutes, and inconsistency with supervisory principles for responsible consumer lending.”  The report’s recommendations discussed below that are directed at bank/fintech lending relationships are intended to make such relationships “that use the privilege of an IDI…subject to regulatory standards for responsible consumer lending programs.”

We are encouraged that rather than making a focus of concern which party in a bank/fintech relationship has the predominant economic interest, Treasury’s focus, as reflected in its recommendations, is whether the lending activity is subject to sufficient supervision and regulation.  While acknowledging the validity of concerns that bank/fintech relationships can devolve into “rent-a-charter” arrangements that engage in harmful lending practices, the report indicates that these concerns are lessened if the loans must satisfy the same underwriting and lending standards as any other loans originated by the bank.  Referring specifically to concerns about usury and rate exportation, the report recognizes “an alignment of incentives if all aspects of the lending activities are regulated and supervised as if conducted by the IDI.”  This suggests that Treasury recognizes that, irrespective of predominant economic interest, preemption and rate exportation may be appropriate for loans made through a bank/fintech relationship if the supervisory and regulatory controls that apply to loans originated through this relationship are the same as those that apply when the bank originates loans through any other channel.

The report distinguishes “incumbent non-banks” from “non-incumbent non-banks.”  Incumbent non-banks are short-term credit providers such as pawn shops and title lenders, specialized installment lenders, such as captive finance companies, non-bank mortgage lenders, money transmitters, and card networks.  The new entrant non-banks on which the report focuses are “non-incumbent non-banks” consisting of:

  • Big Tech companies, meaning large technology companies whose primary activity involves the provision of platform-based digital services;
  • Fintech companies, meaning companies that specialize in offering digital financial services to consumers or enable other financial service providers to offer such services to consumers; and
  • Retail companies, meaning new entrant non-banks that are not fintech or Big Tech companies.

The report is divided into six sections:

  • Overview of current market landscape, which includes a discussion of the deposits, payments, and credit markets and how IDIs and non-banks are regulated and supervised
  • Assessing impacts on competition, which includes a discussion of the role new entrant non-banks are playing in the unbundling or disaggregation of the core banking services offered by IDIs by focusing on a single product or service as well as the recent trend of re-bundling of multiple product offerings on a single platform, the reasons for the popularity of non-bank/bank partnerships, and competition trends in the payments, deposits, and credit markets.
  • Opportunities and risks, which includes a discussion of:
    • whether and how, based on available evidence, new entrant non-banks are servicing customers that IDIs have not by expanding access to credit, payment services, and deposit-taking services.  (With respect to deposits, the report discusses digital only or neo-banks that exist both as IDIs and non-banks that partner with IDIs).
    • The following risks:
      • Regulatory arbitrage;
      • Prudential concerns arising from re-bundling of functions of banking;
      • Mixing of commerce and banking arising from non-banks seeking bank charters;
      • Reliability and fraud in digital financial services;
      • Data privacy and security in connection with growing demand for consumer data;
      • Bias and discrimination arising from artificial intelligence/machine learning models; and
      • Consumer financial well-being as factor in products and services offered by non-banks.
    • Outstanding gaps in reaching low-income individuals.
  • Prospective impacts on competition: Big Tech in consumer finance.
  • Recommendations, which include the following:
    • To enable competition in responsible consumer credit underwriting, Treasury recommends federal banking regulators should take various steps including:
      • Use the existing supervisory framework for model risk management to provide additional clarity and consistency across IDIs with respect to the use of alternative data and new complex algorithms in credit underwriting systems.  This includes IDIs acting as lenders in bank/fintech partnerships.
      • Continue to engage with supervised institutions that are seeking to prudently implement new credit underwriting approaches, including those using alternative data.  New underwriting approaches that are appropriately designed to increase credit visibility, reduce bias, and expand access should be supported.
      • Assess current credit underwriting, fair lending, and consumer lending guidance to identify potential gaps relevant to implementation of model risk management supervision, including the lack of guidance that would be useful to an IDI in developing risk management processes for underwriting approaches and related products that use alterative data or new complex algorithms.  Given that IDIs frequently rely on credit models provided or supported by a third party, it may be important for regulators to clarify or reiterate expectations for the levels of model validation and monitoring documentation sufficient to evaluate compliance of third-party credit scores and models with consumer laws and other risk management standards applicable to IDI activities.
      • Continue to coordinate with the CFPB and other relevant federal agencies regarding principles and practices for identifying and mitigating violations of fair lending laws by IDIs and non-bank lenders that use alternative data in underwriting.
    • To enable effective oversight of bank/fintech relationships, Treasury recommends:
      • To help reduce regulatory gaps and maintain a level playing field, the CFPB, HUD, and the FTC may need to act with respect to the activities of fintechs and other non-banks that provide services critical to bank/non-bank relationships to help ensure that the parties to such relationships are appropriately supervised and held accountable for violations of law.
      • The Federal Reserve, FDIC, and OCC should finalize the interagency guidance for banks on managing risks associated with third-party relationships that was proposed in July 2021.  This would serve the goal of establishing a clear and consistently applied supervisory framework for third-party relationships, including bank/fintech relationships.  In finalizing the guidance, the regulators should include language to help encourage IDIs to negotiate effective oversight provisions in their contracts with third-party providers, such as provisions that require a third party to follow certain compliance and risk-management practices that would not otherwise apply to the third party if it were not in a relationship with the IDI, and to provide the IDI with access to information necessary to assess whether the third party’s activities comply with all regulations and risk management policies to which the IDI’s activities are subject such as fair lending regulations.
    • With respect to bank/fintech lending relationships, Treasury recommends that federal banking regulators take the following steps “to increase consistency in supervisory practices, such as exam practices, related to small-dollar lending programs”: (1) revise the interagency small-dollar lending guidance issued in 2020 to address coverage of larger loans (e.g. loans of $10,000 or more) and address with greater specificity how the guidance applies to a bank-fintech lending relationships, including the activities performed by a fintech or other third party with or on behalf of an IDI lender, and (2) provide IDIs with more specificity on how they can provide small-dollar loan products or related products while complying with applicable laws and regulations.
    • With respect to alternative forms of non-bank lending, Treasury recommends that the CFPB should (1) continue to investigate and monitor developments related to small-dollar installment loan products (such as buy now pay later (BNPL)) and consider what additional guidance might be appropriate, (2) consider whether and how the CFPB can supervise larger non-bank lenders, including BNPL and installment loan providers (which the CFPB had considered under former Director Cordray but abandoned under former Director Kraninger); and (3) revisit its 2020 advisory opinion on earned wage access programs and review whether products meeting the requirements of the advisory opinion should not be considered credit products subject to TILA and Regulation Z.